“Should I buy bitcoin?”
This is the question everyone is asking. Is it a good price? Will the bitcoin price go up in the future? If so, by how much?
No one can predict the answers to these questions, because blockchain-based investments like bitcoin are a new asset class. We simply don’t know the rules.
But we do know the rules for investing. They were laid out in 1949 by the Columbia economics professor Benjamin Graham in his classic book The Intelligent Investor. Graham’s strategy is called “value investing,” and it built the fortunes of great investors like Warren Buffett and Sir John Templeton.
Though there are many types of value investors, what they have in common is investing in great companies at a discounted price, companies whose stock price is a great “value.” While many investors look to “buy low and sell high,” value investors use disciplined analysis to find the “lows” and “highs.” This involves betting against the crowd.
The classic value investor also keeps a portfolio of both stocks and bonds to hedge against risk. Since bond prices generally go up when stocks go down, and vice versa, holding a mix of both — and periodically rebalancing that mix — provides safety against wild market swings in either direction.
But which stocks? Which bonds? In the modern update to The Intelligent Investor, the Wall Street Journal financial columnist Jason Zweig suggests holding the majority of stocks in a total stock market index fund, to diversify across the entire stock market. For bonds, he suggests a total bond index fund.
He does allow, though, that a portion of one’s stock holdings can be used for “mad money,” i.e., picking individual stocks, or precious metals, or even alternative investments. Thus, The Intelligent Investor portfolio today might fall somewhere between these two bounds:
It is in the slice of the pie called “alternative investments” where we can enjoy a taste of bitcoin. Bitcoin is the alternative investment that has seen magnificent returns over the past several years when most financial advisors did not even know what it was.
The approach here is to consider bitcoin (and cryptocurrency) as a slice of the investment pie. Of course, investors should not put more into bitcoin than they are willing to lose completely — and if they do, they see it as “tuition paid.” On the other hand, most can afford to lose a small slice of the pie.
Including a bit of bitcoin within an investment portfolio allows the investor to learn about this new asset class, and potentially enjoy enormous gains that bitcoin has seen since starting at just a few pennies in 2010 and growing to over $5,000 today.
Another advantage to this investment strategy is that bitcoin is not correlated with other investible assets like stocks, bonds, precious metals, and the like. In other words, while bitcoin does experience wild price fluctuations, they are largely independent of other markets, making it a diversification tool.
The biggest drawback is that bitcoin cannot be purchased through traditional online brokerages; you can’t buy bitcoin at E*Trade yet. The investor needs to purchase bitcoin through online blockchain exchanges like Coinbase or bitcoin lending platforms like xCoins.io. The intelligent investor, then, might hold in his or her portfolio:
- 45% total stock market index fund (like Vanguard Total Stock Market Index, VTSMX)
- 45% total bond market index fund (like Vanguard Total Bond Market Index, VBMFX)
- 10% bitcoin
- One who puts his money in stocks only;
- One who puts her money in stocks, bonds, and 2% bitcoin (the “conservative” portfolio above);
- One who puts his money in stocks, bonds, and 10% bitcoin (the “aggressive portfolio above).
Here is a chart showing their three-year returns from September 1, 2015, through September 1, 2018.
The “aggressive” portfolio nearly tripled the value of the stock-only portfolio. Even the “conservative” portfolio outshines the stock market over the past three years. It also hedges risk by holding half stocks and half bonds.
Beyond Bitcoin: Diversifying Blockchain Holdings
The easy way to invest in cryptocurrency, as we’ve shown above, is to simply buy and hold bitcoin. However, the intelligent investor may want to further diversify his or her alternative investments into other cryptocurrencies.
Let’s take the 10% “alternatives” of the Aggressive Portfolio and now further diversify it into the top three cryptocurrencies: Bitcoin (5%), Ethereum (2.5%), and Ripple (2.5%). The new allocation looks like this:
After just three years, the portfolio has multiplied an astonishing 9x. That $10,000 has grown to over $90,000—while still being protected against risk!
This assumes a one-time investment in 2015, then patiently allowing the gains to accumulate. This demands that investors wait out the huge roller coaster swings of the crypto market, avoiding the temptation to buy at every new high and sell at every new low. It requires patience and confidence.
To hedge against this psychological risk, there is another approach that is proven to deliver even bigger returns: investing the same amount every month, or dollar-cost averaging.
Dollar-Cost Averaging: The Easiest Way to Invest
Let’s use a simple stock market example (no bitcoin). Instead of a one-time investment of $10,000, imagine the investor splits that $10,000 over 36 months, investing a fixed amount of $833 per month in the S&P 500. This is invested like clockwork, regardless of what the market is doing; it’s on autopilot.
After three years, that $10,000 one-time payment has grown to a little less than $15,000—but nearly $30,000 if split into monthly installments.
This technique is known as “dollar-cost averaging,” and it is the best approach for most investors for a few reasons:
- You put the same amount in each month, sometimes buying more (if prices are low) and sometimes buying less (if prices are high). In this way, you end up buying the “average.”
- This avoids you making a one-time investment when the market is high (and you never know if the market is high until later). You don’t have to worry about “timing the market.”
- It also easier psychologically. When prices are low, you have the satisfaction of buying more—and when prices are high, you have the satisfaction of prices being high. It’s a win/win.
Combining the Dollar-Cost Averaging strategy with the Aggressive Portfolio above, then, you might take $500 per month and invest it like so:
- 65% ($325) into a total stock market fund (like Vanguard VTSMX);
- 25% ($125) into a total bond market fund (like Vanguard VBMFX);
- 10% ($50) into bitcoin (or a basket of cryptocurrencies).
The intelligent investor would have these investments set on autopilot, transferring to an investment account and crypto wallet at the same time each month (say, on the 1st or 15th) via automatic withdrawal, if possible.
Today’s “intelligent investor” looks similar to the intelligent investor of the past. He or she is still focused on long-term reward while hedging against risk.
But isn’t it a bigger risk to sit out the crypto investing revolution entirely? This approach allows investors to balance risks with the rewards of bitcoin.