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| Pathways Advisory Group, Inc. Evon Mendrin |
“People get excited from big price movements, and Wall
Street accommodates” – Warren Buffett
Boy have we seen big price movements! 2017 showcased our
President’s dramatic first year in office, Congress passing Tax Reform by
Christmas (sure to be 2018’s new hit holiday jingle), and media coverage of one
“all-time stock market high” after another. But the trendiest story just might
be the sudden rise of bitcoin.
Hovering around $900 in January, the price of one bitcoin
suddenly skyrocketed to roughly $2500 mid-year and off to $15,883 in late
December! That’s a near one-year climb of over 1400%!1
Likely to be locked in as the hottest water-cooler topic of 2017,
some investors are rushing to buy this cryptocurrency. Some have even taken out mortgages, run up credit cards, and turned to equity lines. With all of
the press and attention, do bitcoins have a place in a well-diversified portfolio?
We don’t believe so.
First – what is it?
Simply put, bitcoin is a created digital currency. Launched in 2009, it
works on a peer-to-peer system without using an intermediary. Meaning, you can
create transactions without using a financial institution – such as a bank – as
the middle-man. The transactions are recorded on a public ledger called blockchain.
Why not jump in?
Any reasonable investment worth considering for your
portfolio should carry a positive expected return. That is, there is an
inherent value in the investment that will provide some future cash flow or
higher value in the future.
Stocks, for example, are partial ownership in companies.
These businesses produce products and services that people are willing to pay
for. They have leaders, employees, and the power of their brands. These
valuable aspects work to bring in cash flow (revenue). Profits can then be paid
out to shareholders as dividends or reinvested into the business. Owning the
stock of a company gives you a right to that future cash flow and business
growth.
Bonds give you a promised future cash flow. When you buy a
bond, you lend a company or government money, and they promise to pay you back
with interest.
Both of these investments give you an expected return and
the means for investors everywhere to reasonably value them. A globally
diversified portfolio of stocks and bonds allow you to benefit from the cash
flow and growth of businesses all over the world.
Bitcoin, however, does not provide a positive expected
return. It doesn’t produce anything of value. Like a nugget of gold, or the
dollar bill in your wallet, if you leave a single bitcoin in your digital
wallet, a year later you will still have a single bitcoin. It won’t multiply
into more bitcoins, and it won’t pay any additional cash.
The price is driven entirely by supply and demand. Meaning,
a positive return only occurs when someone else comes along later and buys it for more than you paid. You have to hope the frenzy
continues. But what happens when there’s no one left willing to pay $15,000 for
a single bitcoin?
What about its actual
use as a currency?
Holding a currency such as cash in a portfolio is not for maximizing return but for handling short-term expenses. Bitcoin is not currently very useful as a
currency. It isn’t widely used or accepted, goods and services aren’t widely
priced in bitcoin, and it’s extremely volatile.
So, what’s the reason for all this mania? Likely pure
speculation. It’s the hottest thing, and no one wants to be left out. We are
hooked by the glamour of digital currencies and stories of overnight
millionaires.
The blockchain technology behind it may be of great use, and its use as a currency in the future is a different
debate entirely. But bitcoin today is far from a usable asset or currency.
Remain disciplined with your investments as the year comes
to a close. Always start with your goals and have an understanding of how your
investments work. Remember the basic foundation of what drives returns over time
– expected future cash flow. When it comes to cryptocurrencies, it’s the wild
west out there. We urge you to stay indoors, hide the children, and wait for
the mess to be over.
We wish you Happy Holidays and great success in
meeting your financial goals in 2018 (and beyond)!
1Daily prices through 12/26/2017 from CoinDesk.
2See Bitcoin.org
for detailed information on how it works.
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