Investing in Crypto Part One 🤑

I believe investing is all about growing and preserving wealth. This requires that we make investments that will grow at a rate greater than inflation, while not exposing us to an unacceptable level of risk.

That sounds simple. But how do you actually do that?

Evaluating the risks to which we are exposed requires looking into the future and assessing what is likely to happen. The challenge is that the future is unknowable. But the unknowable future can't paralyze us - so what do we do? We need some view. There are two ways to look at the future.

Option One: Precise Predictions

Stock market "experts," monetary policy wonks and a slew of other folks have been trying to predict with some degree of precision how the future will play out since time immemorial. (What will the stock market do this month? What bank is at risk of failing?) They almost always are wrong, sometimes spectacularly so.

An old saying in the financial planning community jokes that the best economic predictor has successfully predicted twenty of the last ten recessions. It's a poor joke as jokes go, but it does make a valuable point: if you're constantly claiming something is going to happen and it eventually does, that doesn't make you a good forecaster. Because timing matters. If I consistently tell you that tomorrow it's going to rain cats and dogs and after forty days of sunshine there are light showers, that's not particularly helpful. It's similar to the old saying about analogue clocks: even a stopped clock is right twice a day.

We don't want to base our entire investment strategy on any one event coming to pass. Because it might never happen - and even if it does, the timing of that event is uncertain. And timing matters because we can lose a lot of money between now and eventually.

Option Two: Plan for a Range of Probable Outcomes

So if we can't predict the future with precision, what can we do?

I believe it makes most sense to make general assessments about a range of probable outcomes rather than rigidly predict precisely what will happen in the future.

To do this, we take a broad and long-term view of what has happened in the past and use that to inform what array of possible events are likely to occur in the future. This long-term views extends back over at least the past century.

With this broad long-term view we then do two things. First, we deploy an investment strategy that protects us against huge losses while positioning us to participate in upside. Second, we preserve our flexibility to change course as the environment around us evolves.

What type of future should we prepare for?

When we take a long-term view, we see that investors have generally been rewarded for being optimistically invested in the traditional markets of stocks, bonds and real estate. To be sure, there have been periods of dramatic stock market declines, high inflation and huge doses of geopolitical instability. During each of these challenging and scary environments, there were voices suggesting that "this time was different" and that this particular macroeconomic environment demanded a radical re-thinking of what assets to invest in. Over at least the the past 100 years, those voices have been consistently wrong: following a traditional (or establishment) method of investing has alway paid off.

But what about today? What are we facing? It's easy to create a compelling narrative as to why this time is different and the traditional, establishment method of investing is doomed to failure.

Failure within the System versus Failure of the System

When I talk about what has happened over the course of the past 100 years, I view those as failures within the system. High inflation, stock market collapses, even the 2008-9 financial crisis - these are failures within the system. Traditional methods of diversified investing have always served investors through these failures within the system. To be sure, it didn't always feel that way. Particularly during the financial crisis of 2008-9, the system itself appeared to be breaking down. But those investors who stayed investing through that crisis were handsomely rewarded with tremendous stock market returns over the past decade plus.

But what about now? Is this time different?

But what are we witnessing today? Today feels, in many ways, unprecedented: we are still in the midst of a pandemic which has upended every aspect of modern life and wrecked havoc on the economy. The governments of the world, including the US government, have responded in myriad ways including printing record-shattering amounts of fiat currency. Surely this is unsustainable and a collapse of the fiat currency system is inevitable.

And it is this type of collapse - financial systems shutting down, fiat currency collapsing or reverting to gold standards, hyper-inflationary spirals - these are likely failures of the system itself (rather than just failures within the system). How traditional, or establishment, methods of investing would fair in these scenarios is unclear: we've never truly experienced them before.

Will these type of financial-system failures occur in the near future? No one truly knows the answer to that question. Indeed, no one can predict any aspect of the future with specificity. Nonetheless, plenty of folks claim that they can see the future and that things looks bad if we don't follow their advice. I typically find it difficult to take those people seriously. Why? Because examination of their historical predictions virtually always reveals they have been suggesting systemic failure is imminent for years (and sometimes decades). And they have been consistently wrong.

But perhaps this time is different. Indeed, at some point the world will change radically. That might mean the end of the US as we know it, or the end of the US dollar as we know it. In fact, I might argue that both of those 'ends' are inevitable. The trick is knowing when those ends will come and whether those ends will be in the form of catastrophic collapses or turbulent-but-manageable transitions.

If we make big financial bets (in the form of investments) on a sudden and catastrophic collapse and we are wrong, we can do real financial damage to ourselves. But of course, the opposite is also true: if we make traditional financial investments and the system collapses, this would also damage our financial circumstances.

What vision of the future should guide our investing behavior?

At the end of the day, each of us have to make that decision for ourselves.

For the time being, I believe a failure of the system is unlikely, although that could change. Does the current environment feel risky and uncertain? Yes. But the future often feels that way, especially when seemingly unprecedented events are unfolding. (I say seemingly unprecedented because almost always events do have historical precedent - we just need to look farther back in history for analogous events.)

I think this analysis of the 2010's from Dimensional Funds provides an interesting example of the future looking uncertain and scary, even when it plays quite well. They recount how scary it was to be an investor around 2010 when things looked very uncertain for the financial markets. But those who did invest were handsomely rewarded. Does that mean history will repeat itself this decade? Of course not. No one knows what will happen. But the point is that just because there are convincing voices telling you to be afraid and stay out of traditional financial investments, doesn't mean they are correct.

I'm bullish on humanity.

I'm optimistic about both the course of humanity as well as  the economies and wealth we create. There are unfamiliar and daunting challenges ahead of us. There always are. But collectively humanity always manages through crises and emerges on the other side. And we (and our systems) often emerge better and stronger. Do we collectively suffer huge losses along the way? In terms of both money and human life, the answer is sadly yes. And yet, we do find ourselves through to the other side.

In just the last 120 years we have endured two pandemics, multiple world wars, countless armed region conflicts, economic collapses of varying flavors, banking and financial system failures, multiple currency crises and consistent (if unpredictable) stock market downturns. We will experience all this and more in the future. When these future calamities will unfold and what they look like is unknown. But the one constant I see is that we manage (or sometimes muddle) or way through. And often that path is less catastrophic, disruptive and crippling than we first think. In the end, that's the bet that I make: the future crises will unfold in turbulent-but-manageable ways.

My resulting investment philosophy

My investment philosophy is a natural outgrowth of my optimism in humanity and my belief that future crises are more likely to unfold in turbulent-but-manageable (rather than catastrophic and crippling) ways.   In that world, I believe somewhere between 90% and 100% of your assets should be in some form of stocks, bonds and real estate. The remaining 0% to 10% could be in precious metals like gold and silver and crypto.

Equities provide growth and protect against inflation. Bonds holdings reduce the volatility of equites. Diversified real estate provides an alternate asset class which also protects against inflation and (in some economic circumstances) also reduces volatility. Crypto and precious metals are stores of value which also protect against inflation, as long as buyers in the market continue to believe such value stores are, in fact, valuable.

But if it were to seem incredibly likely that the system itself were at risk of some form of collapse, I would have to change how I manage investments. I'm always open to re-evaluating the strategy, but it would take a lot of convincing evidence to make me take this view. It's always easy to spin the narrative that this time is different, this time the market will collapse, this time the dollar will collapse into a hyper-inflationary death spiral. But that hasn't happened. Staying the course and following a strategic investment allocation within the "establishment" has continued to pay off. Of course I could be wrong and this time could be different and my investment approach could be a poor one (or worse). We can't know. Investing is a risk. But not-investing is also a risk, as inflation erodes the purchasing power of the money you hold in cash.

I favor diversified Portfolios rather than concentrated bets on single companies or assets.

Remember how I said the future is impossible to predict with precision? That's why I'll never recommend the purchase in the stock of a single company, or recommend one particular asset to make a big bet on. For that kind of bet to pay off, a very particular view of the future needs to come to pass. Sure, that might happen, but it might not. As I've done my best to describe here, investing in any shape does require having some view of what the future likely holds. I want to hold as fluid and non-rigid a view of the future as possible, which is why I don't advocate making singular bets in the world of investing.

In addition to the future being impossible to predict, each of us have already have enough concentrated risk exposure within our lives - we don't need to add to that. We bear concentrated risk in the form of our own human capital, our businesses (or companies we work for) and our residential real estate - among other things. I like to balance that concentrated risk out with a diversified investment portfolio. Which is why I recommend holding diversified, tax-efficient and low cost mutual funds and ETFs.

Where Crypto Fits within my Investing Philosophy

As I said, I believe investing in the alternative asset of cryptocurrency can make sense. However, I believe it only makes sense as a part of an overall investment strategy and portfolio which includes healthy allocations to equity mutual funds, bonds and (perhaps) real estate. And I don't currently believe that crypto should represent more than 10% of your overall investable assets. Are there those who disagree with me? For sure. And those people likely disagree with a lot of what I've said in this piece. This approach isn't right for everyone, but I do strongly believe in it.

When it comes to equities, bonds and diversified real estate holdings (though mutual funds or ETFs), I offer both investment advisory and investment management services. Advisory services means I guide you toward specific percentage asset allocations to hold in each of those assets classes and further recommend specific mutual funds (or ETFs) to hold to satisfy that recommended asset allocation. Investment management means that I also will implement the day-to-day mechanics of making those investments on your behalf. I do all of the heavy lifting.

In contrast, when it comes to crypto I don't yet feel expert enough to offer much in the way of advisory or management. I know what percentage allocation (up to 10%) I feel comfortable with, but beyond that I don't yet feel I know the space well enough to make specific recommendations about what specific crypto assets to hold or how to hold (e.g. invest in) them. And how you invest and hold crypto assets is important and can be complicated.

There are other financial advisors out there who are much more expert in crypto and therefore make much more particular recommendations and can be much more helpful in implementing a crypto investment strategy. I don't know many of these crypto experts who I would recommend, but I do have a handful of names I can pass along.