Does Crypto’s Sizzle Mean Getting Burned?

Cryptocurrencies have staged a stunning rally since the November election. Bitcoin, the most widely traded cryptocurrency, is up more than 40% and crossed $100,000 for the first time.

Spectacular rallies are nothing new for cryptocurrencies, and neither are the damaging declines that can follow them, making crypto a very risky investment.

So, what’s behind the latest rally? A favorable political environment, including expectations that an incoming Congress will help bolster cryptocurrencies by providing a friendly regulatory environment. However, that assumption could prove as speculative as the rally itself given a slim House majority and other challenges Congress faces.

Crypto FOMO

It’s easy to get caught up in the hype of a crypto rally and to want to profit from it, whether you know what it is or not. But it’s a bad idea to invest in something just because it’s gone up. So, what is a cryptocurrency?

In short, it’s a digital asset that is created, used and stored only through computer systems and it’s not maintained through a centralized authority – unlike the U.S. dollar, for example. Despite crypto’s investment risk, there are those who believe crypto has the potential to be a global currency that rivals the U.S. dollar.

It’s hard not to want to get into a disruptive technology in its early stages. More than half of investors believe crypto is a good investment opportunity, according to a recent Edelman Financial Engines survey.

The willingness to invest in crypto should not be dismissed offhand as misguided. History shows how disruptive technologies can take hold even as their births can be messy. Recall internet and biotech stocks. Investors were similarly excited about them, and while many did not survive, many did, as the economic power of the internet and of biotech was borne out.

Putting the opportunity into perspective

We believe the digital asset market may hold exciting investment possibilities, but you need to divide the market into companies that are providing the market’s infrastructure from the digital currencies themselves.

The infrastructure technology has uses well beyond crypto. For example, blockchain technologies may revolutionize how we share and protect our wealth and our personal information.

Our clients’ diversified portfolios already have exposure to the stocks of companies developing these technologies and those that stand to benefit from them.

Then there are the cryptocurrencies themselves, like bitcoin and ethereum. Cryptocurrencies are more accessible to the individual investor than in the past, but – so far – there is little practical use for them in our everyday lives beyond being a speculative trading vehicle. Even though it’s uncertain whether cryptocurrencies will ever have widespread practical use, this doesn’t mean they won’t. Time will tell. But for now, they remain speculative investments.

How we invest in cryptocurrencies

As an independent fiduciary, we have a responsibility to look out for our clients’ best interests. Given the risks, we believe that a crypto allocation should be professionally managed within a portfolio dedicated to retirement or other financial goal. That way, crypto allocations can be rebalanced to manage their size within a portfolio, so overall portfolio risk is maintained. For example, at Edelman Financial Engines, we can harvest gains when crypto appreciates within a portfolio and reinvest the gains into diversified stock and bond portfolio positions that may have lost value.

For those who are interested in having crypto exposure, 1% to 2% of an overall portfolio is a sensible allocation, in our view. We believe a strategic and professionally managed allocation like this one positions investors to have access to a speculative investment without putting their well-thought-out financial plan in jeopardy.

This article is for informational and educational purposes only and does not constitute an offer, solicitation or advertisement with respect to the purchase or sale of any security.