Crypto assets are here to stay. Bitcoin, Ethereum, Dogecoin, Litecoin, Ripple…. There are several thousand options available today, with new ones being released 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 deserve a place in your financial plan.
The invention of blockchain technology in 2009 started a cycle of innovation that will continue to revolutionize financial services and other industries for many years to come. It is quite difficult to understand what exactly a blockchain is and what it does, but it is basically a decentralized online database, where each data point is organized chronologically, linked to the previous block and the block ahead in the chain. In simplistic terms, cryptocurrencies like Bitcoin use blockchain technology to record a transaction record and thus keep the asset safe.
It’s all pretty technical, but the bottom line is that cryptocurrencies have become more secure and accessible than ever. 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 home, a business, retirement savings…. Every asset has intrinsic value and each counts toward your net worth. But not all assets are the same, so it is necessary to categorize them. By doing so, you can objectively manage the risk and performance of 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, such as 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 houses, cars and furniture.
- Assets for life: Investments like your retirement portfolio, which funds your lifestyle when you can no longer earn an income.
- Legacy assets: Investments you don’t have to depend on to finance your lifestyle or retirement – assets that you are likely to leave behind to your beneficiaries.
It is generally quite easy to decide which category an asset belongs to. Take your primary residence, for example. It certainly has value, and it may become appreciated over time, but it is more important as a place of safety for you and your family, which is why it is classified as a lifestyle asset.
But it’s not that 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 an excuse. Remember, all wealth must be classified to have meaning and purpose. So which asset category are cryptocurrencies included in?
- Business asset? Are you mining Bitcoin? Is this a business that you are actively managing and generating income? For a very small minority of people, this could be the case. If your cryptocurrency investment falls into this category, you should have a business plan for capital investment, operations, and budgeted returns, and how you will handle risks such as fraud and business continuity.
- Active lifestyle? 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 cryptocurrency investment as a status symbol, it should be categorized as a lifestyle asset, such as a car, not something you rely on to generate income or contribute to your retirement plan. If this is the case for you, be sure to set a reasonable limit on how much you plan to invest.
- Active for life? If cryptocurrencies are part of your retirement plan, how much should you allocate to your total portfolio: 1%, 10%, more? You must be aware of price volatility and the unpredictable valuation of crypto assets. Remember, your assets for life are your safety net, the bucket of capital that you can turn to when you are no longer earning an income. Therefore, assets for life should be a safe bet, the kind of slow-enriching asset that is predictable and won’t throw you any surprises. We strongly recommend consulting with a Certified Financial Planner® for professional advice in this regard.
- Legacy asset? If your cryptocurrency investment doesn’t fit into any of the first three categories, then it will likely fall here. The inherited category is an all-encompassing asset class: investments you don’t have to fund your lifestyle or retirement; something to have a little fun with. If you’re lucky, you can leave something for your beneficiaries, and if not, that’s fine too. Most cryptocurrency investors fall into this category.
Be brave, but also be careful
With the rise of cryptocurrencies appearing so prominently in the media, it’s hard to sit on the sidelines and not be part of the action. You don’t have to either, as long as you are clear about where your crypto investment fits into your wealth building plan.
In the long term, cryptocurrency will be a central component of any diversified portfolio, but we are not there yet. Currently, all crypto platforms are not regulated in South Africa and financial planners cannot give specific advice on how to invest.
What may Counseling is cautious experimentation. Don’t withdraw your retirement annuity to buy Bitcoin.
But if you have some cash on hand and crypto is your legacy asset, give it a try. The more you know about the asset class of the future, the better.
Ricardo Teixeira CFP® is COO of BDO Wealth Advisers