Are you jealous that you’ve missed out on bitcoin so far? Thinking about jumping in?
There’s some investment advice going around in circles of people half my age. And I admit that some of them are crushing it right now. That’s an understatement, actually.
“You’ve gotta buy bitcoin!”
I’ve had quite a few friends go down this path in the past year, and I’ve tried to ignore it. But when two of my friends decided to sink all of their time, talents, and treasures into cryptocurrencies, I had to take a look.
For the few of you who are not familiar with bitcoin and hundreds of other cryptocurrencies, here is a brief summary courtesy of Coindesk.
What is Bitcoin?
Bitcoin is a form of digital currency, created and held electronically. No one controls it. Bitcoins aren’t printed, like dollars or euros. They’re produced by people – and increasingly businesses – running computers all around the world, using software that solves mathematical problems.
It’s the first example of a growing category of money known as cryptocurrency.
What Makes it Different From Traditional Currencies?
Bitcoin can be used to buy things electronically. In that sense, they’re like conventional dollars, euros, or yen, which are also traded digitally.
However, bitcoin’s most important characteristic, and the thing that makes it different to conventional money, is that it is decentralized. No single institution controls the bitcoin network. This puts some people at ease, because it means that a large bank can’t control their money.
Who Created It?
A software developer called Satoshi Nakamoto proposed bitcoin, which was an electronic payment system based on mathematical proof. The idea was to produce a currency independent of any central authority, transferable electronically, more or less instantly, with very low transaction fees.
Who Prints It?
No one. This currency isn’t physically printed in the shadows by a central bank unaccountable to the population and making its own rules. Those banks can simply produce more money to cover the national debt, thus devaluing their currency.
Instead, bitcoin is created digitally, by a community of people that anyone can join. Bitcoins are mined using computing power in a distributed network.
This network also processes transactions made with the virtual currency, effectively making bitcoin its own payment network.
Note: There is much more I could say about cryptocurrencies, but that is not the purpose of this post.
One of my friends first heard about bitcoin in 2010.
“If I would have invested just $500 in it then, it would be worth well over a billion dollars today!”
This is certainly compelling. Check out this chart:
It’s honestly hard to not be jealous of those who caught this trend early on. And it is tempting to jump into this investment class.
But wait. Is this really an investment class? Or a speculative swing for the fences?
Sound Investment? Or Vegas Crap Shoot?
As someone who has been a serial entrepreneur and investor for decades, I’ve come to delineate investing and speculating a bit differently than some. Here’s my loose definition for the purpose of this discussion:
Investing: If you’ve done a thorough evaluation, and you’re reasonably sure your principal is safe… and you have a chance to make a profit… you are investing.
Speculating: If you are “investing” in an asset that has uncertain protection of principal… and you have a chance to make a profit… you are speculating.
This concept was clarified by Benjamin Graham and David Dodd in their 1934 book Security Analysis. I’ve discussed this in a previous article.
Though they were focused on stocks, their theories applied to all types of assets. Graham and Dodd said, “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Paul Samuelson, first American winner of Nobel Prize in economic sciences, said:
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
It sounds like I’m being pretty hard on speculators. That’s actually not my intent. It’s fine to speculate. As long as you’re clear that that is what you are doing.
I interact with a lot of successful investors, however, and most of them avoid speculation like the plague. It’s one of their key criteria.
How Do I Know if this Investment is Investing or Speculating?
I’m glad you asked. It really comes down to analyzing the risk versus the return. Thankfully, someone has quantified that for us.
Nobel Prize winner William F. Sharpe came up with a formula to quantify the return versus the risk of an asset class in 1966. It was later called The Sharpe Ratio.
The Sharpe Ratio is the average return per unit of volatility: A numeric representation of the return divided by the risk.
An investor who can accurately foretell the future can ignore this ratio. He or she would be better off picking the next Snapchat or cryptocurrency, finishing off a few years in corporate America, then retiring to Maui.
Assuming you are not in this class of prophetic investors, you’d best be cognizant of both the risk and return of your investment.
So what does the Sharpe Ratio tell us about the various major asset classes? Take a look:
Sharpe Ratio Source: Calculated using property and private equity returns obtained from NCREIF property index. Stock returns obtained from Yahoo.com. Average one-year T-Bill obtained from FRED (Federal Reserve Economic Data)
I’m particularly passionate about multifamily real estate. So when I saw these figures, I wanted to know exactly how multifamily stacks up against the other asset classes in this chart. The numbers say that multifamily and retail are:
3x better than the S&P 500
1x better than the Dow Jones
0x better than Office real estate
9x better than NASDAQ
4x better than private equity
3x better than Industrial real estate
I also located the following graph to show how all commercial real estate compares with other asset classes. In keeping with our theme of low risk and high return, your goal here would be to be as high and far to the left as possible. Check this out:
This chart shows that core commercial real estate has by far the best risk-adjusted returns of the major asset classes. This analysis applies to all commercial core real estate (office, retail, industrial, and multifamily).
For those of you who invest in gold, silver, and other precious metals, check out the miserable showing by commodities.
I recall years ago, when I was “investing” in metals, I heard Dave Ramsey say that metals are not an investment. They are just insurance (or something to that effect). This made me mad, and I chose to ignore him. (I later saw the error of my ways.)
Maybe you’re investing in bitcoin now, and choosing to ignore me… I understand. I hope you’ll take a moment to yell at me in the comments section if so.
So where would bitcoin and other cryptocurrencies fall on this chart? If we charted bitcoin, it would be off the chart on the return side. And off the chart on the risk side as well.
Related: Cryptocurrency – A Good Investment or a Fad?
If You Could Plot the Return on the Lottery, it Would Probably Be Similar.
And if that’s what you want to invest in, go for it. Like I said, if you would have invested your pocket change back in 2010, you could be independently wealthy now.
I, for one, don’t like investing speculating that way. Been there, done that. (I have a podcast called How to Lose Money, after all.)
I just noticed that the bitcoin price dropped over 21% from Wednesday November 8th to Sunday November 12th. I checked the news to see what could cause such a precipitous drop.
It turns out that some anticipated plans to alter its underlying technology were scrapped. That’s all.
Wait… that caused a 21% drop in value?
Then the value, errr I mean the price, went up 40% the following week.
If you want to invest in an asset that is that volatile, be my guest. I am personally content to ride this one out. (I’ve missed out on lots of lottery winnings as well.)
Jordan Belfort, immortalized as The Wolf of Wall Street had some strong comments about cryptocurrency launches.
He told The Financial Times, “It’s the biggest scam ever, such a huge, gigantic scam that’s going to blow up in so many people’s faces. It’s far worse than anything I was ever doing.”
JP Morgan Chief Executive Jaimie Dimon said, “If we had a trader who traded bitcoin, I’d fire him in a second for two reasons,” he said. “One, it’s against our rules. Two, it’s stupid.”
He added that it was “a fraud” and “worse than tulip bulbs,” referring to the famous market bubble from the 1600s. “It won’t end well. Someone is going to get killed.”
Dimon’s comments came within a day after Britain’s city watchdog warned investors to only take part in cryptocurrency fundraisings if they were prepared to lose all of their invested capital.
Dimon’s remarks sparked a 23% drop in bitcoin price in the next 48 hours.
Can you imagine any comment… by any person… causing your real estate portfolio to drop 23% in 48 hours?
I could blather on and on about this. And let’s be honest. I could find negative comments about investing in real estate as well. And Dimon and many others may have a dog in this fight – something to lose if bitcoin prospers.
But the question still goes back to risk versus return. The numbers don’t lie.
And there’s another important distinction between real estate and commoditized investments like bitcoin, stocks, bonds, metals, etc: You can often influence or even control many of the factors that will lead to the success of your real estate portfolio.
You’ve heard of forced appreciation, right?
It’s a way to make strategic changes to your commercial real estate to drive increased income and value. It’s real and it’s powerful. It’s a cornerstone of my firm’s commercial multifamily investing strategy.
Could you do this investing in bitcoin or other investments? Not a chance.
I was $2.5 million in debt when the real estate market turned against me in 2008. Not a happy place to be. But after a lot of prayer and hard work, I was debt-free thirteen months later.
I would not have had the opportunity to pull out of this hole if I had invested in most asset classes. Because my debt was tied to real estate, I was able to sell off my assets and my family survived financially.
So I guess you have to ask yourself… what is your investment strategy?
Are you rolling the dice and hoping for that once-in-a-lifetime grand slam? Or are you building your wealth with the advice of two of the greatest investors in world history?
Warren Buffett: “Only buy something you would be happy to own if the market shut down for 10 years.” And, “Our favorite holding period is forever.”
King Solomon: “Wealth gained hastily will dwindle, but whoever gathers little by little will increase it.”
I would argue that investing in real estate provides an ideal opportunity to fulfill the advice of these great sages. And I’m not alone. Multitudes of real estate investors feel the same.
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