Cryptocurrency fever has taken over.
Okay, maybe it hasn’t taken over, but it is clear that cryptocurrency has become a significant player in the financial market in the last couple of years. In fact, according to Bloomberg, the combined value of digital currencies is somewhere around $2 trillion.
Of all the cryptocurrencies, Bitcoin remains one of the most popular digital currencies, and it is worth over $800 billion. As a result, many investors have been seen swarming to the cryptocurrency rush, which is kind of like a digital gold rush. Sadly, many individuals are getting caught up in this “cryptocurrency fever” with a whole lot of hope and not a whole lot of knowledge.
The rapid appreciation of cryptocurrency has caused many investors to question what is cryptocurrency vs. stocks role in their investment portfolios. There are many differences between cryptocurrency and stock. Perhaps, the most crucial difference is that with stocks, an investor has an ownership stake in the business, which is backed by that company’s cash flow and assets. On the other hand, in most cases, cryptocurrencies are backed by nothing at all.
Anyone considering purchasing cryptocurrency must understand what they are purchasing and what is cryptocurrency vs. stocks. Stocks are a traditional investment with a solid track record.
Cryptocurrency vs. Stocks: Which Should You Consider Investing In?
If you want to be a savvy investor, you need to understand precisely what you are investing in.
You need to ask yourself what is cryptocurrency vs. stocks and then weigh all of the risks and the rewards and consider exactly what will ultimately drive the success of the investment. Without the ability to determine what will drive the success of the investment, you’re not investing. You’re gambling.
This article will outline the key points that investors should consider when asking what is cryptocurrency vs. stocks.
Stocks: Defining Stocks
Stocks are fractional ownership interests in a particular business. Investors can quickly lose sight of that fact, especially when they become overwhelmed by fluctuating stock prices and profit potential.
Because it represents a stake of ownership in a particular business, a stock will give the shareholder claim to the cash flow and the business’s assets that the stock represents. These assets back the investment and form the basis for its overall valuation.
Stock prices fluctuate as investors continually assess the company’s future success. Although investors can become quite optimistic about a stock during the short term, the long-term success of a stock price will ultimately depend upon whether or not the company can grow profits over time. The bottom line is that stock prices will rise over time based on the company’s overall success. For stocks to be successful as an investment, the company that the stock represents needs to perform well in the long term.
For more information,watch an awesome video entitled, “Understanding the Stock Market: The NASDAQ, S&P and the Dow.”
Cryptocurrency: Defining Cryptocurrency
In most cases, cryptocurrencies are not backed by hard assets (except specialized stablecoins), including some of the world’s most popular cryptocurrencies, such as Ethereum and Bitcoin. Unlike stocks, however, cryptocurrency often allows crypto owners to use the currency in ways much like more traditional currencies, like using crypto to purchase goods and services, sending money to others, or utilizing smart contracts which will automatically execute under specific conditions.
Since cryptocurrencies are not usually backed by cash flow and assets, the only driver of cryptocurrency prices speculation is driven solely by investor sentiment. As investor sentiment changes, the prices shift. In some cases, that shift in price is incredibly drastic.
So, what is cryptocurrency vs. stocks driven by? It is driven solely by the hope that another individual is going to purchase it for more money down the road. In the world of finance, this is what they call the “greater fool theory.”
This theory suggests that money can be made by purchasing overvalued assets, meaning they have a purchase price that drastically exceeds their intrinsic value, as long as the assets can be resold at a higher price in the future.
For a cryptocurrency investment to be a success, the investor must find someone that is willing to take it off their hands for a price that is more than what the investor paid for that investment in the first place. That means that the market will need to be at least more optimistic than you.
For more information, watch an awesome video entitled, “What is cryptocurrency and why should we care.”
The Pros and The Cons of Cryptocurrency vs. Stocks
This next section of our article on what is cryptocurrency vs. stocks, will address the pros and cons of an investment in cryptocurrency vs. stock.
Cryptocurrency : The Pros of Cryptocurrency Investment
- The possible hedge vs. fiat currency: Some investors are drawn to the decentralized nature of cryptocurrencies. Cryptocurrencies are not currencies that are controlled by governments or central banks who have no problem printing money and generating inflation around fiat currencies, which are monies backed by governments. For example, the euro and the U.S. dollar are fiat currencies. Many investors who are drawn to cryptocurrencies call crypto “digital gold” because they operate under the belief that it will ultimately protect them against rising inflation.
- The potential for significant gains: Investors who buy cryptocurrencies are drawn to the potential to earn high profits on their investment. There are, of course, several cryptocurrencies that have seen their value skyrocket in the time following their introduction. These historic gains are usually the main driver behind investors attracted to crypto. However, it is essential to note that this potential for significant price appreciation will come with considerable risk.
- There’s a steady, increasing number of available cryptocurrencies: During those earliest days of cryptocurrency investment, there were only a handful of coins that a person could invest in. However, the continued speculative interest in cryptocurrencies has changed all of that. These days, new cryptocurrencies are being introduced on a regular basis. Today, there are literally thousands of cryptocurrencies that you can invest in.
- There is broad interest in the use of digital currencies as a form of payment: There currently seems to be an ever-growing interest in cryptocurrencies, not only from an investor standpoint but among companies and even governments. Tesla, for example, is well-known for holding Bitcoin in its balance sheet. The company even briefly accepted Bitcoin as a form of payment before they reversed course. In 2021, the country of El Salvador adopted Bitcoin as a legal tender. However, the International Monetary Fund continues to urge the government there to reverse that decision. Regardless, this increase in digital currency acceptance is seen as a positive sign by many cryptocurrency investors.
Cryptocurrency: The Cons of Cryptocurrency Investment
- Cryptocurrency is Extremely Volatile: Cryptocurrencies have consistently displayed extreme volatility throughout their young existence. Because they are not backed by anything, which separates what is cryptocurrency vs. stocks, the price that they trade at will always be determined by whim. There’s really no way to tell where a particular coin might be traded next. There are fortunes to be made quickly, and lost just as quickly when it comes to cryptocurrency.
- There are cybersecurity risks associated with Cryptocurrency: While cryptocurrency enthusiasts will tout its security benefits, there most certainly have been many well-documented, notable hacks. Often, it can be difficult for investors to recover these stolen funds in these cases.
- Cryptocurrency has no intrinsic value: The bottom line is that cryptocurrencies technically have zero intrinsic value. That means that cryptocurrencies are not backed by any underlying earnings or assets in the same way stock investments are. You see, a stock has value because it holds future earning power and a potential for a return on investment. Unfortunately, cryptocurrency offers nothing of the sort.
- Cryptocurrency comes with a significant regulatory risk: Just because El Salvador embraced Bitcoin as legal tender, it doesn’t mean that other governments will follow in its footsteps. In fact, most governments are a lot more skeptical when it comes to cryptocurrency. For example, China has outright banned cryptocurrencies altogether, and there is some speculation that other countries might follow suit.
Stocks: The Pros of Stock Investments
- Stocks have a long, proven history of providing a solid return: Stocks have a solid, proven track record showing a substantial investment on returns. For example, the S&P 500 returns, on average, about ten percent in the long term. Although stocks may be volatile, at times, over the short term, they’ve generally been a safe investment when held over a long period of time.
- Stocks have an intrinsic value: As we mentioned before, a stock investment represents an ownership interest in the particular company that is behind the stock. Over time, its value will ultimately depend on the success or failure of that underlying company. Because companies have assets that ultimately produce cash flow and earnings for their investors, they create what is known as an intrinsic value.
- Stocks are an accessible investment: It is now easier than ever before for the average person to make an investment in the stock market, thanks to the many online brokers who have cut their trading fees down to a price that is next to nothing. Anyone with a bit of money can make an investment in individual stocks or they can purchase diversified baskets of stock investments through index funds. An index fund helps you to lower costs while building a highly-diversified portfolio even when you don’t necessarily have a lot of money to spend at the outset.
- Stocks come with much stronger regulations: There is heavy government regulation for stock exchanges, stockbrokers, and the companies they represent. Companies must provide certain regulatory information to protect the company’s investors thanks to the Securities and Exchange Commission. While no regulatory body is going to be perfect, the bottom line is that stock investments have been around for quite some time. There are many regulations to protect investors, making them the safe choice for what is cryptocurrency vs. stocks.
Stocks: The Cons of Stock Investments
- Stocks can be volatile: When an investor holds a broad range of stock investments through an index fund, their stock investments will be far less volatile than investments in cryptocurrencies. There is the potential for individual stocks to be volatile, of course. However, they are typically less volatile than a cryptocurrency investment. Since there is a volatility risk that comes with stock investments, it is best to hold stocks as a part of your longer-term investment strategy, giving you ample recovery time when you are faced with short-term losses that may arise.
- There is a lower potential to see more extreme gains with stocks: When it comes to broad stock indexes, such as the S&P 500, an investor has far less potential to realize any extreme gains. With cryptocurrencies, on the other hand, extreme gains are often quite common. In the long term, stocks average a return of approximately ten percent. However, it is not uncommon for a cryptocurrency investment to gain ten percent in one single day.
Cryptocurrency vs. Stocks: Some Additional Considerations to Make When Investing
What is Cryptocurrency vs. Stocks: Time Horizons
A time horizon can best be defined as the time in which you need to see a return on a particular investment. It is a crucial criterion when considering how best to invest your money. The shorter the timeline you need for a return, the safer the investment that you make should be. The reason? It needs to be there for you when you need it the most.
The bottom line is that the more volatile your investment is, the less suited that investment is for anyone with a short time horizon. As a general rule, most investment experts agree that risky investments will need at least a three-year window for riding out any volatility in the market.
Quite often, stocks can be volatile. However, they often tend to be far less so than investments in cryptocurrencies. Furthermore, individual stocks are typically more volatile than an entire portfolio of stocks. That is the benefit of diversification.
Stock investments are best suited for investors who have the ability to leave their money be, without a need to have access to it. As a general rule, the longer a person can leave their money invested, the better off they will be. Of course, some stocks are going to be much more volatile than other stocks. Growth stocks, for example, will tend to fluctuate a lot more than dividend stocks or value stocks.
Here’s a breakdown of these three types of stocks:
- Growth Stocks: Growth stocks are investments in a company generating substantial and sustainable cash flow and a company whose revenues and earnings are projected to grow at a rate that is faster than the average company in the same industry.
- Dividend Stocks: With dividend stocks, a company will distribute a portion of its profits to its shareholders. Each time a corporation earns a profit or has a surplus, it will pay a proportion of that profit as a dividend to its shareholders.
- Value Stocks: A value stock is an investment that trades at a price that is lower than what the company’s performance otherwise indicates. Investors who buy value stocks are attempting to capitalize on market inefficiencies since the underlying equity’s price does not match company performance.
It is common among investors to shift between more aggressive types of stock investments (such as growth stocks) and safer stocks (such as dividend stocks), particularly as they have to tap into their money. They may do this, for example, as they are approaching retirement age.
Although stocks are undoubtedly volatile, you can count on cryptocurrency being far more volatile.
Take Bitcoin, for example. In 2021, this popular cryptocurrency lost more than half of its overall value in just a few short months and then turned around and gained a 100 percent return. Now, if that’s not volatility, I don’t know what is.
This type of extreme volatility makes cryptocurrencies highly unsuited for short-term investment. Cryptocurrencies are far better suited to investors that are willing to leave their money tied up in their investment and be patient as they wait around for it to recover in the long term. In this case, we are not talking about weeks or months. We’re talking about years!
Cryptocurrency vs. Stocks in Portfolio Management?
While considering how you will build your investment portfolio, it doesn’t have to come down to an either-or choice of cryptocurrency vs. stocks or even other types of assets like funds or bonds. You can obviously mix and match. That’s what having a diverse portfolio is all about. In the end, you’re going to weigh your portfolio based on both your risk and on your time horizon.
Cryptocurrencies in Portfolio Management
As a result of its inherent risk, a cryptocurrency investment will work better when you give it a nominal allocation into your overall investment portfolio. I would recommend an investment that makes up five percent, or possibly even less.
Smaller allocations of cryptocurrency can do wonders when it comes to your portfolio, especially if the cryptocurrency you invest in ends up taking off. Also, when you limit the investment to a smaller allocation, you insulate yourself against a total loss should the cryptocurrency tank altogether.
Suppose the cryptocurrency that you invest in grows enough to represent a significant percentage of your investment portfolio. In that case, you have the opportunity to re-allocate that money into stocks, thus lowering your investment portfolio’s overall long-term risk.
Stocks in Portfolio Management
Because stock investments have a long-term solid record of success, the majority of your investment portfolio should be made up of a diversified collection of stock investments. That is especially true if you have a significant amount of time (think, decades) before you will need to tap into it.
For anyone who chooses to invest in individual stocks, it is imperative that they research the stocks they choose very carefully so that you have a better chance to achieve a good return.
For those interested in fund investments, you can purchase a broadly diversified investment fund, like an S&P 500 index, without having to do significant research. When you invest in a diversified investment fund, you can expect that there will be a potential for a higher return.
What is Cryptocurrency vs. Stocks: The Bottom Line
Indeed, there are several cryptocurrencies that have seen their prices soar since they were introduced in the past few years. However, it is imperative that investors completely understand what it is that they are investing in. Do not simply rush into crypto (or any other investment for that matter) simply because that’s what other traders are doing.
Should you decide that you want to own a stake in cryptocurrency, you’ll want to consider exactly how it might fit into your personal financial needs and your risk tolerance.
While many investors have enjoyed significant returns on investments in cryptocurrency, plenty of investors have made the same great returns even without it. It is also important to remember that some investors, and that includes legendary investors like our old friend Warren Buffett, refuse to touch cryptocurrency, even with the proverbial with a ten-foot pole. That is something to think about before you pull the trigger on a cryptocurrency investment.