Can You Consider Bitcoin as an Investment for Your Portfolio?
The growth value of bitcoins has made many consider them for their portfolio
In 2013, bitcoin was being touted as the “next big thing.” It was being discussed as a disruptor to the entire banking system and was a new form of currency. The growth in value of it as a currency was staggering (see the pizza story later in this article). As a financial journalist, I considered the possibility that perhaps it could be considered an investment in a well-structured investment portfolio.
I wasn’t just a financial journalist. In my previous career, I had spent years as a Financial Consultant with a major asset management firm, advising clients on how to manage their portfolios in line with their financial goals and objectives. During the time that I was advising clients, the typical investments were stocks, bonds, mutual funds and possibly, some limited partnerships for those who wanted some “risky action” in their portfolios.
Managing and building a portfolio at that type was based upon managing risk by allocating assets among different asset classes, such as stocks or bonds. A typical allocation was 60 percent stocks to 40 percent bonds and the numbers would vary based on the risk you wanted to take on and the age of a client.
Many years after advising clients and when I was examining the question of putting bitcoins in my own retirement account, my approach was based not entirely on speculation, but with an eye on prudent asset-allocation strategies that I had always used for myself and my clients.
But before you could even get into the specifics of those asset allocation strategies, it’s important to recognize that bitcoin was something that didn’t fit neatly into the category of a stock or bond. Bitcoins were not either and actually at the time, few people had even begun to discuss its applicability into an investment portfolio, and thus define its category of investment, if in fact, it could be considered one.
However, for me, it was my belief at the time that since bitcoins had a dollar-denominated value and were trading on worldwide exchanges, they could be considered an investable asset and therefore, something that could find a place in my portfolio.
What Is an “Investable Asset”?
Let’s first examine what’s meant by an “investable asset” and if bitcoins could be considered as such. The most basic measurement of how well an investor or any individual is doing financially is through evaluating one’s net worth. Net worth is simply a measurement of how many assets you would have after you pay your bills off. It’s a basic measurement that any one who has ever had to balance a checkbook or sending a child to college has to consider.
The formula for Net Worth is Assets minus Liabilities.
In terms of liabilities, those are the debts that one has to pay to avoid prison, bad credit ratings or being forced out of your home. This can include bills, mortgages and credit card payments that must be paid.
Assets are typically your savings, investments and property (home, car, etc.) that you possess. In order to pay your liabilities, many of us must use our assets to generate cash for those debt payments.
Of course, it’s not easy to generate cash quickly from a property like a car or house, and we must use our bank accounts and investments to do that.
Property such as a car or house are often referred to as “illiquid” assets because they require a lengthy process to generate cash and the value or price of that asset is not as clearly defined as the price of an investment or case, which is known as a “liquid” asset.
The illiquidity of assets such as real estate or vehicles doesn’t diminish their status as assets, but the process of valuation and liquidation of these assets takes time and doesn’t allow to quickly hit a bill’s due date or invest in a great stock tip. Because of the ability to use the “known” cash value of our savings and investments easily either to pay debts or acquire more assets, they are considered to be “investable assets”.
The process of adding all of your savings and investments together, without considering “illiquid” assets provides you a way to understand the amount of money you have without the need to liquidate personal property.
For an investor, having the ability to understand what the value of an “investable asset” is at any point in time, allows you the ability to buy appropriate investment opportunities and sell others when changes require it. In this way, you can effective manage your investment portfolio when the situations require changes.
I used to advise clients that it’s prudent to only buy investments for your portfolio that you could find the value of in a daily newspaper. The price of stocks and bonds are found each day in the newspaper and their current price during the day is found on the many exchanges that they trade on. Therefore, you always have an idea of what you would sell or buy an asset for. Assets such as real estate and other property are subjective and require a buyer on the other side of the transactions who acknowledges that your valuation of an asset matches theirs.
Let’s go back to my consideration of bitcoin as an “investable asset”.
The Most Expensive Pizza Ever!
When bitcoins began, it was difficult to understand the inherent value of a single bitcoin for pricing purposes. One of the first examples of using bitcoin as a currency to purchase something was the famous pizza purchase of May 22, 2010. This is actually a day that is celebrated by many in the bitcoin world and is known as Bitcoin Pizza Day.
At that time, bitcoin was being used more as a barter instrument among those in the developer and programming world. Bitcoins were being created through computers that ran the program and these were used to pay other programmers for their work. When the technology was approximately one-year-old, Laszlo Hanyecz, a programmer made the leap of paying a fellow user on an internet forum 10,000 BTC for two Papa John’s pizzas.
Considering that bitcoin had reached a high price of over $1,000 in November, 2013, the value of those pizzas were over $10 million. Now that truly warrants its own holiday!!
The time between the pizza purchase in 2010 and the $1,000 high in 2013, was a time that bitcoin became more widely used as a form of currency primarily due to the ability to own bitcoin through an exchange rather than the previous manner of gaining them exclusively through mining for them. The exchange that allowed for these bitcoin transactions was Mt. Gox (which had originally began as a site to sell and trade cards from Magic The Gathering, thus the name of the exchange).
Is It an "Investable Asset"?
The rise and fall of Mt. Gox has been part of the history of bitcoin, but the important aspect that should be taken away from it is that it created the first widely used method of trading dollars and other currencies for bitcoin. Mt. Gox was an exchange that allowed people to know what people were willing to buy and sell bitcoin for on a 24-hour basis. The collapse of Mt. Gox didn’t kill off bitcoin (although many people still believe that) as other exchanges filled the void and now anyone can buy and sell bitcoin on a 24-hour basis through numerous exchanges.
Because of this ability to value bitcoins and either purchase or liquidate them easily, it seems fair to me that it should be considered an “investable asset.”
But could it really be considered for a portfolio in the same manner as an equity or bond? After all, there are thousands of analysts writing each and every day about equities and there’s a lengthy track record for those investments. The number of analysts covering, the amount of available bitcoin for purchase and the daily transaction levels of these exchanges were nowhere near the same as stocks or bonds. If I was to consider bitcoins as an “investable asset," it would have to also be considered a much more speculative investment.
Bitcoin Is an “Alternative Investment”
It’s fair to say at this point that in terms of an investment vehicle, bitcoin is speculative and thus it could be considered as appropriate for the alternative investment sleeve of my portfolio. After all, advisors were (and still are) advising clients to have a small portion of their portfolio (typically around 10 percent) invested into "non-correlated" assets such as gold, real estate or hedge funds to protect in order to manage the risk of your portfolio.
Alternative investments are those assets in a portfolio that provide a lack of correlation to the majority holdings of equities and bonds in an individual’s portfolio. In this manner, the alternative investment portion of a portfolio can act as a “shock absorber” in times of market turmoil by having one aspect of the portfolio (hopefully) respond differently to that turmoil.
Many may say that bitcoins may not belong in an investment portfolio but the success of the ETF, GBTC which has traded at levels of 50 percent above its new asset value, shows the appetite that investors are having for it. However, it’s still a young asset and implementing prudent asset allocation strategies in your account should take precedent to chasing the “next big thing.”