Cryptocurrency: The SoFi Wealth Perspective
Interest in cryptocurrency, specifically Bitcoin, has taken off like a rocket in the last 30 days, spurred largely by the precipitous spike in Bitcoin’s price. While the interest is driving conversation, we feel there hasn’t been enough advice offered to individual investors of how to both make sense of the cryptocurrency boom and to make a decision on whether buying any is a good idea.
Bitcoin is network software that facilitates the secure exchange of digital tokens–called Bitcoins–among anonymous users of the network, anywhere in the world. This New York Times article explains how it works. Other cryptocurrencies work much the same way.
Cryptocurrencies act in some ways like actual currency and can be used to buy a limited number of things, but they are not created by or backed by any government. The full faith and credit of the US government stands behind the dollar. Bitcoin is not backed by anyone. It is hard to create more of most cryptocurrencies, so the interest in them has created demand that is difficult to match, and this has driven up their prices.
For those who got in early, the wild price swings in cryptocurrencies have given some investors huge, headline-grabbing gains. There have also been price swings of more than $3,400 between the high and low on a single day.1 This volatility has many claiming that cryptocurrencies are a “bubble.” John Foley, a CFP with SoFi, agrees that recent price movements have made these very risky, but adds: “While these currencies are pure speculation and have no fundamental value, there can be a place for speculation in an aggressive investor’s portfolio–as long as they understand and accept the risks. There is a real risk of losing a lot of money.”
So far, cryptocurrencies have been uncorrelated to traditional stock and bond markets and could provide portfolio diversification, in a similar way to commodities like gold. Unlike gold, however, these have a very short history and the long-term impact on a portfolio is not known.2
While SoFi Wealth advisors don’t recommend cryptocurrency, if our members want to take the plunge, we strongly suggest they limit their investment to no more than 5% of their assets and diversify among cryptocurrencies, such as Bitcoin, Litecoin, and Ethereum. “Don’t invest more in crypto than you can afford to lose,” said Foley. “These don’t belong in your emergency fund, college savings, or investments for short-term goals–like a downpayment on a home–where you can’t tolerate much risk.” They are unregulated and investors may have no recourse if their coins are stolen or their digital currency firm closes.
It is also important to monitor your crypto positions frequently. “This is a trade, not a long-term investment.” Foley says. “If you’re lucky and have a sudden, big gain, it might be smart to sell the amount of your initial investment and let your profits ride–play with the house’s money.” Remember that those rapid price movements go both ways.3 If you can’t stomach big moves down, this is not the investment for you. “This is speculation,” says Foley. “There is no complaining in speculation!”
The cost of crypto trading is another factor that many new investors may not be taking into consideration. The fees for buying and selling cryptocurrencies through some of the largest brokers are around 1% and sometimes can be as high as 10% on low dollar value purchases.4 This can significantly reduce their returns.
Additionally, any realized gains are taxed like capital gains on any investment–at your ordinary income rate if held less than a year or long-term capital gain rates if held longer. Like traditional investments, losses can offset capital gains and are deductible up to $3,000 per year. You’ll probably need to keep track of these gains and losses yourself since most crypto exchanges don’t send 1099s unless you are operating a business that gets paid in a cryptocurrency.
Foley said: “There is a lot of interest among our members in buying cryptocurrency and there may be a place for crypto in some people’s portfolios. We just want to help them understand what they are buying and the risks they are taking.”
Advisory Services offered through SoFi Wealth, LLC. Investments are not FDIC Insured, have No Guarantee and May Lose Value. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. SoFi Wealth does not render tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.
1 On 12/7/2017 per Bloomberg
4 Source: Coinbase