The big difference between investing and speculating
Cryptocurrencies, like Bitcoin and Etherium, have been much in the news lately. That’s not surprising, because the quoted value of these esoteric assets has skyrocketed over the past year. So should you add cryptocurrency to your portfolio, say with one of the new cryptocurrency ETFs, for the chance for some spectacular capital gains? Think twice before you do.
Tales from the crypto
Before you go shopping for some Bitcoin for your portfolio, there are a few things to consider. Cryptocurrencies carry an insane level of risk, they produce no income, and are highly speculative. In other words, they are a speculative asset and not an “investment.”
In purely investment terms, cryptocurrencies are a non-producing asset. They don’t pay interest or dividends. What about capital gain? Possibly. Certainly since the beginning of this year cryptocurrencies have skyrocketed in value. Bitcoin, for example, was valued at around US$57,000 as of March 18. That’s up from about $29,000 at the beginning of the year, and from $5,900 a year ago. But that will only be of importance to someone who owned Bitcoin a year ago or on Jan. 1 this year.
The big question is where will it go next? There’s simply no way to tell. According to analyst Mark Hulbert writing in MarketWatch.com, the standard deviation of Bitcoin’s monthly returns since the beginning of 2016 is 25.3%. That’s volatility with a vengeance. You stand to lose most or all of your money in the blink of an eye.
Do you really want to take that chance with your retirement portfolio or a business investment account? Probably not. But then what about assets like gold and other precious metals?
The bugs in gold
Gold is up about 17% over the past year to mid-March. Gold does tend to be a kind of “fear barometer,” and it made some gains as the pandemic raged around the world. It’s also easy to trade as an asset. But it’s volatile, and its predictive value is questionable. Consider that it’s down about 8% year to date. Still, unlike cryptocurrency, gold is considered a “safe haven” asset when financial conditions deteriorate badly. It is a physical commodity with limited supply and continues to be in demand both for jewelry and industrial applications, and these factors also tend to influence the price, albeit on a cyclical basis.
If you’re truly nervous about global business and financial conditions, it doesn’t hurt to have a small allocation to gold as a cushion against troubled times. But bear in mind that gold is also a non-productive asset – it has no yield and produces no income. The only growth available is through capital gain, and that depends entirely on the vagaries of the commodity markets. When you buy gold in the hopes of selling it later at a profit, you are speculating, not investing.
Speculating versus investing
Unlike an investment in, say, a stock or a bond, where you expect the asset to produce a return in the form of interest or dividends, holding cryptocurrency or gold provides no return at all. You essentially hope that you can sell the asset down the road to someone who’s willing to buy it at a higher price than you did. Will there be such buyers down the road? Will there be such a big demand for (or a sudden shortage of) of the asset that you’ll profit handsomely when you sell? Who knows? When you purchase these types of assets, you’re betting that there will be. And note the key word there: “betting.”
A small allocation to gold may be useful as a crisis or inflation hedge. Cryptocurrency seems to have no immediate use other than as a way to shield transactions from the tax department. And that’s exactly what it’s widely used for – it’s particularly in favour with the criminal element for money laundering and other applications where anonymity is a must. You can be sure that governments the world over are putting cryptocurrency under the microscope, and it’s a fair bet that their days as an unregulated, anonymous currency wild west show are numbered.
If you are tempted to speculate, bear in mind that you could lose most or all of your stake. That’s the nature of speculation. If you’re still determined to go ahead, try to get a handle on some of the risks involved. One of the key risks is liquidity risk. How easy would it be for you to sell your speculative asset? With penny stocks, for example, either unlisted or on venture exchanges, you can discover quickly what kind of trading volume is available. Gold ETFs are also transparent and liquid. Not so much with physical gold.
Cryptocurrency has no regulated central market to gauge liquidity, there is no “price discovery” mechanism, and it’s impossible to assign a risk premium. So speculating in cryptocurrency is pretty much like going to Las Vegas and putting your entire stake on a single number on the roulette wheel.
When it comes to investment assets, it makes a whole lot more sense to purchase ownership in something that grows intrinsically while rewarding you along the way than it is to hold a completely speculative asset like cryptocurrency.