Bitcoin, NFTs and Other “Hot” Investments – Is the Time Right?August 3rd, 2021 by Jim Allen
In my 35 years as a financial planner, I have seen a multitude of so-called “can’t miss” investments come and go. I’ll get the call about my thoughts on a certain investment and whether the client should buy in or not. Often, it is fear of missing out or “FOMO” that drives these questions, but sometimes it may actually be a legitimate investment opportunity. So how to differentiate between what may be a viable investment opportunity and what is just the latest iteration of a get rich scheme that is usually too good to be true?
To know, you must answer the following questions – “will this investment help me reach my financial goals” or “will the consequences of losing the money ruin my chances of meeting those goals”? So, a get rich quick scheme for one person may be entirely appropriate given their risk willingness and ability, but it may be potentially devastating to another. In all honesty, most of these investments are too good to be true and we normally advise against investing in. We aren’t doing that because we are too conservative, out of touch, or not “hip” enough to recognize the next big thing. It is because we have a fiduciary responsibility to act in our client’s best interest and we need to make informed decisions about helping our clients best meet their goals. Our firm’s 80 years of combined experience has taught us to recognize when an investment opportunity is real and when it is pure speculation, or even worse, not legitimate at all.
So this brings us to the hot investments of the 2020’s: Bitcoin and other digital currencies, non-fungible tokens (NFTs) and “pot stocks.” We probably have not advised you to invest in these “opportunities”, not because we don’t know about or understand them, but because they most likely aren’t appropriate for your individual situation.
Bitcoin and Other Digital Assets or Digital Currencies
Bitcoin (and the hundreds, if not thousands, of other variations) are digital assets that are traded on per-to-peer networks. Because they can be traded on these networks, they are often referred to as “digital currencies.” However, they are not actually a currency. To be a currency, there has to be a stable value that is accepted by everyone, for example the U.S. Dollar. The U.S. Dollar is backed by the taxing authority of the U.S. government and the value is accepted by everyone who uses it. Bitcoin and other digital assets fluctuate wildly in value on a daily basis thus making them unsuitable to be a currency. If I can pay $39,000 for a bitcoin today but then if I try to use it to purchase something next week and the value has dropped to $11,340, which was the value a year ago, it can’t really be considered a reliable measure of an exchange of value. Any “fiat” or regular currency of any established country is very stable and users can rely on the fact that a dollar earned today can be able to be used as a dollar tomorrow.
So, these digital currencies are really just assets that move dramatically up and down in value based on whatever someone else is willing to pay to buy it from you. There is, in theory, a finite amount of some of these digital assets, so they may retain some value due to supply and demand. But, their value is in “the eye of the beholder.” I consider these assets to be much more like artwork than a currency. There is only one Mona Lisa so people are willing to pay large amounts of money for the painting. However, if everyone decides that the Mona Lisa is an ugly painting, it becomes worthless. In addition, you can hang a Mona Lisa on your wall but you can’t show off your Bitcoin account. Some digital assets like Bitcoin etc. may provide substantial appreciation but it is very much unknown as to the long-term viability of each type of digital asset at this point.
There are other issues that are concerning about the digital asset space. It is currently largely unregulated and the ability to freely transfer these assets make them subject to market manipulation, to use in illegal ways like money laundering and tax evasion, and to use by criminals. In addition, there are tax consequences to trading in digital assets of which the IRS is starting to clamp down on. For instance, unlike a normal currency, because the value fluctuates so wildly, if you use bitcoin to purchase something at a store or restaurant, you may be triggering capital gains. The IRS has stated in multiple rulings that digital assets are like any other capital asset and if you dispose of them with a gain, it is taxable. Other examples would be if you receive an airdrop of digital assets or involved in a hard fork, there can be tax consequences. Unfortunately, the use of digital assets is not even in the “wild west” phase of regulation, but more like “Lewis & Clark.” This is uncharted territory and there is still tremendous potential for abuse and future government regulation.
Because of all this, we consider digital assets like Bitcoin to be highly speculative. There is a real possibility your value could go to zero and you should be prepared to accept this risk before investing. The underlying technology behind these digital assets (blockchain, cryptography and digital ledgers) very well could be the next evolution of our economy and could be as disruptive as the internet and e-commerce has become. However, it is too soon to know who the winners and losers will be. In the dot.com boom of the late 90’s, for every Amazon or Google, there were tens or hundreds of Pets.com that failed.
If you are in a situation where you are financially independent and your goals are fully funded, then investing a small portion of your portfolio in something as highly speculative as digital assets very well could be appropriate. Just be willing to accept the fact that you could lose every dollar of the investment. Finally, at this point we do not consider an allocation to digital assets to be appropriate unless you have the financial ability to speculate and not be concerned about a 100% loss of your investment.
Along with digital assets, investment in companies that produce or distribute marijuana is something we are frequently asked about. It is an industry that is in its’ infancy, much like the internet was back in the 1990’s. Like the growth of the internet, there will be winners and losers, and it is a big unknown at this point who those winners and losers will be. However, unlike the internet boom of the 90’s, there are still regulatory issues with pot stocks that create additional uncertainty. Many of the people investing in pot stocks are making a bet that the Federal Government is going to legalize pot at the federal level soon. That could be the case, but the U.S. is lagging behind other countries like Canada in this respect. This has created difficulty for pot companies to do even simple banking transactions because their product is illegal in several states and federally. In addition, as pot has become legalized in more states, there have been many players entering the market which has led to a glut of supply, thus reducing prices. Plus, the legitimate companies are still competing with a robust black market. Due to these factors, many of the existing companies are struggling to be profitable and likely will not make it. At this time, investing in pot stocks is also highly speculative and is only appropriate for situations where you are comfortable taking a 100% loss.
Non-Fungible Tokens (NFTs)
The newest hot investment we want to discuss are Non-fungible tokens or NFTs (unit of data stored on a digital ledger, called a blockchain). Simply put, this is the ability to buy a slice of some digital asset and be a part owner. Where this is starting to pop up is with athletes, artists and entertainers selling shares of a digital image similar to a baseball card. One of the issues with this concept is that these images are also readily available on the internet to the entire public. So, a person who doesn’t want to buy into an NFT of Lebron James dunking a basketball during a game can go onto YouTube or another venue and find the same picture and capture it. This means that the intrinsic value of the NFT is only if someone else is willing to pay you in the future to be a part owner of the NFT. There will likely be some of these NFTs that end up with tremendous value (think a Mona Lisa), but the reality is that many will become worthless if this trend fails to catch on. Think Cabbage Patch Kids in the 80’s or Beanie Babies in the 90’s. If digital assets are in the Lewis & Clark or early exploration phase, NFTs are essentially Columbus setting sail to find the new world. These assets will be extremely speculative.
The point of this rather lengthy article is not to try and convince you that these assets are all bad – they may be entirely appropriate in certain limited circumstances. But what we want you to know is that we fully understand these markets even if we are not discussing them with you. Our role as your advisor is to make sure that you meet your financial goals, which normally means keeping your nest egg safe. Just know that if you have questions or want to talk about any of the newest, hottest investment trends we are on top of it and here to help.
Jim Allen, CFP, ChFC, EA, CDFA is President, Sr. Advisor and a Principal at Anchor Bay Capital. In addition to his 30+ years of financial planning experience and his professional credentials, he holds a Master’s Degree in Financial Planning and is a former instructor in the CFP program at the University of California Irvine. He is also the co-author of the book “The Tools & Techniques of Charitable Planning.” Jim can be reached at [email protected]