Last year, Bottom Line Personal explained the basics of investing in Bitcoin and how to decide if it was right for you. Since then, the volatile cryptocurrency market has lived up to its reputation for both making front-page news and polarizing investors. Bitcoin doubled in price last year soaring to around $68,000 as one in five Americans reported investing in it or using it. But this past spring, prices crashed. Bitcoin lost 70% of its value in just months. Major crypto broker Voyager Digital filed for bankruptcy after suspending account holders from withdrawing assets from their accounts. Warren Buffett, at the latest Berkshire Hathaway shareholder meeting, concluded, “I wouldn’t buy all the Bitcoin in the world for $25.”
To help you understand what all this drama means…whether the price of Bitcoin is attractive now…and how to use it in your portfolio going forward, Bottom Line Personal spoke to certified financial planner and cryptocurrency expert Adam Blumberg, who trains financial advisers how to evaluate and use cryptocurrencies in their clients’ portfolios….
Why did Bitcoin have such an epic meltdown earlier this year? I think of it like Internet stocks in the late 1990s. It has vast potential, but its purpose hasn’t been fully realized yet, and the speed and extent of the technology’s adoption isn’t clear. To put the 2022 carnage into perspective, investors were abandoning all kinds of risky assets, alarmed by rising interest rates, inflation and economic uncertainty. Everything from blue-chips to Big Tech has suffered. Examples: The Walt Disney Co. was down 27%…General Motors, –33%…Meta Platforms, parent to Facebook, –53%…and Netflix, –63%.* Since Bitcoin was first launched, it has survived multiple corrections of 70% or more like this one. It has recovered each time and bounced back to new highs. For a lot of small investors who jumped in last year, it feels like they’ve bought into another tulip-bulb craze and their Bitcoin is doomed to go to zero. That’s very unlikely. The price of Bitcoin may have already found a floor for the year. According to a recent Columbia Business School study, 61% of Bitcoin holders haven’t sold their positions in the last 12 months, and when Bitcoin was around $20,000, more than half of all Bitcoin holders were still sitting on profits.
Why should Bitcoin bounce back this time? I see three catalysts…
The technology behind crypto really is a once-in-a-lifetime opportunity. Cryptocurrency is just the tip of the financial-technology iceberg. Below the surface, hundreds of trillions of dollars of transactions surge through payment networks every day. These networks are incredibly costly, outdated and ripe for change. It may take many years to realize those changes, but they will happen.
This year’s crypto winter is likely to stimulate more government regulation, which will, in turn, help legitimize cryptocurrencies for users and investors.
Most importantly, institutions haven’t soured on Bitcoin even if many small investors have. BlackRock, the world’s largest asset manager, overseeing nearly $10 trillion, recently partnered with Coinbase Global Inc. to make it easier for institutional investors to manage and trade Bitcoin. And Fidelity announced that it has started allowing tens of thousands of companies with 401(k) plans on its platform to include Bitcoin as one of the investment options and let workers invest up to 20% of their account assets. That’s a game-changer. It vastly increases the potential market for Bitcoin. Until now, most investors had to keep Bitcoin in self-directed IRAs or in taxable accounts. But traditional
401(k)s are where most people have the bulk of their long-term savings. Plus, Fidelity’s imprimatur is likely to create a new reality for the largest US banks, securities firms and Wall Street institutions, many of which once greeted the emergence of digital assets with skepticism.
If I want to invest in Bitcoin, is my 401(k) the best place to do it? The US Department of Labor has been critical of including Bitcoin in retirement accounts, worried that inexperienced investors will be swayed by the hype around crypto. If Bitcoin losses in your 401(k) would compromise having a safe retirement, my advice is that you can’t afford to do it. And if holding Bitcoin just makes you too uncomfortable, it’s okay to skip it altogether. That said, owning Bitcoin in retirement accounts does offer one clear advantage—it simplifies your tax situation since you pay no taxes until you draw down assets in retirement.
Tax exposure: In taxable accounts, the IRS is cracking down despite crypto’s reputation for being beyond government control. Federal taxes are due whenever you sell, trade or dispose of cryptocurrency in any way and recognize a gain. Tax rates depend on your income, tax-filing status and the length of time you owned your crypto before selling it. If you owned it for a year or less, you pay short-term capital gains taxes, which are equal to your income tax rate. If you owned it for longer, you pay long-term capital gains taxes.
What role is Bitcoin supposed to play if I add it to my portfolio now? It’s confusing for small investors. In the past, Bitcoin was pitched as a get-rich-quick investment and, more recently, as “digital gold,” a safe hedge for uncertain times. Neither has really proven true for many small investors. I look at Bitcoin as a new alternative asset class that is still being tested in a variety of economic environments. In general, alternatives are investments such as commodities and private equity, whose prices tend not to move in sync with stocks and bonds. Adding alternatives can help improve long-term returns and diversify a portfolio of traditional investments. Bitcoin has moved in lockstep with the stock market in this year’s very unusual environment. But historically, Bitcoin is likely to have a low correlation with stocks.
Is Bitcoin a bargain right now? Prices are back to what they were in December 2020. But it’s very hard to game short-term Bitcoin movements or attractive valuations. Unlike stocks, which have a long history of historical valuations and trade on estimated profits, Bitcoin’s price depends largely on perceived demand and investor sentiment. That has clear implications for how and when to invest. My strategies for investing in Bitcoin…
Dollar-cost average your purchases. Decide how much you want to invest in total, then buy equal amounts of it over a period of a year or more. Averaging into a position helps smooth out rampant volatility.
Allocate only a small portion of your portfolio to Bitcoin. The consensus Bitcoin allocation ceiling for advisers I work with is typically between 3% and 5%, depending on a client’s risk profile. With a small allocation, heavy losses won’t drag down your portfolio’s overall long-term returns. But since Bitcoin has potential for outsized gains, that same allocation could substantially improve portfolio returns.
Stop thinking of Bitcoin as a way to get rich quick. Bitcoin trades 24 hours a day, 365 days a year, including weekends and holidays. So it’s very tempting to jump in and out of positions after big spikes and declines. It’s also very easy to get burned. Instead, plan to buy Bitcoin and tuck it away, holding it through ups and downs.
Should I invest in other crypto-currencies besides Bitcoin? New cryptocurrencies continue to flood the market. There now are thousands trading on various exchanges with colorful names such as Bitsubishi, PancakeSwap and PUTinCoin. Many are likely to fail. For most small investors who devote a minor portion of their portfolios to crypto, Bitcoin is adequate exposure. I do like the idea of getting instant diversification through a crypto spot ETF, which directly tracks the price movement of several other prominent digital currencies such as Etherium and Tether. However, the SEC has rejected several proposals this year for such a fund, including one by Fidelity, and I don’t expect to see such an offering any time soon.