Is Bitcoin a Good Investment?

Legendary investor John Templeton famously said, “The four most expensive words in the English language are “this time it’s different.” But every couple of decades or so, a new generation of self-proclaimed visionaries manages to successfully persuade a large swath of the investing public that THIS time it really is different. It happened in the late nineties when investors became temporarily convinced that any new company with dot com at the end of its name was destined for success. And now it’s happening again with the ascension of cryptocurrencies like Bitcoin and so-called meme stocks like GameStop, AMC Entertainment and Blackberry.

So, is it different this time? Are these really compelling investment opportunities? And can their soaring prices really be justified? Frankly, it’s difficult to make that case in this moment. Bitcoin and other cryptocurrencies look much more like high-risk speculations at this point. They are extremely expensive compared to their estimated current usage and have limited practical utility at this stage. Investors are paying a premium for them on the expectation – or perhaps just the hope – that they will achieve widespread adoption in the years ahead. Similarly, most meme stocks are selling at staggering multiples to their current earnings. Their stock prices, in other words, seem entirely disconnected from the underlying businesses.

Why is this happening? A combination of factors is fueling the boom:

• Technology now allows people to trade more easily and inexpensively than ever before. As in on their phone, for free. And history has shown that speculation increases when barriers to speculation are reduced or removed by technology.
• Abundant stimulus and relief funds during the pandemic gave people who were still employed extra money to invest. Add to that the fact that most were spending less and had more time on their hands during the pandemic and the outcome is predictable. At the end of the first quarter, total U.S. bank deposits stood at $18.5 trillion, $2.7 trillion more than a year ago.
• The increasing popularity of online investing communities is attracting more millennial and Gen Z investors, many of whom have a higher comfort level with the concept of digital assets and an admitted distrust of traditional financial institutions like banks and brokerages. According to a new CNBC Millionaire Survey, nearly half of millennial millionaires have at least 25 percent of their wealth in cryptocurrencies.
• Finally, adding fuel to the fire is the FOMO phenomenon. Soaring profits and stories of overnight fortunes made trading crypto and meme stocks have created a gold rush mentality that has lured more inexperienced investors to the table and pushed prices even higher. 

In 1996, Federal Reserve Chairman Alan Greenspan coined the phrase “irrational exuberance” to describe the burgeoning internet-stock bubble. Those who heeded this very gentle and somewhat cryptic warning missed out on three more years of soaring prices. But those who did not ultimately paid a much higher price when the bubble finally burst in early 2000. By October of 2002, many former dot com darlings were out of business, and the Nasdaq stock index on which most of those companies traded had declined almost 80 percent from its peak.

Will cryptocurrencies and meme stocks be the dot com bubble of this generation? It’s probably too early to make that determination, but there are some troubling similarities, as well as some new factors which could potentially exacerbate the bursting of this bubble. The most obvious similarity between the two eras is the easy willingness of those speculating in these assets to suspend disbelief. By definition, that is the “intentional avoidance of critical thinking or logic in examining something unreal or impossible in reality in order to believe it for the sake of enjoyment.” As in not worrying about the fact that internet stocks in the ‘90s had no earnings and were losing money every quarter, or the fact that meme stocks today are selling for prices that cannot possibly be justified by their meager current earnings and absence of inspiring turnaround strategies.

But that’s where the similarities begin to diminish. The ‘90s internet bubble was inflated, at least in the beginning, by naïve, true-believer investors convinced that the internet was going to change the world (they were right about that) and that those companies that had the foresight to develop their business model around that inevitability first were destined for wild success. They were only partly right about that part – it turned out that having a viable business plan and being able to execute on it matters even in times of revolutionary upheaval.

The meme stock bubble has been largely inflated not by investors who truly believe in these companies, but by waves of short-term traders attracted largely by the huge upward price moves in these stocks and banking on the greater fool theory – the idea that there will always be someone out there willing to pay more than they did. Yes, it’s true that the first big moves in some of these stocks were the result of small online investors united by their desire to stick it to Wall Street types who were “shorting” the stocks (betting their prices would decline), but that’s long since given way to the hyping of these stocks via the social media memes from which their name is derived as more savvy opportunists seek to profit from artificially inflating prices and then cashing out. Remarkably, the average daily value of shares traded in AMC Entertainment Holdings, the struggling movie theater chain, reached $13.1 billion in June, more than that of tech giants Apple ($9.5 billion) and Amazon. ($10.3 billion).

A case can be made that Bitcoin is a somewhat different story. Many of those investing in Bitcoin more closely resemble the true believers of the early internet-stock period. They are convinced of the merits of the blockchain technology that underlies Bitcoin and, in some cases, passionate about the potential benefits of a decentralized monetary system. But even the most informed of these enthusiasts will acknowledge that they have no idea what Bitcoin or other cryptocurrencies are actually worth, or whether they will ever achieve widespread acceptance. It’s also worth noting that there are prominent non-believers. Minneapolis Federal Reserve Chairman Neel Kashkari recently opined that “Cryptocurrency is 95 percent fraud, hype, noise and confusion.” And just as was the case with internet stocks in the ‘90s, the true believers have, over time, been overrun by millions of short-term speculators attracted only by the possibility of turning a quick profit. 

In fact, there is some evidence that meme stock speculators and cryptocurrency speculators may, at least in some cases, be the same people. In a recent Barron’s Advisor article, Steve Sosnick, chief strategist at Interactive Brokers, expresses the belief that meme stocks tend to trade inversely to cryptocurrencies because their fans rotate from one to the other as the momentum shifts. This pattern is certainly more indicative of the behavior of short-term speculators than of long-term investors and is likely to perpetuate the extreme volatility that has been characteristic of both cryptocurrencies and meme stocks.

So what should individual investors make of all this? First and foremost, it’s important to understand that this time isn’t really all that different. Cryptocurrencies and meme stocks do not offer some magical shortcut to financial independence. Meme stocks in particular seem to offer a poor risk-reward proposition with their high prices and the murky future prospects of most of the underlying businesses. Worse yet, the speculators whose buying is driving the prices up don’t really seem to have any conviction about the long-term prospects of the companies. That means they will be more likely to bail when prices inevitably dip. That’s called “selling low” and it’s not a recipe for long-term investment success.

The Bitcoin story is considerably more nuanced and complex. Investing in Bitcoin now is a speculation that comes equipped with a healthy amount of risk, but it is based on the plausible narrative that bitcoin, which today is just a non-sovereign and, counterintuitively, very volatile store of value, can eventually become a viable decentralized global currency. Just how plausible that narrative is depends on who you ask. But the very fact that a cogent story to support the potential rise of Bitcoin exists and that there are well-informed investors who are willing to make a calculated bet on it makes it less likely that Bitcoin will quickly go the way of the dinosaurs than many meme stocks.

Does that mean that you should load up your investment portfolio with Bitcoin? Definitely not. Speculative investments are classified as such because it’s more likely that they will fail than succeed. Yes, the potential payoff can be a powerful lure. But so can the craps table at a casino in Vegas or a lottery ticket you purchase at the corner store – and nobody in their right mind would wager their entire financial future on those paying off.

That’s precisely why First Command does not and will not pursue speculative purchases with the capital entrusted to us by our clients. While the price moves in such trades can be exciting, they can also be permanently destructive to building long-term wealth. As explained in greater detail in this paper published earlier this year, Bitcoin and other cryptocurrencies simply do not meet our standard for investing in tangible businesses backed by real assets.

It won’t give you the adrenaline rush or the entertaining stories that you might get from trading meme stocks and crypto, but working with a knowledgeable financial advisor to construct a well-diversified investment portfolio that’s aligned with your goals and tolerance for risk offers a much more attractive risk/reward proposition. But if you’re racked with FOMO and feel like you simply must get in on the Bitcoin craze, there are now ways for small investors to participate. If you’re even considering that possibility, here are some suggestions on how to do so in a judicious and responsible way:

1. Never invest in something you don’t understand. Reading online endorsements from amateur investors does not qualify as research.
2. Don’t invest more than you would be comfortable losing.
3. Don’t “borrow” from your primary long-term investment program – in terms of either lump sums or monthly dollars – to speculate in more risky investments.
4. Set a limit for how much you will invest in speculative assets and don’t exceed it. When it comes to high-risk investments like Bitcoin and meme stocks, it’s probably best to treat it the same way you would the gambling money you set aside for a Las Vegas junket.
5. Make your financial advisor aware of your plans to speculate so they can advise you and ensure that the risk level of your overall portfolio is in sync with your investment time horizon and personal risk tolerance.

A surprisingly high percentage of the amateur investors who have been dabbling in meme stocks say they do so because it’s a form of entertainment. The problem is that it’s likely to become less and less entertaining to them if prices take a sustained dip. So before you decide to take the plunge into high-risk investments, consider alternative forms of entertainment. Like going to a nice restaurant, buying tickets to a game, or taking a vacation with your family. None of them will make you rich, but you’re guaranteed to at least get something in return for your money.

The opinions expressed in this article are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. Risk is inherent in the market and the value of your investment may be more or less than its original cost at any given time. Your investment returns will be affected by investment expenses, fees, taxes and other costs.

This article is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this article as the sole basis for investment decisions. Never select an asset class or investment product based on performance alone. Past performance does not guarantee future results and should never be the sole basis for selecting an asset class or specific investment. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Should you require investment advice, please consult with your financial advisor.