At its fundamental level, the goal of investing money today is to someday in the future receive a greater amount of capital, or return, on that initial outlay. The future might include plans to make a big purchase like a car or a house, but that’s usually for retirement. Investors need to think about which assets to own in order to increase their chances of achieving their financial goals.
The opportunity set consists of stocks and bonds. But recently, a new asset class has emerged as a possible investment option. Let’s take a closer look at whether or not cryptocurrencies should be part of your retirement plans.
The answer varies for everyone
Since Great Recession ended in 2009, investors had to deal with a historically low interest rate environment, making the search for yield a top priority. For fixed income investors, this has been a difficult situation. But for equity investors, the easy money policies of the past decade have resulted in the S&P500 producing an annualized total return of 13.2% over the past 10 years. This performance easily outperforms the historical return of the broad index by approximately 10% per year.
But cryptocurrencies promise even greater fortunes for those bold enough to follow the trend. Bitcoin and Ethereum, the two most valuable digital assets in the world, have produced five-year returns of 942% and 604%, respectively. Those numbers easily top the S&P 500, catching the eye of those looking to invest in the nascent asset class.
If you are a younger person who is decades away from retirement, I think it would be quite prudent to allocate a certain percentage of a well-diversified portfolio to cryptocurrencies. How much depends on your risk tolerance, but I would say no more than 5%. As you become more comfortable and knowledgeable about the space, increasing this allowance might be the right move. A younger person can afford to take more risks and be more aggressive thanks to a longer time horizon.
Someone nearing or in retirement, on the other hand, should be much more conservative in their investment approach. In fact, I would go so far as to suggest avoiding cryptocurrencies altogether. The reasoning is quite simple. Cryptocurrencies are incredibly volatile, as many observers know. The entire digital asset market has lost around two-thirds of its value in the past eight months. Having a large sum of money invested here that you will need in a short time is probably not a smart decision.
Then there is the idea of stake your crypto or invest it in decentralized finance protocols with the intention of earning a return, like a fixed income instrument, on your assets. While the rates paid to investors here can be much higher than what is typically offered in the traditional financial services industry, the risks are undoubtedly greater.
For one, the investor protections provided by the Federal Deposit Insurance Corporation or the Consumer Financial Protection Bureau are non-existent in the crypto world. Moreover, we see today how bad things can go. Struggling crypto lender Celsius just filed for Chapter 11 bankruptcy protection and has frozen customer accounts for nearly a month due to market conditions.
Someone earlier in their investment journey has plenty of time to recover financially if they experience a major drop in their crypto assets. A retiree, however, is not so lucky. As with all financial decision-making, one must assess risk tolerance, time horizon and annual cash outlay. Knowing this essential information will help determine the types of investments that will be made, leading to the ultimate goal of financial freedom.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.