Although there has been a significant decline in cryptocurrencies this year, investor interest in them remains robust. It is so strong that certain 401(k) plans may soon allow individuals to include Bitcoin as an investment choice. However, it is important to note that the availability of Bitcoin as a retirement savings investment does not necessarily imply it is a wise decision.
“Cryptocurrencies are still relatively new, largely unregulated, and very volatile, which isn’t a great mix for a traditional long-term portfolio,” says Rob Williams, managing director of financial planning, retirement income, and wealth management at the Schwab Center for Financial Research. “Think of your retirement savings as the foundation of your financial house. You want to build your foundation out of strong, trusted materials.”
This implies the necessity of investing in well-established asset classes such as stocks and bonds, which have a proven history of long-term growth potential and are appraised based on assets, earnings, and other concrete factors.
“These securities are tied to the intrinsic value of their underlying companies, whereas cryptocurrencies do not yet have such inherent value,” Rob explains. “And, unlike fiat currencies, cryptocurrencies aren’t backed by the full faith and credit of a government—they’re worth only what others in the market are willing to pay for them.”
Additionally, taxes should be taken into account. If the value of the cryptocurrency you possess in a traditional 401(k) or IRA increases, the profits will be subjected to regular income taxes when withdrawn—whereas if the cryptocurrency is held in a taxable account for more than a year, it would be subjected to more advantageous long-term capital gains rates of 0%, 15%, or 20%, depending on your income. (No taxes would be applicable to any gains from crypto investments within a Roth 401(k) or a Roth IRA.)
Furthermore, in the case where the cryptocurrency held in a retirement account diminishes in value, it cannot be utilized to counterbalance acquired profits or income as it would be possible in a taxable account. “Taking into consideration the highly unpredictable nature of cryptocurrencies, it is inevitable that losses will occur. Hence, it is desirable to exploit these losses to one’s benefit – this is yet another explanation of why undertaking speculative trades, like these, tends to be less logical in retirement accounts”, Rob elaborates.
Although a few early investors in cryptocurrency have made profitable investments, the majority have experienced financial losses. Rob advises caution and recommends staying away from risking one’s savings if interested in entering the world of cryptocurrency.
Bitcoin and other digital currencies are characterized by high volatility and do not have the support of a central bank or government. These digital currencies lack the regulations and safeguards that traditional legal tender currencies and regulated securities possess. Given the considerable risk involved, investors should regard Bitcoin primarily as a speculative tool.
Not all investors find currencies suitable due to their speculative nature and high volatility.
There is a risk involved in investing, including the potential loss of the initial amount invested. When interest rates rise, fixed income securities are more likely to experience a significant loss of the initial amount invested. Additionally, fixed income investments are exposed to various risks such as changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax implications, and other factors. Securities with lower ratings have a higher level of credit risk, default risk, and liquidity risk.
Retirement plans
Crypto investments in the retirement industry are met with caution, and it is challenging to locate a US 401(k) plan that offers them, save for the recent collaboration between ForUsAll and Coinbase. In Australia, where the equivalent retirement plan is called “superannuation,” most funds view crypto investments unfavorably. Nevertheless, crypto enthusiasts are opting to establish self-managed superannuation funds (SMSFs) to oversee their own investments, and this trend is on the rise.
In an interview with Magazine, Caroline Bowler, the CEO of BTC Markets, revealed that there was a fivefold increase in the number of SMSF accounts participating in trading on the exchange last year. Additionally, she noted that balances within these accounts have experienced exponential growth.
According to her, the investments for SMSFs used to be in the tens of thousands of dollars, but now they are in the low hundreds of thousands. She also mentions that the majority of users are not close to retirement age.
People in their thirties, who are well-versed in cryptocurrencies and feel confident using them, are the ones actively taking charge.
Don’t do it, but if you do …
Ellison, a certified financial advisor with extensive experience, has dedicated a large portion of the last twenty years to providing guidance on retirement planning. Additionally, he has authored two books on this subject matter. His recurring advice emphasizes the importance of living within one’s means, saving the surplus income, and gradually building assets that appreciate over time. Ellison consistently directs individuals towards the four primary asset categories: stocks, real estate, cash, and fixed interest. He holds the belief that investments beyond these categories generally pose higher risks.
He firmly believes that cryptocurrency carries too much risk to use as an investment for one’s retirement. “When it comes to saving for my retirement, I would never even contemplate it, even if there was a slight possibility of it increasing by a hundred or a thousand times,” he asserts.
If someone decides to engage in such behavior, as I have previously mentioned, it can be considered gambling. It entails making speculative investments and risking one’s future retirement. Ultimately, it is a personal decision for individuals to determine if they are willing to take such speculative risks.
When advisers begin working with new clients, one of their initial tasks is to evaluate their risk tolerance, as he clarifies.
He mentioned that despite all the risk assessments, it is impossible to accurately predict one’s emotional and behavioral response after experiencing a significant financial loss. The only way to truly determine an individual’s risk tolerance is either by losing some money or encountering rare occurrences like the ’87 crash, the GFC, or the crash that happened last year.
Investors who engage in crypto will quickly determine their risk tolerance due to frequent marketwide drawdowns ranging from 30% to 50% that occur every few months. Bitcoin, for instance, reached a peak of $65,000 in April but has since nearly halved, currently standing closer to $35,000. Furthermore, individual coins experience weekly gains and losses exceeding those figures. Therefore, participating in this field is only recommended for investors capable of withstanding such a turbulent journey.
Ellison suggests that it is wise to limit the allocation of a portfolio to a specific percentage for highly risky or speculative investments.
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