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It is quite likely that you’ve heard of the stellar performance of Bitcoin in 2020. Over this year, the digital currency soared in value by over 160%, leading to an historic high of $28,000 for one coin. In comparison, the S&P 500 (i.e. the largest US stock market indices) returned 13.73% and gold 21.6%. Given this surge, many investors are asking whether they should get on the bandwagon by including Bitcoin in their portfolios.
Should you, or shouldn’t you? Our financial advisers at Cedar House offer some reflections on Bitcoin from a financial planning perspective. We hope you find this useful. If you’d like to find out more or discuss your own pension/retirement with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or email@example.com
Why has Bitcoin done so well in 2020?
Simply, digital currencies like Bitcoin rise in value when people are prepared to pay more for them using fiat money (e.g. USD). There are many reasons why Bitcoin rose so exponentially in 2020. First of all, many investors seem to have been attracted to the digital currency as a hedge against stock market volatility. The COVID-19 pandemic caused a huge decline in equity values – especially in March 2020 – which led many people to look for assets which did not fluctuate as much. This partly explains why some investors, particularly in younger age groups, also built up their gold holdings in this period.
Secondly, digital currency achieved greater institutional recognition in 2020 – leading to greater investor confidence. PayPal, for instance, announced that it would now accept transactions in Bitcoin. Japanese banks accelerated their efforts to create payment systems based on digital currencies, whilst large investment firms are also getting on board – e.g. Fidelity, which has said it will grant cash loans to customers to place Bitcoin as collateral.
Thirdly, some investors seem to be turning to digital currencies to hedge against future inflation. Whilst inflation was low in 2020 across developed economies, there is concern that quantitative easing (QE) used to pay for fighting COVID-19 could eventually drive a rise – possibly in 2021. Fiat currencies, therefore, could lose their value – as might the investments denominated in the likes of USD or pounds.
Why Bitcoin is sometimes called “digital gold”
On the surface, gold and Bitcoin hold little in common. One is a shiny, ductile metal which you can physically store. The other is a digital invention with no corporeal form – sitting on servers across the world and represented by numbers on a screen. Yet there are some similarities:
- Both are a finite resource. There is only a limited amount of gold to mine, and there are only 18,612,631.25 Bitcoins available to buy.
- They have hardly any correlation with “mainstream” asset classes like cash, bonds and equities (e.g. stock market indices).
- They are not controlled by monetary policies, central banks or governments – only by the supply/demand dynamic.
- They cannot be made like “paper money” and so are not affected by interest rates.
One of the biggest advantages that Bitcoin has over gold, however, is storage. Whilst the latter needs costly physical space and security measures to keep safe, the former just sits happily on the computer. This makes it easier to safeguard and move for transactions.
Should you own Bitcoin in your portfolio?
As financial planners, our role is to help clients achieve their goals by recommending measures which grow and preserve their wealth. This means mitigating unnecessary risks – e.g. by making sure a portfolio is “spread” across a range of investments, in case any of them underperforms. The challenge with Bitcoin is that it is difficult to gauge the risk.
Take an equity investment – e.g. a fund following the S&P 500 index – as an example. Here, you can make informed judgements about the risks and opportunities of the fund. You can check the fund’s liquidity, for instance, and the balance of sectors that it contains. Is the fund excessively concentrated in a handful of companies which, according to historic data, may be overvalued? Using this kind of logic, financial planners can recommend periodic rebalancing of a portfolio to give it the best chance of success.
Bitcoin, however, holds value only for as long as people are prepared to pay a premium for it – which might change in an instant. As such, whilst Bitcoin may not follow markets down during a stock market crash (like in 2020), it can be very volatile. Between October of 2017 and January of 2018, for instance, the volatility reached nearly 8%. Far from a “safe haven” asset, therefore, buying Bitcoin involves taking on a high level of risk. Those attracted to it, therefore, should be careful to weigh its place in their portfolios. If you are a more “aggressive” investor with a long investment horizon before you, then perhaps your financial adviser/planner might suggest you speculate with some money that you can afford to lose. More cautious investors looking mainly to preserve their wealth, however, should consult their adviser/planner before committing any large sums into digital currencies.
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or firstname.lastname@example.org