Hodlers, Consider This

Given the absolute stunning rise in the value of the cryptocurrency market, this is leaving many with the difficult decision of whether they should sell some of their position or not (remember, it doesn’t have to be all or nothing). So what should you do? There is no single answer as everyone has different financial goals and risk tolerance. But I ask you to consider two principles when determining when and how much you should sell, loss aversion and rebalancing.

Loss aversion “refers to people’s tendency to prefer avoiding losses to acquiring equivalent gains: it’s better to not lose $5 than to find $5”. Given this, hedge your bets against your future self feeling devastated if the value of your position plummets. This will cause less pain than the pain of missing out on even greater potential gains.

Rebalancing “is the process of realigning the weightings of a portfolio of assets.” You never want your asset allocation to be heavily skewed toward one specific asset (e.g. Apple stock, Bitcoin, etc.) as this decreases the diversification of your portfolio and increases your level of risk. If you have $20k in traditional non cryptocurrency investments that include a range of different stocks, bonds, etc. and $20k in Bitcoin, half your portfolio is in one specific asset. This is an extremely risky position given all it takes is for Bitcoin to diminish in value, and that brings your entire portfolio down with it. You may even feel that given the performance of cryptocurrencies recently you should invest even more than you already have. This is dangerous. As the prices continue to climb, simply by not selling you are in effect increasing your investment already, because you have that much more to lose. Consider this, let’s say you purchased 1 Bitcoin in 2017 for $1k. At the time of this writing, your initial $1k investment is now worth ~$20k. You may be tempted to continue to hold, because you think to yourself, “this was only a $1k investment anyway, so what if I lose it.” This is an incorrect way of thinking and just because cryptocurrencies are new, doesn’t mean sound financial principles do not apply. The reality is, you now have $20k to lose, not $1k. And framing your position this way will allow you to make more sound decisions regarding when and how much to sell.

For those who have made significant gains, I would say there are two groups. The first group is loss averse, made up of those who are constantly worried about their crypto assets and constantly checking the prices throughout the day. To this group I would say, this is no way to live. If done in a healthy manner, making money should reduce the stress in your life, not increase it. If you fall into this group, I would sell enough so that even if all of your crypto assets go to zero, you will still be satisfied with the amount you made. The amount to sell to reach this point will be different for everyone but I would say a good starting point is to sell at least enough to get your initial investment back plus some on top of that. The second group is not phased by the extreme price changes and is not letting it affect their daily lives. To this group I say, seriously consider selling to rebalance your portfolio to a more appropriate asset allocation. Yes, crypto market capitalization has seen a fantastic increase, but that doesn’t mean it will continue forever, it almost certainly won’t.

Whatever you do, be sure you are aware of your country’s applicable tax laws (here is a great guide for US citizens). Even though it is in a gray area right now, I would err on the side of caution and report your gains to the government. You don’t want to get in a situation where you have made a bunch of money, didn’t report it, and then get in trouble for tax evasion down the road. That would cause stress and remember, making money should reduce stress. For those in the United States, the IRS has released guidelines which means your crypto gains are taxed as capital gains, just like a stock. If you have held for at least a year before you sell, it will be taxed as a long term capital gain, which means you will be taxed at a lower rate than if you held for less than a year. This should certainly factor into when you plan to sell, but don’t take this to mean you should wait a year no matter what. The extra tax associated with short term gains may pale in comparison to the loss of value of your crypto assets while you wait for the one year mark.

A lot of the narrative around cryptocurrencies is that they will replace our entire financial system and investing in tradition stocks and bonds no longer makes sense in this new world order. This is absolutely wrong. I think John Bogle’s thoughts on gold being a speculation instead of an investment apply to crypto as well. He argues “Bonds are supported by interest coupons, stocks are supported by dividend yield and earnings growth, and gold is supported by the ability that someone is going to take it off your hands for more than you paid for it.” Regardless of whether cryptocurrency proves to be a success and ultimately facilitates a large part of the world’s financial transactions, this doesn’t mean that investing in companies through stocks and bonds will be obsolete. No matter what happens in the crypto world, a steel company will still make and profit off of selling steel, and that profit will flow to its shareholders. The crypto world right now is where the web was in 1995. The pieces are there but no one quite knows for sure what’s going to be built. Bitcoin and all these other cryptocurrencies could very well be the Netscape of the crypto world.

Whatever happens with the price, the winners, the losers, don’t forget to appreciate how unbelievable all this is. A bunch of personal computers connected to each other in 2009 started something that the world’s largest banks and governments are needing to respond to. What a time to be alive.