Bitcoin and its cryptocurrency cousins have taken a wild ride over the past year, with big ups and downs. But the ups have seemingly garnered far more attention, driving widespread enthusiasm for this hot trend. Fisher Investments hears from many investors who are considering diving in and want to know our take. We aren’t inherently for or against many investments outright (although we aren’t fans of costly deferred annuities and non-traded REITs), but we do think there are a few things you should think carefully about before you take a flier on cryptocurrencies. Here are some key considerations.
1. Why are you interested?
For most people, interest stems from bitcoin’s well-publicized big returns, like its 1,216.7% return from its pandemic-era low on 03/12/2020 through its most recent high on 04/13/2021. Those seduced by such astronomical figures tend to pay less attention to things like bitcoin’s subsequent -45.4% decline over the next six weeks. We will return to that huge volatility momentarily but, for now, consider: Bitcoin’s price is still quite elevated, and it can move thousands of dollars in a single day. Buying after a big run is therefore largely a “greater fools” argument—the belief that even if you buy high, some other sucker will happily buy from you at an even higher price. This isn’t a solid thesis, in our view. It is a wild guess. A hope. Not something you can assign a probability to, and not driven by anything fundamental.
2. Can you identify fundamental forces that drive cryptocurrencies’ returns?
Bitcoin is just over 11 years old, as we write—a very, very short history compared to stocks, where good data begin in 1925. That lack of history means no fundamental thesis to own cryptocurrencies has enough evidence to prove whether it does or doesn’t work. In Fisher Investments’ view, an investment thesis should hold across multiple market cycles (meaning full bull and bear markets) in order to prove itself valid. It needn’t work 100% of the time, but there should be time. We don’t have that with bitcoin. For instance, many view it as an inflation hedge, yet its existence has coincided with one of the lowest-inflation spells in modern history. During that span, it has boomed and busted multiple times, which doesn’t match what one would logically expect of an inflation hedge, especially with some of those busts starting while the CPI inflation rate was accelerating, like it did in April and May 2021. A proper inflation hedge should have a steady, repeating correlation with price movement, in Fisher Investments’ view.
3. How comfortable are you with volatility?
As mentioned earlier, bitcoin has enjoyed some huge booms and catastrophic busts, suggesting one must be an impeccable market timer or have nerves of steel to reap long-term returns. To see this another way, consider the following exhibit, which compares bitcoin and S&P 500 daily price movement (including reinvested dividends) since bitcoin’s birth in July 2010. As you will see, it has had far, far more big moves up and down than stocks during this span. Are you comfortable with losing -10% of your investment in a single day? Bitcoin has achieved that dubious milestone 91 times since its birth, or 2.2% of the time. The S&P 500 did it just once.
Exhibit: Bitcoin’s Daily Volatility Dwarfs Stocks’
4. Have you considered thieves?
Bitcoin is unregulated, which, according to some proponents, is part of its appeal, but there is a dark side. Cryptocurrencies are big in the criminal underworld. Hackers and all manner of crooks like getting paid ransoms in bitcoin because it is designed to be untraceable. They also like stealing bitcoin, which is an irreversible transaction with no recourse. The same goes for those whose cryptocurrency holdings live on an exchange that collapses, as those who used an old exchange called Mt. Gox learned the hard way several years back.
Stocks and bonds held in regulated brokerage accounts are far more secure. You typically own them in an account in your name, and there are government and private-sector insurance vehicles to help protect you on the very outside chance that your brokerage firm collapses suddenly. With cryptocurrencies, you take significant risk above and beyond the risk of market declines.
5. How good are you with passwords?
A lot of people made big money on bitcoin over the last year. Unfortunately, some of them will never be able to access it, because they lost their passwords, and many of the exchanges don’t have password-retrieval features. That is another major difference with traditional brokerage accounts, which have plenty of fail-safes to ensure you have access to your financial property.
6. Do you love having complicated taxes?
Proponents claim cryptocurrency is the future of money, but there is one very large counterpoint to this thesis: taxes. The IRS considers bitcoin property, rendering it subject to capital gains taxes. That means every dispensation of bitcoin, whether you are selling it or spending it, is a taxable event if you have an unrealized gain. For several weeks earlier this year, an infamous electric-vehicle maker accepted payment for cars in bitcoin, to much fanfare. If you did this and bought a car with bitcoins after enjoying the big run-up in the price, you didn’t just have to pay sales tax. You had to pay capital gains taxes on the difference between the price you paid for your bitcoins and the value of that holding at the time you spent it.
Now, stocks incur capital gains taxes, too. But people know and expect this, and brokerage houses report transactions to the IRS. Not so for bitcoin, leaving many people with a nasty surprise when they discover transactions were taxable—and setting them up to be accidental tax evaders if they aren’t careful.
Again, we aren’t inherently against bitcoin. But we think it is important to consider all facets of an investment before you take the plunge, carefully weighing the potential risks and rewards.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: Global Financial Data, as of 05/27/2021. Bitcoin price return, 03/12/2020–04/13/2021.
[ii] Ibid. Bitcoin price return, 04/13/2021–05/23/2021.