SPRINGFIELD, Mo. – Once the darling of day traders, Hollywood actors and financial publications, cryptocurrencies have been experiencing difficult times over the last couple of years.
Last year, major cryptocurrency exchange FTX collapsed and its CEO was arrested. Now, the Securities and Exchange Commission is taking legal action against two more major exchanges.
Local financial professional J. Barry Watts from Wealthcare Corporation explained crypto’s volatility, and what you need to know before investing.
WHAT IS CRYPTOCURRENCY?
- Cryptocurrency is a digital currency that, unlike traditional money, isn’t created or backed by a government.
- Cryptocurrencies are mostly unregulated. Many governments are concerned about taxes and their lack of control over the currencies.
- You can create some cryptocurrency tokens through a process called mining, where you have your computer solve complex math problems in exchange for the chance of being rewarded with cryptocurrency.
- The drawback is that it takes a very powerful, specialized computer to mine cryptocurrency effectively. That costs a lot of money and uses a lot of energy. While there are new, less energy-intensive ways of generating crypto, most people simply buy and sell cryptocurrencies on exchanges.
Q: WHY HAS CRYPTO BEEN SO VOLATILE?
- To understand that, you need to know why traditional money is usually stable.
- The U.S. dollar is backed by the government, which promises the dollars you have today will be useful for buying things in the future. Because of that promise, the value of the dollar doesn’t tend to go up and down in wild swings.
- But cryptocurrency isn’t like traditional money. A cryptocurrency doesn’t have any governmental guarantees, so its value is whatever people think it might be at any given time. That opinion can change rapidly!
- It’s not always obvious exactly why a cryptocurrency sees volatility, but investors should be aware that volatility has been a normal experience for cryptocurrencies. Consider how much risk you feel comfortable with before you invest.
Q. WHY IS THE SEC TAKING LEGAL ACTION AGAINST MORE CRYPTO EXCHANGES?
- Binance and Coinbase are the two largest crypto exchanges in the world. The SEC is suing them for violations of securities regulations.
- The SEC hopes to bring cryptocurrency under greater scrutiny to protect investors from bad actors in the industry.
- For example, when the crypto exchange FTX collapsed last year, it was revealed that the CEO, Sam Bankman Fried, had been investing customer money in other risky endeavors without their knowledge.
Q: IS CRYPTOCURRENCY TOO RISKY FOR THE AVERAGE INVESTOR?
- Cryptocurrencies are unstable. That means drastic changes in price can happen very quickly.
- When the cryptocurrency TerraUSD collapsed, other cryptocurrencies lost $200 billion in just one day due to investor panic.
- That means if you’re going to invest in crypto, you need to understand your risk tolerance, and it needs to be pretty high!
- Personally, I look at crypto the same way I look at a lottery ticket. It’s fine to buy as long as you do it with money you know you can afford to lose, and it probably shouldn’t be considered part of your retirement plan.
Q: HOW DO WE BALANCE OUR RISK?
Dial Back Risk With Age
- How close you are to retirement plays a big part in how much risk you can take with your investments.
- If you’re in your 20s or 30s, you have years to recover from large losses. If you’re approaching or in retirement, you should be taking less risk with your money.
- Dial back your risk as you get closer to retirement.
Have a Purpose
- Each of your investment accounts should have a specific purpose.
- Ask yourself, what is your objective and your timeframe for each investment, and do the math to figure out the gains you will need to meet that purpose.
- For example, you may need a 5% return on an account in order to keep up with your withdrawal rate in retirement. If you are chasing 8% or 9% returns, you may be taking unnecessary risks with your money.
- As Warren Buffett said, “Never risk what you have and need for what you don’t have and don’t need.”
Create a Plan
- You should have a written financial plan that helps you manage market risk and covers other important areas like taxes and inflation as you work towards retirement.
- It’s a good idea to sit down with a financial professional who can help you create a plan and understand it.
- At WealthCare Corporation, we help our clients manage risk by designing tailored solutions to address all of their concerns so that they can retire with confidence.
- You can learn more about the planning process at wealthcarecorp.com.