When it comes to cryptocurrency, how should you treat it differently than other assets in your portfolio?
That isn't to say that everyone is approaching cryptocurrency ownership and investment strategically. There's a difference between buying a few hundred dollars' worth of bitcoin and using a crypto exchange like Coinbase to build out your portfolio the way rappers, athletes, and the ultra-wealthy do with exquisite art, high-end watches, and rare footwear.
Many financial planners would say this: if artwork, sneakers, and other alternative assets are considered speculative or volatile, crypto appears to be the Wild West.
At least, that's what Lazetta Rainey Braxton, a certified financial planner in New York and co-founder of the financial planning business 2050 Wealth Partners, believes.
"There are new crypto groups, new coins coming out, new taxes, and new platforms," Braxton explains. Some people buy cryptocurrency through applications or the internet, while others buy it on famous exchange platforms with the intention of holding on to it if its value rises.
So, how should a person treat cryptocurrency in comparison to their cash savings and securities? And, if you're interested in investing in crypto, how much of your portfolio should you allocate to this new asset class?
Adding cryptocurrency in a portfolio
The proper amount to invest in crypto, according to Braxton, is “generally not more than what you're willing to lose.”
Meanwhile, Dave Abner, the global head of business development at Gemini, a cryptocurrency trading software, sees bitcoin as neither an asset class nor a currency, albeit "there are chunks of it that people use to purchase and sell things," as he puts it.
This kind of nuance is what draws people to crypto in the first place, but it's also what makes it so perplexing.
While Abner does not consider himself one of the "crypto OGs" (original gangsters) like his bosses, Cameron and Tyler Winklevoss, he can speak to how people initially thought about adding cryptocurrency to their investment portfolio when bitcoin first became famous in the early 2010s.
"The first thing people heard about bitcoin was as a potential inflation hedge for their portfolio and very much as a substitute for gold," Abner adds.
The fundamental feature of bitcoin that makes it an inflation hedge is its fixed issuance, he says. There will only ever be a limited number of bitcoins available — 21 million to be exact.
"At a time when the United States is printing a tonne of money and advisors are wondering about what they can do to protect the true value of their portfolios," Abner says, the built-in scarcity surely turns heads.
Crypto, in addition to its potential as an inflation hedge, is based on blockchain technology, which has a lot of potential as an infrastructure system that is more efficient than anything we've seen previously. We've already begun to glimpse the potential of non-fungible tokens (NFTs), which have sparked discussions about a more efficient approach to issue smart tickets and property rights.
About the crypto world and blockchain technology, Abner adds, "It's a more current type of platform for businesses and transactions to take place on and to be recorded on."
Approaching a crypto investment
Despite the potential of crypto and blockchain technologies, many financial consultants and planners advise clients to keep crypto in their speculative portfolios. Braxton advises clients to keep their crypto investments to no more than 5% of their overall portfolios and to do their homework before purchasing. That means starting with the basics: a healthy emergency fund, a retirement account like a 401(k) or an individual retirement account (IRA), or both, and a passive brokerage account with index and exchange-traded funds (ETFs). Braxton advises that you use your crypto money as "play money."
Braxton does note, though, that a person's risk tolerance has a role in whether their "play money" starts at $50 or $5,000. Your risk tolerance is determined by a variety of factors including your personality, overall "gut check" attitude toward volatility, and, of course, your financial safety nets. Braxton cautions against spending your entire life assets on cryptocurrency, but if you can afford to engage, the potential rewards are substantial.
Tax implications TBD
Those who bought bitcoin years ago and haven't spent it yet, for example, may be sitting on a substantial profit. According to Abner, the tax ramifications of selling a large quantity of coin for a huge profit are so new that many are waiting to see what kind of gains taxes they will due before selling it.
“Many people who have made those gains are hesitant to sell. So if you bought bitcoin for $100 and it's now worth $45,000, you've made a profit that could result in a huge tax burden down the road," he explains.
It's still unclear how much those tax bills will cost. There isn't much clarification on the tax ramifications of selling cryptocurrency right now, but it's coming.
But no one wants to be the test subject. If your clients' crypto holdings are driving you crazy, Abner suggests an unusual alternative: "Rather of selling, [they] may wish to hold the asset and use it in a different way." It's almost like if you own a priceless painting. You could use it as security and go out and buy a house, paying down the mortgage in dollars. Traditional loans are now available using [crypto] as collateral."
Just keep in mind that, while the crypto market is constantly changing and innovating, the fundamentals of financial well-being stay the same. As Braxton suggests, have your clients tick all the typical saves and investment boxes, but then assist them choose a safe amount to invest in crypto, almost like an alternative investment – and always double-check the taxes.
