Cryptocurrency assets are here to stay. Bitcoin, Ethereum, Dogecoin, Litecoin, Ripple …. There are several thousand options currently available, with new ones being launched almost daily. They are not a fad, nor are they a Ponzi scheme – if selected wisely.
The reality is that crypto assets are real, and they deserve a place in your financial plan.
The invention of blockchain technology in 2009 began a cycle of innovation that will continue to revolutionise financial services – and other industries – for many years to come. It’s quite hard to wrap your head around what exactly a blockchain is and what it does, but it’s basically a decentralised online database, where each data point is arranged chronologically, linked to the block that came before and to the block ahead in the chain. In simplistic terms, cryptocurrencies like Bitcoin use blockchain technology to record a ledger of transactions and thereby keep the asset secure.
It’s all quite technical, but the take-home message is that cryptocurrencies have become safer and more accessible than ever before. It’s time to take them seriously as an asset class.
It’s all about the asset class
Financial wealth is represented by the assets you own. This can be your house, a business, retirement savings …. Each asset has intrinsic value, and each counts towards your net worth. But not all assets are equal, which is why you need to categorise them. In doing so, you will be able to objectively manage the risk and return on each asset category.
A well-structured financial plan generally allocates wealth into four broad asset categories, the total of which represents your net worth. These categories are:
- Business assets: Investments that generate a source of income, like an actively-managed business; a rental property; or your profession, which earns you a salary.
- Lifestyle assets: Investments we use to enjoy the life we choose to live; like our homes, cars and furniture.
- Lifetime assets: Investments like your retirement portfolio, which funds your lifestyle when you are no longer able to earn an income.
- Legacy assets: Investments that you don’t have to rely on to fund your lifestyle or your retirement – assets you’re likely to leave to your beneficiaries.
It’s usually quite easy to decide which category an asset falls into. Take your primary residence, for example. It certainly has value, and it may well appreciate over time, but it’s more important as a place of safety and security for you and your family, which is why it’s classified as a lifestyle asset.
But it’s not so simple when it comes to crypto assets – the new kid on the block. You could call crypto an “investment” and leave it at that, but that would be a cop-out. Remember, all wealth needs to be categorised to have meaning and purpose. So, which asset category does crypto fall into?
- Business asset? Are you mining Bitcoin? Is this a business that you’re actively managing, which is generating an income? For a very small minority of people, this might be the case. If your crypto investment falls into this category, you should have a business plan for capital investment, operations and budgeted returns, and for how you’ll manage risk like fraud and business continuity.
- Lifestyle asset? Many people are dabbling in cryptocurrency trading – they’re the ones who like to discuss Ripple vs Ethereum around the braai. If you think of your crypto investment as a status symbol, it should be categorised as a lifestyle asset, like a car – not something you rely on to generate an income or contribute to your retirement plan. If this is the case for you, make sure you set a reasonable limit on how much you plan to invest.
- Lifetime asset? If crypto is a part of your retirement plan, how much should you allocate to your total portfolio – 1%, 10%, more? You need to factor in the price volatility and the unpredictable valuation of crypto assets. Remember, your lifetime assets are your safety net – the bucket of capital that you can draw on when you no longer earn an income. Lifetime assets should therefore be a safe bet, the get-rich-slowly type of asset that is predictable and won’t throw any surprises your way. We would highly recommend consulting with a Certified Financial Planner® to provide you with professional advice in this regard.
- Legacy asset? If your cryptocurrency investment doesn’t fit into any of the first three categories, then this is likely where it will fall. The legacy category is a catch-all asset class: the investments you’re not counting on to fund your lifestyle or your retirement; something to have a little fun with. If you’re lucky, you might leave something for your beneficiaries, and if not, that’s also okay. Most crypto investors fall into this category.
Be bold, but also be careful
With the rise of crypto featuring so prominently in the media, it’s difficult to sit on the side-line and not be part of the action. You don’t have to either, so long as you’re clear about where your crypto investment fits into your wealth creation plan.
In the long run, cryptocurrency will be a core component of any diversified portfolio, but we haven’t quite reached that point yet. All crypto platforms are currently unregulated in South Africa and financial planners are not allowed to give specific advice about how to invest.
What we can advise is cautious experimentation. Don’t cash out your retirement annuity to buy Bitcoin.
But if you do have some spare cash lying around and crypto is your legacy asset, then give it a try. The more you know about the asset class of the future, the better.
Ricardo Teixeira CFP® is chief operating officer at BDO Wealth Advisers