Cryptocurrency continues to gain in popularity and we field questions all the time from clients who are interested in or already invested in these assets.
Many individuals have incorporated cryptocurrency into their asset portfolios, but MYRA typically does not recommend these assets to most clients. And we are not alone. In the FPA’s 2018 Trends in Investing Survey, only 1.4% of financial planners recommend cryptocurrency to their clients.
Here are four reasons we do not recommend cryptocurrency investments to MYRA clients.
Reason 1: Our Clients Typically Don’t Have the Right Risk Profile for Crypto Investing
Cryptocurrency is a very volatile asset and is best suited for people with high risk appetites. Putting your money on cryptocurrency is highly speculative. Most of our clients are looking for ways to invest their money in less volatile assets because most of our clients are looking to save for a milestone or goal such as retirement, college tuition, or a major purchase. At MYRA , we seek to match each client’s risk profile with their own unique investment portfolio. It is the rare client that has the right profile for a volatile and unregulated asset such as cryptocurrency. That said, we are happy to advise clients who are already invested in cryptocurrency or who do have a risk appetite that can tolerate such an asset.
Related Article: Top 10 Immigrant Tax Mistakes
Reason 2: Very Few People Truly Understand Crypto Currencies – Don’t Invest in What You Don’t Understand
A recent survey showed that many institutional investors don’t even understand what cryptocurrency is - and 27% even called it “a fraud.”
There is even disagreement about what cryptocurrency is. The term cryptocurrency is a bit of a misnomer. Since cryptocurrency doesn’t have a stable value, it can’t really be considered a currency. Although some people view it as a currency, it is in fact a security, more similar to a stock or bond. The IRS considers it property and it is taxed in a way that is similar to securities such as ETFs or stocks (you are taxed on the capital gain, which is the sale price minus your basis (the price you bought it for).
Even the government is having trouble understanding cryptocurrency and the SEC has expressed concern in a recent report about the lack of regulation on cryptocurrency exchanges.
Reason 3: Cryptocurrency is Now Subject to Capital Gains Tax And Record Keeping Can Be Challenging
Although certain cryptocurrency transactions used to be exempt from capital gains tax, the Tax Cuts and Jobs Act passed in 2017 closed that loophole. You have to report cryptocurrency transactions to the IRS and pay capital gains tax. The IRS has made it clear in 2018 that they are serious about taxing cryptocurrency transactions: In 2018, Coinbase had to comply with a court order to provide the IRS with information about customers who bought, sold, sent or received at least $20,000 in cryptocurrency in any one year between 2013 and 2015. Some exchanges provide tax forms describing transactions and gains to investors but others do not. This can create an extensive bookkeeping burden for investors and their tax advisors who need to closely track transactions and the basis of assets.
Related Article: 4 Ways To Reduce Your Taxes Under The New Tax Law
Reason 4: Unlike A Stock or Other Asset, Bitcoin Is Not Backed By Any Intrinsic Value
The intrinsic value of an asset is generally accepted to refer to the future cash flows from the asset. If you buy stocks, for instance, you own part of the company. If the company generates profits, these profits will flow to investors in the form of dividends or be re-invested in the company with the hope of future profits.
Cryptocurrencies only rely on the market value or how much investors are willing to pay for the asset. They are backed by no underlying asset, business, or cash flow. Without demand of the market, cryptocurrencies are worth nothing. Cryptocurrencies are highly speculative and rely on the faith of the market. Without the market’s faith in the asset and willingness to trade it, the asset is worth nothing. Investor Warren Buffet was quoted in an interview with Yahoo Finance as saying, “if you buy something like Bitcoin or some cryptocurrency, you don’t really have anything that has produced anything. You’re just hoping the next guy pays more.”
Focus on Diversified, Standard Investments First
If you’re considering cryptocurrency trading, ask yourself these questions first:
Do you have an emergency fund of 3 to 6 months of living expenses?
Have you paid off all high-interest debt?
Have you maxed out your tax-advantaged 401K and IRA contributions for the year?
Are you contributing to a tax-advantaged Health Savings Account and/or 529 Plan?
Have you amassed a nest egg of traditional assets: diversified index funds, ETFs, and bonds?
Have you engaged in an estate planning conversation to maximize the accumulation of tax-advantaged assets for your own use and for heirs later on?
Have you evaluated your risk-appetite and do you understand that cryptocurrencies are extremely volatile and can result in your losing a large portion of your assets quickly?
If you have done all of the things above and have a risk-appetite that can tolerate cryptocurrency investing, then go for it!
Related Article: Should You Use A 529 Plan for Primary School Tuition?