SBJ: "Should I Buy Bitcoin And Pot Stocks?"

"Should I Buy Bitcoin And Pot Stocks?"

Industry Insight

 
 

We frequently hear variations on that question: “should I invest in 3D printers?” or “I heard on TV that Company X stock is set to take off…should I buy?”

The current shiny object is the eye-popping growth in the value of Bitcoin and other “cryptocurrencies”—digital money enjoying increasing popularity as an alternative to traditional banking. And as more States legalize marijuana, there is a lot of buzz about “pot stocks”—tiny new companies trying to take advantage of a growing market. All puns intended.

Whatever the trendy new investing opportunity, our response is the same:

First, a new industry or freshly-launched company stock is a speculative investment with a relatively strong risk of loss. Speculative investments may have little or no track record, or may not be well diversified, or may have additional types of risk that make them unsuitable for many investors.

To be clear, the broader well-established investment markets—stocks and bonds on the major exchanges, mutual funds, exchange traded funds—may be much less speculative, but there are still risks, including the risk of fluctuations in value, or even loss.

But with speculative investments like cryptocurrencies or pot stocks, or the contraption your uncle invented in the garage, the risk is greater for major price fluctuation or loss. Liquidity is another potential problem for a thinly-traded investment as you may wait a long time for a buyer when you’re ready to get out.

Having said all that, you could make a killing if you pick the right pot stock, or the right cryptocurrency, at the right time. The problem is that stock-picking and market timing generally don’t work, as shown by decades of academic research. Think back to the Betamax v. VHS videocassette era if you’re old enough to remember…which would you have chosen as an investment before knowing the outcome? Your chance of winning would have been a coin flip. Which of hundreds internet companies would you have added to your portfolio in the late ‘90’s as the tech bubble inflated? Which ones are still standing? Your odds there were perhaps much worse than a coin flip.

The problem with trying to outsmart the investment market is that publicly traded securities in the U.S. are strictly regulated, with issuing companies required to provide very specific information at specific intervals, such as quarterly reports…and additional “insider” information-sharing is strictly prohibited. Management shakeups in the news, or new products, add widely available publicly information to official company reports. So generally all investors have access to the same information at the same time, by law.

Thousands of professional investment managers around the world then analyze that data to determine what they believe to be a fair price. Thousands of resulting trades set the price of a given stock from moment to moment, as new information comes out over time. This including information and opinions shouted by people in rolled-up sleeves on cable shows.

So to beat the market, you have to be smarter or luckier than the average of tens of thousands of investors around the world, all working from the same information. Do you think you are smarter or luckier than those thousands of traders, most of whom are professionals who analyze and trade stocks and currency markets all day for a living? If not, proceed carefully.

If instead you simply buy a broad basket of stocks and bonds using mutual funds or ETF’s, for example a total-market fund holding a large swath of securities, you will essentially be accepting the collective expertise already at work within the markets. You will likely also eventually own a portion of newer industries and companies which have profited their way onto the major securities exchanges, including pot stocks and cryptocurrencies…in proportion to the place they have earned in the investing marketplace.

Other examples of speculative investments include art, collectibles, thinly traded small- or micro-company stocks in any industry, and gold and other precious metals. (Many people mistakenly believe gold is a conservative, stable investment—but prices for gold and other precious metals are often extremely volatile. Again, if you own a broad basket of securities, you probably already hold a portion of precious metals, and/or companies which use those metals, in manufacturing for example.)

The unexpected micro-crash of Bitcoin values in December, and the U.S. Attorney General signaling a possible return to more aggressive enforcement of marijuana laws, should give pause to even the bravest speculator thinking about cryptocurrencies or pot stocks…let alone us “regular” investors.

Treat speculative investments as you would treat any individual company stock: a good rule of thumb is not to put more than about 5% of your portfolio into any single potentially volatile asset, including a speculative flavor-of-the-week.