Paul Winkler: Welcome. This is “The Investor Coaching Show.” I’m Paul Winkler talking about money and investing. I believe an educated investor is a more confident investor. Unfortunately, more often than not, financial planning information is simply marketing, and I think you ought to understand what you’re hearing.
One of the things going on this week is cryptocurrencies and Bitcoin. I remember wondering what Bitcoin was when it first came out and what the attraction was for investors. So I thought I would share a little with you.
I did a video about five years ago on this particular topic because it was just really starting to hit the media at that point in time. People were talking a lot about it and asking what I thought, and so I did a video explaining cryptocurrencies and how to regard them as investments.
Cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transaction control, the creation of additional units, and verify the transfer of assets.
Matter of fact, one of the biggest things to come out of cryptocurrencies is something called blockchain. It could actually revolutionize banking in a lot of different industries in the future. That’s one of the biggest benefits of it. Now, what are they worth?
What’s a Cryptocurrency Worth?
What should we pay for? Well, it’s basically worth whatever you’re willing to pay for it. If you’re willing to pay $23,000 for it, then that’s what it’s worth.
Is it an investment? That’s the next question I get. Well, by the strict definition, it’s not. You have to have a cost of capital, and currencies aren’t investments because there is no cost of capital.
A cryptocurrency is worth whatever a buyer is willing to pay for it.
Now, what is the cost of capital? Well, let’s say we’ve got a savings account and they tell you that they’re going to pay you a thousand dollars of interest. Well, the bank is going to pay you that interest and based on a 1% interest rate. We can figure out the value of your account by going backwards.
Say they’re going to pay you a thousand bucks, 1% interest. Well, the account must be worth a hundred thousand dollars. Now, if we’re talking about stock and we know that the earnings on the stock are a dollar, we know that historically large U.S. stocks sell for about $15.99.
So by definition, our stocks should be worth around $16, and that is the cost of capital there. Well, if we’re talking about currencies, we’re talking about zero earnings, right?
There are no earnings with currencies, and our coin is basically going to be worth whatever you’re willing to pay. It’s kind of shaky ground really, when it gets down to it.
So what are some of the threats with these virtual currencies? Well, one is a supply increase. If the number of Bitcoins or whatever currency we’re talking about increases, the value can go down, or we could have an alternative currency that actually wins the day and becomes more popular.
If the one you bet on doesn’t do that well, that could be a real risk. Theft of your currency could be another risk or a change in attitude. What if some people just say, I just don’t believe in this anymore, and they don’t want to pay the high prices?
A Look at History
It’s kind of like the tulip bulb craze or the electronics craze of the 1960s or the oil craze in the 1970s or bonds in the 1980s. Every decade has its own little bubble that tends to happen and people get sick of it and all of a sudden the price drops and you’re left standing there with nothing.
The other thing that could actually affect it is government action. So the government could decide to tax or outlaw it. What’s the big motivation that drives people to pay these big prices? Well, we call it FOMO, and it is the fear of missing out.
So they keep buying at a higher and higher price until somebody says, “Wait a minute, this is crazy. One of these things that I would stay away from.” It is not an investment by the very definition, and I hope that helps.
Companies have to pay to use your money and they pay through the use of your money through earnings.
Of course, when you buy CDs and those types of things, you get paid interest, but this is something that people get really caught up in. It’s because they see this recency of good jumps and value in something, and then everybody starts talking about it, and then it becomes this thing that we can’t stop talking about because we want to somehow get rich.
It’s kind of like the lottery. When the lottery gets really high, people start to talk about it all the time. Then people who would never think about going and buying a ticket, go out and buy a ticket.
That’s kind of what happened with Bitcoin. It’s funny how people respond to things. People do this from time to time with technology and with biotech, and they’ll do it within things that aren’t really investments as well.
Change Fuels Emotional Investing
Another example of that would be gold. People got really, really fired up about gold and you saw all these commercials and then gold just basically did nothing.
So gold actually jumped in value back then because of the fears that were going through everybody’s minds about what was going to happen, where the economy is going, whether the dollar was just going to crash because inflation is the devaluation of the dollar, and that’s by definition what inflation is.
And it went up and then all of a sudden there was change in leadership and it wasn’t immediate. I mean, think about back at that point in time, we went through some serious pain in the early 1980s, even though we had a change in leadership that everybody felt good about, well not everybody, but a lot of people felt good about.
Ronald Reagan came in and he was changing some things and he was wanting to reduce taxes. And people were saying, that’s crazy, you can’t do that. That’s terrible. It’s going to destroy everything. And he went against the grain there.
It’s so easy to chase things because that is what sells.
And then all of a sudden, a few years later, the economy zipped along and did really, really well, and then gold dropped. People chase things. That is the problem.
Short-term Past Performance
If I want to try to market something to you, all I have to do is show you how well it did versus something else. You can see this with insurance companies and annuity companies. If they want to make their product look good all they have to do is compare it to something that did worse in some period of time.
That’s what people were doing in insurance companies with annuities. They were comparing them against the S&P 500, which had a dead decade. Well, now they can’t do that because the S&P 500 is far, far outperformed.
So they’re looking for anything else that they can actually compare to. So what happens is that people get pulled in these stories and then they get bad performance. And then what happens is they hear another story that seems to make more sense to them, that appeals to their emotions.
Don’t invest based on the emotion of fear or greed.
With Bitcoin, it was greed. It may be loyalty sometimes that companies will appeal to. Well, how do they prove that the company is so good at predicting the future? If it weren’t for past performance, what would they have to go on? So that’s what they do is go based on short-term past performance.
Sometimes they don’t even do that. They just may even not talk about performance at all if it’s not so great. Then they just try to use feel good type of metaphors. But what happens is that investors get pulled into these things and then they go through disappointment after disappointment.
Finally some people just give up altogether. A good example of this goes back to the 1930s in the Great Depression. When investors got in the market, they lost money, then they got out and then the market went up, they got back in again, and then World War II came and it went back down again. Then they got back out and it went back up during the war, which didn’t make sense.
I mean, why would the stock market go up during a war? So maybe they got back in and then at the end of the war, the market dropped. Why? Because companies changed from producing and manufacturing airplanes and tanks and battleships to other things, so their company profits went down some.
Don’t Let Yourself Become a Burned Investor
So investors got back out and eventually the market went back up again. At that point, they had been burned three times. Some people never invested in the stock market again after that.
It may take years and years and years before a burned investor can trust the market again. Then they get back in and the market goes down again, so they get burnt once more and can’t believe they fell for it again.
The problem the whole time has been that their instincts and emotions are working against them. Matter of fact, that’s a formula we often use around here: I plus E is greater than C. Instincts plus emotions tend to outweigh the cognitive part of the mind.
Unfortunately with the investment industry, they’re going to play to the emotions and they’re going to play to the instincts because that is what moves products, that’s what moves people to take action.
They’ll promise all kinds of things and the whole time they’re jumping in, jumping out, and doing the same things that you did, but you just don’t know what they’re doing because you handed over the reins. So you don’t even understand what they’re doing and how they’re doing it.
How do I know this? Well, studies actually show that most money is under significant active management. If you look at the research out there on how people manage money, it’s usually tactical asset allocation, moving money between large and small companies.
If you listen for this language when you’re watching TV or listening to an investment advisor, you’ll hear them say, we’re shifting over to this area right now. It’s not just the general public falling for this stuff, it is even the investment industry itself.
The primary thing to remember about investing is that it should be somebody using your money and paying you to use it.
So we go back and forth through this, and then all of a sudden we get really bad investment results and wonder what happened. It’s our brain that happened, our instincts, our emotions. The investment industry preys on all of these things.
You can’t judge human behavior because humans will jump back into things, they’ll run things up and they’ll run them down.
The Idea of Investing
If it is interest, like a CD or a savings account or a bond, then that’s an investment. You’re getting paid interest for letting somebody use your money. If it’s company stock, you’re talking about profits.
You might be looking at dividends, you might be looking at retained earnings, where money is plowed back into the company, but the profits are basically yours because you own the company (or whatever proportion of the company that you own).
The idea of investing is letting someone else use your money in such a way that both parties benefit.
It may be real estate where somebody’s paying you rent. It’s a little bit different because it can have price appreciation because the value of property tends to go up with inflation anyway. Rental payments also can go up and down or disappear for a while.
If your property isn’t rented, the property can go down in value. There are lots of risks. Property actually starts to fall apart and you have to put money into it. But there still is that use of your money aspect of real estate, where somebody’s paying you to use your property.
Again, that is the idea of investing. Now, how you divide things, how you move things around, well that’s a lot of other material that we tend to cover on this show. But I just wanted to revisit that because somebody had asked that question and I thought it needed a longer answer than I normally give on here.
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*Advisory services offered through Paul Winkler, Inc. (‘PWI’), an investment advisor registered with the State of Tennessee. PWI does not provide tax or legal advice: please consult your tax or legal advisor regarding your particular situation. This information is provided for informational purposes only and should not be construed to be a solicitation for the purchase of sale of any securities. Information we provide on our website, and in our publications and social media, does not constitute a solicitation or offer to sell securities or investment advisory services, or a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.
