Why Not Cryptocurrencies?
This post was written by Audrey Keohane, a Summer Intern here at Woodside Wealth.
Cryptocurrencies: they seem to be everywhere right now, yet people still don’t know what they are or what to do with them. Cryptocurrencies are new, exciting and risky; something that may pique the interest of someone trying to make some quick money. As financial advisors, it is very important that we do not immediately ignore these currencies or write it off as a fad. Instead, we aim to become familiar with them, and educate our clients to help them make an informed decision. A few of our clients have asked for more information about these “currencies”, and in that it appears we are not alone: In FPA’s 2018 Trends in Investing survey, it was found that 53% of planners had been asked about cryptocurrencies by their clients in the past six months.
In order to dive deeper into how these currencies work, we must first understand the basic definitions involved. First, cryptocurrencies could be described as digital currencies that have been “mined” by people or organizations, rather than issued by the government. Mining is defined as a way in which transactions are approved or added to the public ledger. We must also understand that blockchain technology is the system for the digital transactions without the need for a third party. The “miners” who verify bitcoin transactions and add them to the blockchain are rewarded for their work with small amounts of bitcoins. Bitcoins are supply limited, there cannot be more than 21 million in existence. This scarcity, combined with the difficulty in obtaining bitcoins, is what give bitcoins their value.
However, recently bitcoin’s value has been controlled almost entirely by speculators, or short-term traders who are willing to take a risk on the price of bitcoin going up or down in the future. These people, who hold almost half of the bitcoin in circulation, are aiming to make money off of any price changes caused by news and other related events. Their short-term mindset causes them to overreact to every event, positive or negative, in order to try and capture any gains they have accumulated or minimize losses. When this occurs, the price of bitcoin often swings wildly, sometimes increasing rapidly, which causes bitcoin to show up on the radar of individual investors looking for the next “hot” stock or technology.
In the same FPA 2018 survey mentioned earlier, only 1.4% of planners recommend investing in cryptocurrency. However, some clients may disregard the recommendation not to invest, and instead insist on putting some money into it. In this situation, investors should meet both of the following recommendations. First, they should have spare money that they are willing to gamble on a risky asset such as this. In these cases, only a small amount should be invested, and it should not have any affect on retirement savings if the money is lost. They should have a financial plan showing a secure retirement and they should already be taking full advantage of all tax-advantaged retirement savings accounts before diverting any money into these cryptocurrencies. Additionally, they should a vast understanding of cryptocurrencies, their inner workings and associated risks. In 2014, a Bitcoin exchange called Mt. Gox, failed after they revealed that 850,000 Bitcoins, or $450 million worth, had gone missing. The company later liquidated, and bankruptcy claims totaled $2.4 trillion. The company ended up paying back $91 million from the sale of their assets, a return of about 4 cents on the dollar. The cryptocurrency industry is still tainted with a lack of regulation and therefore it is possible that cryptocurrencies will continue to be plagued by fraud and mismanagement in the future.
If you are to invest, it is important to note the tax implications surrounding cryptocurrencies. The IRS views these as capital assets and therefore the gains made are taxed. Therefore, any gain made through these investments must be reported, although it was found that less than 0.04% of people report these gains.
Estate planning is another area that is affected by the ownership of these digital currencies. There two things to keep in mind when looking ahead: 1. Passwords to online accounts must be recorded and included in their instructions on how to access their earnings after their death. And 2. Treat the cryptocurrencies as personal property and designate who they will go to after death as part of their taxable estate.
While most financial planners agree that it is not the smartest move for most people to invest in cryptocurrencies, many believe they have potential stick around and grow into something worth investing in. For this to happen, they must first be regulated to become less volatile and risky. They must also become easier to understand to allow most people to make more informed investments choices. However, until this happens, financial planners and clients alike should be wary when talking about investing in cryptocurrencies. While they may seem intriguing, getting too caught up in it could cost you a comfortable retirement!
Click here to read the full article from the Journal of Financial Planning.