Just a Bit Outside
The year was 2017, and my wife and I were attending a potluck event organized by our church small group. Great food and great people; you couldn’t ask for more. As what typically happens at these events, you come as a couple, and then as the night proceeds, you have a group of guys huddled together in conversation. The women gathered among themselves, sharing stories. On this particular night, the topic du jour on the “guys side” was bitcoin.
My friend was sharing his most recent experience with mining bitcoins and his vision for the expected appreciation in the future. Being the “finance guy” in the group, all heads turned my way when I was asked my opinion on cryptocurrencies. My response was simple; I don’t invest in them – this wasn’t a judgment statement, but rather just a fact. The next natural inquiry of “why not?” sparked a lighthearted debate between my friend and me. Much of what I shared that night was about how I felt it was impossible to value such a thing (bitcoin), which is why I always viewed buying a cryptocurrency as speculation (instead of investing), and that I personally and professionally believe speculating is dangerous.
Over the next few weeks and months, the price of bitcoin began skyrocketing. The price appreciation was parabolic. I started a text message thread with my friend who was advocating for bitcoin that night, and some of the others who were part of that conversation. The text message was simple, and I notated the potluck’s date, what the price of bitcoin was then, and the current price. On the next line of the text, I would include a blurb about “if Trevor would have invested on that date what it would’ve been worth now…” I accompanied this message with some comical emojis, and I continued this fun little routine as bitcoin’s price continued to climb.
The Principal Principle
A friend would later ask me if I was disappointed that I didn’t buy any bitcoin. He wanted to know if I was experiencing FOMO (fear-of-missing-out), and I told him I was not. My text message to my bitcoin comrade was in jest, and it was fun for me to watch from the sidelines, but my convictions and principles for investing hadn’t changed. Writing this some three years later and still, those principles and convictions remain the same.
Investing principles are key. They help one stay true to their investment philosophy and strategy. I’m a firm believer that the best way to decipher a fair valuation of an investment is to view that investment in relation to the future cash flows you expect it to produce. If you were investing in real estate, you’d want to know the expected rental income the property would produce. If you were investing in a business, you’d want to know the expected profits generated by that business. Then you could calculate what the present value of those future cash flows should be. This is a valuation process, a way of concluding what price you are willing to pay for something. This is more process-oriented versus buying securities on a wing and a prayer that someone else will be willing to pay more for it in the future.
What happens if you don’t have principles or an investment philosophy? Then you are going to lean on what “feels” right at the time. These feelings, or what you might label intuition, are often influenced by the current environment you find yourself in. So, in a year like 2017, when you see bitcoin climb from $1,000 to nearly $20,000, you might find that it piques your investment interest. On the other hand, in a year like 2018, when you see that $20,000 mark plummet back to the $3,000 range, then you would likely be a bit more disenchanted. An investor without principles is like an unanchored balloon; it will go wherever the wind takes it, for better or for worse.
My friend advocating for bitcoin could not convince me that there was a clear way to understand or justify bitcoin’s price – whether that price was $3,000 or $20,000. Since that conversation in 2017, I’ve read a significant amount about cryptocurrencies from folks on both ends of the spectrum – doubters and advocates. And the deeper I go, I still find myself in the same place, not understanding how to determine a fair value. Does this lead me to camp out with the “doubters” and shame my friend for his investment choice? No, not one bit (pun intended!). It just means that cryptocurrencies are not something I’ve owned, nor recommend to my clients, and more importantly, the direction of the price or appreciation, no matter what it does, won’t change my mind on this.
So, what would change my mind? We talked a few weeks ago about the art of not being stubborn, so I think it is only fair to apply that challenge here. Here’s my current thinking…
- I don’t believe that bitcoin will replace fiat currency (legal tender).
- I don’t see a reliable utility for bitcoin – it is rare for people to exchange goods or services for bitcoin.
- I don’t agree with proponents that argue it is a good “store of value,” as it is proven to be an extremely volatile asset.
There’s Gold in Them Thar Hills
Some bitcoin devotees have referred to bitcoin as a digital ‘gold,’ which is their best argument for obtaining new converts. Based on this analogy, I can see why some advisors and portfolio managers would become interested in this crypto-gold. One can argue that the benefits of adding an asset that does not correlate to stocks or bonds could create diversification benefits in a portfolio. Yet, even with this logic, I still opt-out.
The problem with this analogy is that you’d need a deeper track record to give real teeth to this argument. Gold has an advantage over bitcoin, gold has been around since the beginning of time. This means there is a whole lot of data and abundant research one can conduct before allocating. This allows an investor to run historical analysis and see how the asset has behaved in different market environments and potentially strengthen one’s argument for allocating.
Still, for me, I’ve never owned gold and I’ve never recommended it to a client. I feel confident that one can achieve their financial goals without this asset. Again, I’m not convinced there is a process for deciding when it is prudent to own this allocation (gold) and when it is not. This is an asset that does not produce cash flow, which makes it very difficult to determine fair value.
For these reasons, I choose to stay the course and I am content to be a spectator as opposed to a speculator.
If this article sparked any questions or comments, feel free to contact me at email@example.com. I will be back next week with more of my Thoughts On Money.