More and more these days, I’m getting questions – mostly from young people – about investing in bitcoin and similar products.
They hear about quick and huge profits. They think they should get on board. Of course, they have also heard of huge losses in cryptocurrency.
But for many young people, the allure of quick and easy money is far more compelling than the risk of losing your shirt.
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I understand. Over half a century ago, I was just beginning to immerse myself in the investment industry. I made what I thought was an investment (now I realize it was really speculation) on a commodity futures contract.
I doubled my money in less than a week. Dude, did I feel smart! I had started to understand (I thought) how investing worked.
I knew what to do: I took all that money and put it back into another contract. And quickly lost everything. In the process, I learned a more valuable lesson on how to invest really works: losses can occur as quickly and easily as profits.
I remembered all of this recently while chatting (separately) with a few investors who appeared to be on the verge of getting into cryptocurrency. One was 28, the other 30.
The amounts of money they proposed to invest were relatively small – $ 40 in one case and $ 400 in the other. Everyone told me it was money they could afford to lose.
To better understand their state of mind, I listened to an interview with a dogecoin investor who said he converted his first investment into several million dollars.
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As I listened, part of my mind was worried about the losses he might suffer; another part of my mind wanted to cheer him on as he led what he saw as a battle against Wall Street.
The two investors I spoke to seemed to want to show Wall Street how investing should really work. I recognized this feeling.
I knew better than to tell these two what to do. Instead, I tried to educate them.
Bitcoin, dogecoin, and many other varieties of digital currencies do not have a long-term history. They are not regulated. They are not legal tender. Their value is determined solely by supply and demand.
These two young people have a job. Neither had put money aside in an IRA, which would certainly save them taxes.
So I painted another picture: Inside a Roth IRA, their money could grow tax free. I have described an investment established with a history of above-average long-term returns: small cap value companies.
As an asset class, the value of small caps has some of the volatility that these young people seek. But he also has a habit of rewarding investors with patience.
When you look at the US Small Cap Stock Index through 1928, you’ll find that the 40-year average compound return was 16.2%. (The best return in the 40-year period was 19%; the worst was 11.6%.)
Towards the bottom of that scale, at 12%, a one-time investment of $ 400 would become $ 37,220 if left alone for 40 years.
Over the years, most young people could afford to invest well over $ 400, of course. But let’s review the results of this very modest one-off investment.
If you retired with $ 37,220 in a Roth IRA and started making 5% annual withdrawals, you would have $ 1,861 to spend in your first year of retirement.
If the investment continued to return 12% and you continued to withdraw 5% per year based on the growing balance, you would have $ 8,248 to spend in your 25e (and possibly the last) year of retirement.
During 25 years of retirement, you would have withdrawn $ 108,045. Your account at that time would be worth around $ 156,712, which would likely go to any people or entities you named as beneficiaries in your IRA.
The math in this scenario is awesome. For just $ 400 (probably less than the cost of a weekend beach getaway), you would have made $ 264,757, all tax-free.
Imagine what would be possible if you did this with $ 400 each year before you retire.
Of course, this plan has a downside compared to putting $ 400 into a cryptocurrency.
The Roth IRA I described will not dazzle your friends or give you bragging rights. It won’t let you thumb your nose at Wall Street or the old folks who think people should be reasonable with their money. It won’t make you a quick millionaire or lose a fortune overnight.
In short, it’s quite boring. Worse yet, it takes a lot of patience. What a drag.
I think there is a happy medium that might make sense to a lot of people.
Start by maximizing your Roth IRA to $ 6,000 for one year. (Multiply the numbers above by 15 and you will see the impressive payout.)
After that, if you can still ‘afford to lose’ $ 400, go ahead and invest it in cryptocurrency and see what happens.
Better yet, use that $ 400 for next year’s Roth IRA contribution.
Like many people, I have been curious about cryptocurrencies and have spoken to many investment experts. Not even one has been able to explain why this could earn me a lot of money in the long run. The best rationale I have heard for investing in bitcoin is a variation of “It’s increasing”.
It reminds me of a quote often attributed to Will Rogers: “Don’t gamble. Take all your savings and buy good stocks and hold them until they go up, then sell them. If it doesn’t go up, don’t buy it. For more on this topic, here’s a recent podcast I recorded titled “Sex, Food, Money… and the Impact of Emotional Decisions”.
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 easy ways to boost your retirement.