Quarterly update to clientsContinue reading
The first three months of the year would not be described as boring by any stretch of the imagination. With the war in Ukraine continuing to create global uncertainty and the government-assisted closing of two of the largest regional banks in history, there is plenty to capture our short-term focus. But even with these and other events, many stock indexes are up since early January and bond prices have seen some recovery as interest rate pressure has eased a bit. The point is that sometimes investment returns can tell a different story than does the current headlines.
However, whether the numbers are up or down in any given year, we caution against letting them alter your mood, or as importantly, your portfolio mix. Because, when it comes to future expected returns, short term performance is among the least significant determinants available.
Thumbs Down…Thumbs Up
In the thumbs-down category, U.S. stock market indexes1 turned in annual lows not seen since 2008, with most of the heaviest big tech stocks2 taking a bath. Bonds fared no better, as the U.S. Federal
Reserve raised rates to tamp down inflation. The U.K.’s economic policies3 resulted in Liz Truss becoming its shortest-tenured prime minister ever, while Russia’s invasion of Ukraine and China’s continued COVID woes kept the global economy in a tailspin. Cryptocurrency exchanges like FTX4… well, you know what happened there.
On the plus side, inflation has appeared to be easing slightly, and so far, a recession has yet to materialize. A globally diversified, value-tilted strategy5 has helped protect against some (certainly
not all) of the worst returns. An 8.7% Cost-of-Living Adjustment (COLA)6 for Social Security recipients has helped ease some of the spending sting, as should some of the provisions within the newly enacted SECURE 2.0 Act of 2022.
Now, how much of this did you see coming last January? Given the unique blend of social, political, and economic news that defined the year, it’s unlikely anything but blind luck could have led to accurate
expectations at the outset.
In fact, even if you believe you knew we were in for trouble back then, it’s entirely possible you are altering reality, thanks to recency and hindsight bias. The Wall Street Journal’s Jason Zweig7 ran an experiment to demonstrate how our memories can deceive us like that. Last January, he asked readers to send in their market predictions for 2022. Then, toward year-end, he asked them to recall their predictions (without peeking). The conclusion: “[Respondents] remembered being much less bullish than they had been in real time.”
In other words, just after most markets had experienced a banner year of high returns in 2021, many people were predicting more of the same. Then, the reality of a demoralizing year rewrote their memories; they subconsciously overlaid their original optimism with today’s pessimism.
What have we learned?
Where does this leave us? Clearly, there are better ways to prepare for the future than being influenced by current market conditions, and how we’re feeling about them today. Instead, everything we cannot yet know will shape near-term market returns, while everything we’ve learned from decades of disciplined investing should shape our long-range investment plans.
As we head into a new quarter, always know that we are here to help and are grateful for your
Speaking of control…You likely have heard us say in the past that market performance is not an area that any of us have control. Because of this, it is wasted energy to focus and worry about market movements. You should spend that energy doing things you can control: spend less than what you make, avoid debt, build cash reserves, plan your generosity and plan your future – practical principals that have an outsized impact on your life.
Small, quiet actsWhether the temptation is to abandon a free-falling market (like the one we encountered less than a year ago), or chase after winning streaks, an investor’s best move remains the same. Concentrated bets on hot hands generate erratic outcomes, which makes them far closer to being dicey gambles than sturdy investments. Trust instead in the durability of your carefully planned investment portfolio. Focus instead on small, quiet acts. That is what we are here for, for example, to:
- – Remind you that your globally diversified portfolio already holds an appropriate allocation to Tesla stock (which may be a lot, a little, or none, depending on your financial goals.
- – Guide you in rebalancing your portfolio if recent gains have overexposed it to market risks.
- – Help you interpret the 5,600 pages of the newly passed Consolidated Appropriations Act, 2021, so you can manage your next financial moves accordingly.
- – Assess potential ramifications of the Biden tax proposals and advise you on any additional defensive tax planning that may be warranted for you in the years ahead.
- -Remain by your side as you encounter whatever other challenges and opportunities 2021 has in store for you and your family.
This will be the quarter that we look back on and never forget. It was the time that a virus spread with a silent vengeance, and the world came to a screeching halt. You may be feeling quite disoriented, fearful or even anxious as you read this note since ‘normal’ for all of us has been shaken to its core due to Covid-19. You are likely hunkering down at home, which is what you should do, with little of your regular activities to keep you busy. If you are like me, it literally feels like the earth has stopped spinning on its axis. Up is down, and right is left. Trust me when I say that it is completely normal to feel this way in the context of what we are dealing with as a human species.
I do not come to you with answers or any conclusions that will change the world…there are people that are much smarter than me working on that now, and I have confidence that they will figure it out. But I can bring some encouragement and suggest some small actions that might, just maybe, help us feel like planet earth is starting to rotate once again.
What can you do?
The spread of Covid-19 has impacted the global economy with a speed and impact that is unlike anything seen in our lifetime. This does not mean that happiness and contentment are totally out of your control, however. Mindset is key…start by realizing that the sun still rises every morning like the picture at the top of the article. There is new hope with each new day. I am sure you have found, as have I, that there is now more time to watch movies, read a book, take a distance-appropriate walk to enjoy the spring weather or call someone (yes, actually call them rather than text) to see how they are doing.
If you are sheltering at home with loved ones, you have probably seen them more in the last two weeks than you have for months. We should all continue to do more of these things, and the more we do, the more connected we will stay. I am not a loquacious extrovert, but I have thoroughly enjoyed being around and talking with the ones I care most about. And the more connected we stay, the more human we will feel. This is where happiness and contentment hide, not in your investment portfolio or the latest round of news.
What are we doing?
Actions taken during times of fear in the markets will have implications for years to come. The question is whether they will be positive or negative. For the long-term investors, which are clients that we serve, volatility creates opportunity. We have taken advantage of this opportunity by tax loss harvesting, which allows us to realize the losses for tax savings, but then invest the proceeds right back in something else so the money is never out of the market. The tax savings for our clients this year will be significant. We have also looked to strategically rebalance portfolios. Because some of the fixed income assets have gains over the last year, we have sold those gains to go buy equity funds that are now at a discount. It rebalances the ship and holds to the strategy of selling high and buying low.
What is next?
The fact is, I don’t know. No one does, but that’s OK. We are still waiting on the details of the massive Stimulus bill that was signed into law on March 27th. There are too many details for me to summarize here. If you want a deep dive in to the details, you can find that here. I plan to write more on this soon, but if you have any questions about this, please do not hesitate to call our office. We are all working remotely, but the extensions still ring right to us. Know that we are here to help in this time of uncertainty. Your well-being is of greatest concern to us, and not just financially. Be safe, be smart, and be part of the global solution for everyone by staying home.
We will see you soon,
Josh, Mike, Matt and Sandra
By Matt Miner
August 15, 2019
First, THANK YOU for your business with PLC Wealth Management! We are honored to serve as your advisors and to walk through life with you.
Second, we think today is a good day to talk with you about jumpy stock markets, falling bond yields, and our thoughts regarding the US economy. Our letter wraps up with actionable advice for you to implement immediately. Pretty exciting, right?
As I prepared to join my family for dinner last evening, I received a forwarded email. According to a tweet by advisor Michael Batnick, yesterday was the 307th time that the Dow fell 3% or more in a single day, over the course of the last 100 years. To see the folks on CNBC jumping up and down, wild eyed and foaming at the mouth, you could be forgiven for imagining that the entire US economy been vaporized.
Volatile Stock Markets
On average a downward move of the magnitude we experienced yesterday happens 3.07 times each year. Equity markets have been mostly placid over the last decade, and yesterday’s market decline was the first drop of that size in 2019. But if we simply achieve historically average volatility, we can expect two more moves of the same size before we celebrate New Year’s Day 2020! Said differently, drops of 3% come around slightly more than three times as often as Christmas.
For a different comparison, UNC and Duke always get invited to the NCAA Men’s Basketball Tournament. In each program’s history, UNC has played 160 NCAA tournament games and Duke has played 147 NCAA tournament games. Coincidentally, the Dow Jones Industrial Average has declined 3% or more in a single day in the last 100 years the same number of times as the two most storied programs in college basketball have played a game in the NCAA tournament: Many, many, times! Stock market volatility is table steaks. It’s why investors expect to earn a positive return for investing in stocks.
The Russell 3000, one of our preferred index comparisons, was down 2.89% yesterday and is down 4.85% for the month. No one likes that. But the same index is up 14.63% in 2019, 9.53% per year on a rolling five-year basis, and 13.20% per year on a rolling ten-year basis (ftserussell.com as of 8/14/2019 market close).
The stock market can be a rough ride, but it has reliably propelled investors’ wealth upward over time. The chart below shows the growth of one dollar from 1970 to 2017 invested in one-month T-Bills, the S&P 500 Index, and in a globally diversified stock portfolio, similar to PLC Wealth’s equity investment style.
Friends and neighbors, you only get hurt on a roller coaster if you jump off.
Falling Bond Yields
It is true that bond yields have fallen, meaning that money invested in the bond market today earns less interest than it did at this time last year. This has resulted in strong appreciation of bond funds (bond prices move in an inverse relationship to bond yields). For example, DFAPX, an investment-grade bond fund, has appreciated 7.81% in 2019, something I did not expect as we entered this year. On the other hand, falling rates mean that maturing bonds will be reinvested at lower interest rates than bonds that matured in the recent past. It also means that interest rates earned on assets like money market funds, certificates of deposit, annuities, and savings accounts have been reduced.
The Yield Curve
What about the ever-famous inverted yield curve? Once you finish this article you’ll be able to amaze your friends and confound your enemies because you’ll know the answers to questions like, “What is a yield curve?” and “What is an inverted yield curve?” and “What does a yield curve inversion mean?” and most meaningfully, “What should I do?”
First, a yield curve plots the returns investors expect on debt over different periods of time – for example one, five, ten, and thirty years. Investors normally demand to be paid more to loan their money for longer periods. You may have experienced this as a consumer: 30-year mortgage rates are higher than 15-year mortgage rates. This is because the longer the loan, the greater the investor’s exposure to the vagaries of inflation, the risk that the borrower fails to repay, and the risk that the money is locked up at a time the investor wants liquidity. In the graphic below, the August 2018 yield curve (the line with the gray diamonds) is the most “normal” looking, even though the rates are low by historic standards.
Second, an inverted yield curve like the blue line with dots, labeled “Current” in the graph above, means that investors demand 2% to loan to the US government for one year, but only ~1.65% to loan for ten years. How can this be? The inverted yield curve signals that bond investors expect poor economic performance resulting in low interest rates over that time period.
Third, an inverted yield curve has accurately predicted economic recession (two or more quarters of negative growth) or an economic slowdown (a reduction in the growth rate) with 100% accuracy going back to the Eisenhower administration. The predictive value of the inverted yield curve is particularly potent if the inversion lasts for more than one full quarter which is the case as I write you this letter.
Here’s the unvarnished truth: A recession is coming. A recession is always coming. What we don’t attempt to do is predict when the recession will arrive. The fact that a recession is coming is part of your plan. When you work with an advisory firm like PLC Wealth, your plan includes the expectation of recession. It’s kind of like knowing you’ll need to replace your car. You don’t know exactly when you’ll need a new car, but you’ll need one sometime. By planning with PLC Wealth, you have prepared for recession.
Cam Harvey, a terrific professor at my business school alma mater – Duke’s Fuqua School of Business – was quoted yesterday by WRAL saying, “Maybe this is not the right time to max out your credit card…Maybe it’s not the right time to take the vacation with your family that is going to overextend you.” Professor Harvey goes on to recommend you “[do] 100% effort at your job.”
At PLC Wealth we never recommend you max out your credit card. Instead, we recommend you negotiate discounts and pay cash!
We love vacations, but we don’t recommend you overextend yourself to take one. Go camping if that is what your budget supports!
Putting in 100% effort at work is timeless advice your dad gave you, too.
Call to Action
What should you do to prepare for the coming recession? For that matter, what should you do to prepare for the coming prosperity? The advice does not change. Do excellent work. Live on less than you make. Invest the difference wisely. Make a good tax plan. Bless your family with a thoughtful estate plan. Prepare for catastrophe with suitable insurance and emergency funds. Care for your health. Spend time with the people you love. Live according to your values. Be kind.
If you have questions about market volatility, bond yields, or the coming recession, give us a call. We are here to help with any topic where life meets money. Once again, thank you for your business with PLC Wealth Management.
Photos (left) Laurinda & Matt and (right) Ruben, Oriana, Matt, Laurinda, Monique, & Francisco
April 10th, 2019
Whoa! Sitting over here at WaDuke thinking about the excellent conversation we had together this morning. Such a delight to be with y’all, with Laurinda, and with Professor Dyreng. Huge thanks to BLMBAO for this opportunity.
Thanks to all the folks who wanted to chat afterward. I am honored that our time together was helpful to you.
Thanks to the several of you who asked about copies of the slides. They are posted below for you to review, anytime.
Wishing you every success with life and money,
Some additional reference material below:
My website, Design Independence, with lots of content geared to MBAs
Recent interview on Radical Personal Finance podcast about my career transition to planning.
Interview on Masters of Money podcast
Blogs posts I referenced yesterday:
Renting versus owning – Afford Anything
The Shockingly Simple Math – Mr Money Mustache
Millionaire Next Door by Stanley is always top of the heap. The idea is that wealth is about habits.
Total Money Makeover by Ramsey is the best motivation book (“why”) and the best budgeting book
The Only Investment Guide You’ll Ever Need by Chris Tobias is terrific on both PF and investing topics
Personal Finance for Dummies by Tyson is comprehensive and accessible.
If you Can by Bernstein is a great DIY resource.
Your Money or your Life, by Dominguez and Robbins, is the frugality book. Frugality: you can control your spending and achieve a high savings rate on any income.
The Automatic Millionaire by Bach
Richest Man in Babylon by Clason – seminal in this genre
The Wealthy Barber by Chilton – story based and easy PF content
December 20th, 2018
By Matt Miner
Dear Clients and Friends,
At PLC Wealth we enjoy a good New Years party as much as anybody. But we also know that the end of the year can be a chance to pause and reflect on how 2018 went, and what we aim to change in 2019.
We think it’s terrific to take some time to move from undefined “hope” to vision, and from vision to goals, and from goals to specific plans to make things happen in your life and your family. As our friend Dave Ramsey says, “Goals are visions and dreams with work clothes on.”
If you’re ready to get a jump on 2019, here are a few financial best practices for the year ahead. Pick one or two of them to tackle. Give us a call if you’d like to work together to translate these goals into specific plans you can achieve or begin to achieve in the coming year.
1. Do nothing
Seriously. If you have a well-built investment portfolio in place, guided by a relevant investment plan, your best move in hyperactive markets is to let that plan be your guide. That often means doing nothing new with your holdings except your planned, periodic rebalancing. We list investment inaction as a top priority, because “nothing” can be one of the hardest things to (not) do when the rest of the market is in perpetual motion!
2. Double down on your planning
In order to advance your SANF (“Sleep at Night Factor”) in volatile markets, you must have a relevant plan in place that you understand. That plan guides your portfolio and your new investments. A fresh new year can be a great time to tend to your investment plan – or create one, if you’ve not yet done so. Have any of your personal goals changed, or will they soon? How might this impact your investment mix? Have market conditions put your portfolio ahead or behind schedule? Are you unsure where you stand to begin with? It’s time well-spent to periodically ensure your plan remains relevant to you and your personal circumstances.
3. Prepare for the unknown with a rainy-day fund
Time will tell whether 2019 markets are friendly, foul, or (if it’s a typical year) an unsettling mix of both. Having enough liquid, rainy-day reserves to tide you through any rough patches is a best practice no matter what lies ahead. Knowing your near-term spending needs are covered should help with both the practical and emotional challenges involved in leaving the rest of your portfolio fully invested as planned, even if the markets take a turn for the worse.
4. Redirect your energy to contributing financial factors
While you’re busy staying the course with your investments, you can redirect your attention to any number of related financial and advanced planning activities. While you don’t necessarily need to act on everything at once, it’s worth reviewing your financial landscape approximately annually, and identifying areas in need of attention. Maybe you’ve got a debt load you’d like to reduce, or an estate plan that’s no longer relevant. Perhaps it’s been too long since you’ve reviewed your insurance line-up, or you’d like to revisit your philanthropic goals in the context of the latest tax laws. Refreshing any or all of these items is likely to contribute more to your financial success than will fussing over the stock market’s daily gyrations.
5. Perform a cybersecurity audit
Protecting yourself against cybercriminals is another excellent use of your time. With the new year, revisit a a few basic, protective steps:
Enable two-factor authentication on important accounts
Change key passwords on your most sensitive login accounts
Review your credit reports (using AnnualCreditReport.com)
Place a freeze on your credit file, to block unauthorized access (now free, based on recently enacted federal law)
Especially with child identity theft on the rise, these actions apply to your entire household. Unfortunately, even minor children are now at heightened risk.
6. Have “that money talk” with your kids, your parents, or both
When is the last time you’ve held any conversations about your family wealth? It’s never too soon to begin preparing your minor children for a financially literate adulthood. As they mature, their financial independence rarely happens by accident, with additional in-depth conversations in order. Then, as you and your parents age, you and your kids must prepare to step in and assist if dementia, disability or death take their tolls. There also can be ongoing conversations related to any legacy you’d like to leave as a family. For all these considerations and more, an annual “money talk” can be critical to successful outcomes. If you’d like help completing this task, PLC Wealth is ready to work with you to get it done.
7. Make 2019 a year you absolutely crush it in your work, business, or volunteer efforts
All of us are engaged in some kind of productive activity that puts us into contact with other people. This may be our career, our own business, a non-profit organization we serve, or simply running our family’s household.
We all have things we’d like to be different in our daily situation. As you conclude 2018, think back on items you would like to change in 2019. Focus on what you can change or influence, not what you can’t, concentrating your efforts your “locus of control.” For example, if you have a difficult boss or co-workers but you don’t want to change your actual employment, change how you respond emotionally to a difficult situation. Use tactics like focusing on what you are grateful for in this context, getting more exercise, or having that difficult conversation with someone about why a situation has become problematic for you.
Many of us have room to be more organized and focused on the vital few that really matter. Make a plan for how to tune out the noise and get the right things done.
Two great resources here are Stephen Covey’s Seven Habits of Highly Effective People, and David Allen’s Getting Things Done. If you don’t love reading, try an Audible audio book while you exercise or commute.
So, there you have it: seven creative ways to bolster your financial well-being while the stock market does whatever it will in the year ahead. While this list is by no means exhaustive, we hope you’ll find it an approachable number to take on … with two critical caveats.
First, we’ve got a bonus “financial best practice” to add to the list:
Above all else, remember what your money is for. Money is meant to fund your moments of meaning. At PLC Wealth, we want our clients to live rich, not die rich.
Second, we recognize that each of these “easy” best practices aren’t always so easy to implement. We could readily write pages and pages on how to tackle each one.
But instead of writing about them, we’d love to help you take action on these steps. At PLC Wealth, we work with families every day and over the years to convert their dreams into plans, and their plans into achievements. We work in the context of single-issue planning engagements, comprehensive financial planning, and investment management. We hope you’ll be in touch in the new year, so we can partner with you.
Merry Christmas & Happy New Year to you and your family from the team at PLC Wealth – Josh, Mike, Sandra, & Matt
If you were a member of the popular press, you’d probably be happy with 2018’s first quarter performance. At last – some volatility fueling news1 in early February, with plenty of enticing “largest,” “fastest,” and “worst” market superlatives to savor after a long, languid lull.
As usual, there are plenty of potential culprits to point to among current events: global trade wars heating up, the arrival of quantitative tightening (rising interest rates), troubles in tech-land over data privacy concerns, ongoing Brexit talks, and some interesting events over in the Koreas. At quarter-end, one hopeful journalist asked, “Is the Bear Market Here Yet?”2 Another observed: “[T]he number of [Dow Jones Industrial Average] sessions with a 1% move so far in 2018 are more than double 2017’s tally, and it isn’t even April.”3
Has the coverage left you wondering about your investments? Most markets have been steaming ahead so well for so long, even a modest misstep may have you questioning whether you should “do something,” in case the ride gets rougher still.
If we’ve done our job of preparing clients and their portfolio for market jitters, clients may might be able to cite back to us why they’ve already done all they can do to manage the volatility, and why it’s ultimately expected to be good news for evidence-based investors anyway. Remember, if there were never any real market risk, you couldn’t expect extra returns for your risk tolerance.
That said, you may have forgotten – or never experienced – how awful the last round of extreme volatility felt during the Great Recession. Insights from behavioral finance tell us that our brain’s ingrained biases cause us to gloss over those painful times, and panic all over again when they recur, long before our rational resolve has time to kick in.
If you noticed the news, but you’re okay with where you’re at, that’s great. If the volatility is bothering you, talk to a CFP® professional or other qualified financial professional; it may help ease your angst. If you continue to struggle with whether you made the right decisions during quieter markets, plan a rational shift to better reflect your real risk tolerances and cash-flow requirements. Not only is your peace of mind at least as important as the dollars in your account, you could end up worse off if you’ve taken on more risk than you can bear in pursuit of higher expected returns.
As Wall Street Journal columnist Jason Zweig said during the February dip: “A happy few investors … may have long-term thinking built into them by nature. The rest of us have to cultivate it by nurture.” We couldn’t agree more, and we consider it our duty and privilege to advise you accordingly, through every market hiccup.
If we’ve been doing our job as your fiduciary advisor, you might already be able to guess what our take is on current market news: Unless your personal goals have changed, stay the course according to your personal plan. Have you checked your plan progress in the last couple of days? If not, you should.
Still it never hurts to repeat this steadfast advice during periodic market downturns. We understand that thinking about scary markets isn’t the same as experiencing them. No matter what happens next, context is always helpful to better understand what is happening around you. This article today by Neil Irwin in the New York Times does a great job of giving context.
Good news is bad news?
So, what’s going on? Why did U.S. stock prices suddenly drop after such a long, lazy lull, with no obvious calamity to have set off the alarms? As Financial Planning guest columnist Kimberly Foss, CFP® described: “To understand the anxiety that led to many investors rushing to sell last week, you need to follow some tortuous logic. … If American workers are getting paid more, then companies will start charging more for whatever they produce or do, which might boost inflation. ‘Might’ is the operative word.”
“Good news, it seems, is bad news again,” this Wall Street Journal columnist added.
Context and Action
While these sentiments may suggest the catalyst for the current drop, they do not inform us of what will happen next. Sometimes, market setbacks are over and forgotten in days. Other times, they more sorely test our resolve with their length and severity. As Jason Zweig of The Wall Street Journal pointed out yesterday, ‘The stock market didn’t get tested – You did.’ You must understand that the four most expensive words in finance are, ‘This time it’s different.’ We can’t yet know how current events will play out, but we do know this:
1) The (US) stock market goes up more than it goes down. Do you see now why we emphasize the wisdom of long-term?2) Capital markets have exhibited an upward trajectory over the long-term, yielding positive, inflation-beating returns to those who have stayed put for the ride.
3) If you instead try to time your optimal market exit and entry points, you’ll have to be correct twice to expect to come out ahead; you must get out and back in at the right times.
4) Every trade, whether it works or not, costs real money.
5) Volatility creates opportunity for the long-term investor.
For a longer explanation of #5, see my post from just last week on Strategic Rebalancing. In short, the stock market roller coaster is too unsettling for some investors, who sell when they experience a market lurch. Don’t be ‘that guy.’ However, this does give long-term investors a valuable—and frequent—opportunity to buy stocks on sale. That, in turn, lowers the average cost of the stocks in your portfolio, which can be a boost to your long-term returns.
Ignore the Hype
Please, please, please be smarter than the marketers. Be wary of hyperbolic headlines bearing superlatives such as “the biggest plunge since …” While the numbers may be technically accurate, they are framed to frighten rather than enlighten you, grabbing your attention at the expense of the more boring news on how to simply remain a successful, long-term investor. And they have absolutely nothing to do with whether your personal financial plan is still on track. (Not sure if your plan is on track or not? Send me an email here and I would be happy to talk to you about the tools we use to help answer this question on a daily basis.)
Instead of fretting over meaningless milestones or trying to second-guess what U.S. economics might do to stocks, bonds and inflation, we believe the more important point is this: Market corrections are normal – and essential to generating expected long-term returns. In short, before you consider changing course if the markets continue to decline, of course we hope you’ll be in touch with us first. Oh, and turn off the TV.
Have you caught cryptocurrency fever, or are you at least wondering what it’s all about? Odds are, you hadn’t even heard the term until recently. Now, it seems as if everybody and their cousin are getting in on it.
Psychologists have assigned a term to the angst you might be feeling in the heat of the moment. It’s called “FoMO” or Fear of Missing Out. Education is the best first step toward facing FoMO and making informed financial choices that are right for you. So before you make any leaps, let’s take a closer look.
What is cryptocurrency?
Crytpocurrency is essentially a kind of money – or currency. Thanks to electronic security – or encryption – it exists in a presumably secure, sound and limited supply. Pair the “encryption” with the “currency,” and you’ve got a new kind of digital asset, or electronic exchange.
Well, sort of new. Cryptocurrency was introduced in 2009, supposedly by a fellow named Satoshi Nakamoto. His Wikipedia entry suggests he may not actually be who he says he is, but minor mysteries aside, he (or possibly “they”) is credited with designing and implementing
bitcoin as the first and most familiar cryptocurrency. Ethereum is currently its second-closest competitor, with plenty of others vying for space as well (more than 1,300 as of early December 2017), and plenty more likely to come.
Unlike a dollar bill or your pocket change, cryptocurrency exists strictly as computer code. You can’t touch it or feel it. You can’t flip it, heads or tails. But increasingly, holders are receiving, saving and spending their cryptocurrency in ways that emulate the things you can do with “regular” money.
How does cryptocurrency differ from “regular” money?
In comparing cryptocurrency to regulated fiat currency – or most countries’ legal tender – there are a few observations of note.
First, since neither fiat nor cryptocurrency are still directly connected to the value of an underlying commodity like gold or silver, both must have another way to maintain their spending power in the face of inflation.
For legal tender, most countries’ central banks keep their currency’s spending power relatively stable. For cryptocurrency, there is no central bank, or any other centralized repository or regulator. Its stability is essentially backed by the strength of its underlying ledger, or blockchain, where balances and transactions are verified and then publicly reported.
The notion of limited supply factors in as well. Obviously, if everyone had an endless supply of money, it would cease to have any value to anyone. That’s why central banks (such as the U.S. Federal Reserve, the Bank of Canada, and the Bank of England) are in charge of stabilizing the value of their nation’s legal tender, regularly seeking to limit supply without strangling demand.
While cryptocurrency fans offer explanations for how its supply and demand will be managed, it’s not yet known how effective the processes will be in sustaining this delicate balance, especially when exuberance- or panic-driven runs might outpace otherwise orderly procedures. (If you’re technically inclined and you’d like to take a deep dive into how the financial technology operates, here’s one source to start with.)
Why would anyone want to use cryptocurrency instead of legal tender?
For anyone who may not be a big fan of government oversight, the processes are essentially driven “by and for the people” as direct peer-to-peer exchanges with no central authorities in charge. At least in theory, this is supposed to allow the currency to flow more freely, with less regulation, restriction, taxation, fee extraction, limitations and similar machinations. Moreover, cryptocurrency transactions are anonymous.
If the world were filled with only good, honest people, cryptocurrency and its related technologies could represent a better, more “boundary-less” system for more freely doing business with one another, with fewer of the hassles associated with international commerce.
Unfortunately, in real life, this sort of unchecked exchange can also be used for all sorts of mischief – like dodging taxes, laundering money or funding terrorism, to name a few.
In short, cryptocurrency, blockchain technology, and/or their next-generations could evolve into universal tools with far wider application. Indeed, such explorations already are under way. In December 2017, Vanguard announced collaborative efforts to harness blockchain technology for improved index data sharing.
That said, many equally promising prospects have ended up discarded in the dustbin of interesting ideas that might have been. Time will tell which of the many possibilities that might happen actually do.
Even if I don’t plan to use cryptocurrency, should I hold some as an investment?
If you do jump in at this time, know you are more likely speculating than investing.
Bubble or not, consider these two points. First, there are a lot of risks inherent to the cryptocurrency craze. Second, cryptocurrency simply doesn’t fit into our principles of evidence-based investing … at least not yet.
Let’s take a look at the risks.
Regulatory Risks – First, there’s the very real possibility that governments may decide to pile mountains of regulatory road blocks in front of this currently free-wheeling freight train. Some countries have already banned cryptocurrency. Others may require extra reporting or onerous taxes. These and other regulations could severely impact the liquidity and value of your coinage.
Security Risks – There’s also the ever-present threat of being pickpocketed by cyberthieves. It’s already happened several times, with millions of dollars of value swiped into thin air. Granted, the same thing can happen to your legal tender, but there is typically far more government protection and insurance coverage in place for your regulated accounts.
Technological Risks – As we touched on above, a system that was working pretty well in its development days has been facing some serious scaling challenges. As demand races ahead of supply, the human, technical and electric capital required to keep everything humming along is under stress. One recent post estimated that if bitcoin technology alone continues to grow apace, by February 2020, it will suck away more electricity than the entire world uses today.
That’s a lot of potential buzzkill for your happily-ever-after bitcoin holdings, and one reason you might want to think twice before you pile your life’s savings into them.
Then again, every investment carries some risk. If there were no risk, there’d be no expected return. That’s why we also need to address what evidence-based investing looks like. It begins with how investors (versus speculators) evaluate the markets.
What’s a bitcoin worth? A dollar? $100? $100,000? The answer to that has been one of the most volatile bouncing balls the market has seen since tulip mania in the 1600s.
In his ETF.com column “Bitcoin & Its Risks,” financial author Larry Swedroe summarizes how market valuations occur. “With stocks,” he says, “we can look at valuation metrics, like earnings yield. With bonds, we can use the current yield-to-maturity. And with assets like reinsurance or lending … we have historical evidence to make the appropriate estimates.”
You can’t do any of these things with cryptocurrency. Swedroe explains: “There simply is no tangible relationship between any economic or financial parameters and bitcoin prices.” Instead, there are several ways buying cryptocurrency differs from investing:
- Evidence-based investing calls for estimating an asset’s expected return, based on these kinds of informed fundamentals.
- Evidence-based investing also calls for us to factor in how different asset classes interact with one another. This helps us fit each piece into a unified portfolio that we can manage according to individual goals and risk tolerances.
- Evidence-based investing calls for a long-term, buy, hold and rebalance strategy.
Cryptocurrency simply doesn’t yet synch well with these parameters. It does have a price, but it can’t be effectively valued for planning purposes, especially amidst the extreme price swings we’re seeing of late.
What if I decide to buy some cryptocurrency anyway?
We get it. Even if it’s far more of a speculative than investment endeavor, you may still decide to give cryptocurrency a go, for fun or potential profit. If you do, here are some tips to consider:
- Think of it as being on par with an entertaining trip to the casino. Nothing ventured, nothing gained – but don’t venture any more than you can readily afford to lose!
- Use only “fun money,” outside the investments you’re managing to fund your ongoing lifestyle.
- Educate yourself first, and try to pick a reputable platform from which to play. (CoinDesk offers a pretty good bitcoin primer.)
- If you do strike it rich, regularly remove a good chunk of the gains off the table to invest in your managed portfolio. That way, if the bubble bursts, you won’t lose everything you’ve “won.” (Also set aside enough to pay any taxes that may be incurred.)
Last but not least, good luck. Whether you win or lose a little or a lot with cryptocurrency – or you choose to only watch it from afar for now – we remain available to assist with your total wealth, come what may.