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A Small Fortune

A Small Fortune

March 31, 2022
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With all things being equal, the simplest explanation tends to be the right one.

                                                                                                                                                     William of Ockham

 

It is human nature to run when we see other people running away from something. We do not need to see danger. In fact, no danger need actually exist. If we see people fleeing in fear, we are likely to join them.

This survival instinct is mostly a good thing, or so we think. If we run and it turns out to be a false alarm, what have we lost? We tend to think the worst that could happen, by blindly operating on this instinct, is that we get a bit winded from running.

That is not true. It is so untrue, in fact, that I will make crowd induced fear, as it relates to investing, the subject of next month’s post.

It is also in our nature to run toward things we notice people running to. As we all know, nothing attracts a crowd like a crowd.

The history of investing is full of crowd attracting phenomena. They are often called speculative bubbles. The term bubble is used because, like soap bubbles and the bubbles we make when chewing gum, they inevitably burst. And what is left after they burst? Not much, if anything.

To my mind, the current markets in cryptocurrencies and nonfungible tokens (NFTs) share certain characteristics with speculative bubbles of the past. Those are:

  • An unshakable belief by their supporters that it is a once in a lifetime opportunity.
  • A massive disparity between the asset’s price and any intrinsic value.
  • A rapidly increasing price fueled by speculative buying.

Cryptocurrencies have also been called electronic money and digital gold. The claim is that they offer privacy, cannot be counterfeited, and are not easily subject to willful devaluation. These characteristics are considered attractive as a counterbalance to what some consider governmental overreach, particularly via monetary policy. Bitcoin is the oldest and best known of the cryptocurrencies.

Because, unlike traditional currency, more Bitcoins are not easily created, so the claim goes, they are better protected against inflation. That is to say, many more cannot be created on a whim, reducing the value of those that already exist.

It is worth noting that more Bitcoins are being slowly “mined” on a schedule. It is said there is a fixed limit of 21 million that will be reached around 2040.

The important thing to understand is that there is a perception of scarcity when it comes to cryptocurrencies. People want what they cannot have, so scarcity triggers people’s fear of missing out (FOMO.)

FOMO, in this case, leads to buying, buying leads to higher prices, which raises people’s fear of missing out, leading to even more buying. And so on and so on.

On the other hand, selling causes prices to drop, which makes people afraid, which leads to more selling, causing prices to drop still faster. Concern becomes fear, which gives way to panic and a mass rush to the exit causes a crash. Crashes harm people both financially and psychologically.

 These kinds of speculative bubbles seem to happen every 20 years or so. I once read that “Every generation of young people thinks they invented sex.” So it is with investing. This time is different, these folks think. Except, usually, it is not.

Non fungible tokens, in my view, are an extension of the current crypto fever. NFTs are unique digital assets. Art and sports memorabilia are two areas in which NFTs have become prominent. For example, the following headline recently appeared in the New York Times:

Why an Animated Flying Cat with a Pop-Tart Body Sold for Almost $600,000.

I will tell you why. Because when it comes to the lessons of history - as one astute commentator said of the 2008 financial crisis - in the short-term humans learn a tremendous amount, in the medium term they learn an awful lot and in the long term, they learn absolutely nothing. I cannot remember who made this statement, but they made a good point.

I part company, however, on the learning nothing in the long term. I believe we can get better at learning from the lessons of history, yet we have a long way to go. All things considered; humanity is still young.

We may not be able to change the world, in the broadest sense. However, we can most certainly change the world around us. Making small changes often leads to big improvements. I believe we can improve our investment lives by applying the lessons of the past.

Yet, I cannot predict the future. It might be that all cryptocurrencies and NFTs will skyrocket in value forever and ever and ever. What concerns me most, however, is that neither of these asset classes produce anything.

Now, I know there are thousands of intelligent, wealthy, and accomplished people who could educate me for hours about all the things I do not know or understand about cryptocurrency and NFTs. I believe they would share some valuable information.

I have done my share of reading and research on digital assets – another way of referring to cryptocurrencies and NFTs. Despite my research, there is still much I do not know. I will continue to educate myself on this emerging asset class.

However, the following will not change: Digital assets do not produce anything, like, for example, a farm, which grows food. The farmland has value because you can do cool stuff on it like grow food. The food has value because everyone needs to eat. If we do not eat, we die. Simple.

Please note that the land in my farm example does not have to increase in value to be a good investment. We can make a profit by farming on it and selling our produce to a hungry world. Similarly, Fortune 500 companies and other small and medium sized businesses sell their products and services to folks who want and need them, daily.  We can make money with certain investments, not simply by virtue of capital appreciation, but by the steady dividends which they pay us just for holding them.

Conversely, for the value of cryptocurrency or NFTs to rise, there must always be someone willing to pay you more for them in the future. I am not at all convinced we can rely on that to be the case indefinitely.

Some people might devote a small portion of their investment dollars to crypto as a potential calamity hedge, much in the way people have used gold.  If you are considering this, it is important to keep two things in mind.  First, we do not know when or even if calamity will befall us. Second, and far more importantly, we cannot know for certain that crypto will provide the slightest hedge against it if it does.

Crypto and NFTs as “portfolio insurance” or efficient transaction devices are not the sober ways these assets are generally being discussed. I think we can all agree they have fallen squarely into the “get rich quick” camp, at least at the moment.

There are certainly things in this world that produce nothing but have a track record of increasing steadily in value. Great works of art - paintings by renowned masters - come to mind. However, these works of art are truly scarce and that scarcity has not been manufactured.

It is at least conceivable that whatever process made Bitcoin can make more. On the other hand, I feel comfortable saying Da Vinci and Vermeer will not be producing new work. 

Additionally, I believe most of the individuals who invest in masterpieces are truly rich and have a steady stream of income from their businesses and other investments. If the value of their rare art tanks, they can still fuel up their yachts and private jets.

The question remaining is whether someone will pay the buyer of the Pop-Tart Cat more than $600,000 in the future. The answer is clear. Maybe. But it seems like a gamble. Complicated.

It has been said that the best way to make a small fortune gambling is to start with a big fortune. If, on the other hand, you want to start with something small that might grow larger over time; work hard, save more and consider investing in assets and businesses that produce things people want and need. Simple.

If you like, work with a financial planner you trust to lay out and help you implement a plan based on tried-and-true methods. The plan you develop together should be a unified one, taking into consideration the myriad of factors that are important to you and your family. After all, life and business are complicated enough.

Act now. You will be glad you did.

 

Scott R. McGimpsey March 31st, 2022

Digital currencies are highly volatile and not backed by any central bank or government. Digital currencies lack many of the regulations and consumer protections that legal-tender currencies and regulated securities have. Due to the high level of risk, investors should view cryptocurrency as a purely speculative instrument. You cannot currently buy or sell individual cryptocurrencies directly in a Cetera account. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. All investing involves, risk, including risk of loss. There can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio.

This blog post was written by Scott McGimpsey and does not necessarily represent the views of Cetera Advisor Networks LLC. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Neither Cetera Advisor Networks LLC nor Scott McGimpsey is engaged in rendering legal, accounting, or other professionally services. If such assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any federal, state, or municipal tax penalty.