Is Cryptocurrency worth your investment?
You may have probably heard the term “cryptocurrency” in the news or social media. You might even have friends who have invested in Bitcoins or Dogecoin or some other form of cryptocurrency. But, are these worth the investment? Before you consider if the new digital currency is a good option for your investment portfolio, what exactly is cryptocurrency?
What is Cryptocurrency?
Cryptocurrency is an intangible currency. It does not have a physical coin or bill to represent value. It was initially developed as a type of digital currency that you can exchange for goods or services online instead of traditional transactions that go through a bank.
Bitcoins, Ethereum, and many other types of cryptocurrency are stored in digital wallets and used for quick transactions. Because people see this value, virtual currency has quickly grown into an investment opportunity where people buy cryptocurrency in hopes of an increased value.
You can purchase cryptocurrency from an exchange platform similar to the way you would purchase a foreign currency.
A popular method used to earn cryptocurrency is called mining. This method involves computers and servers running consistently to solve complex equations. Miners will lend their personal computers to be run as a server then, in return, compensated with virtual coins such as Bitcoins. Originally, with mining, you could generate ‘one coin’ per day. However, with the increase in demands and investment opportunities, mining now makes small fractions of the coins.
Cryptocurrency Scams
According to the Federal Trade Commission, a cryptocurrency account is not protected or insured by a government, unlike the US dollars deposited into a bank account. In the event of theft, hack, or fraud, you do not have the same protection against the theft of digital currencies.
The lack of government regulations means greater control to the individuals when it comes to virtual currency. Unfortunately, though it sounds great to have the power in your hands, it also comes with the consequences of scammers.
Scammers have evolved significantly from the “good ole” days of random faxes about wealthy relatives in Africa who have left an inheritance and that you are the last of the bloodline.
One popular scam is where Bitcoin scammers contact individuals to make payment for something only with the cryptocurrency. What happens is that the scammers will hack into your digital wallet and drain the account, leaving you with less amount or sometimes nothing. Not having the federal laws backing digital currencies, you cannot claim fraud as you would do with a credit card or bank account.
Lower Risk Alternatives to Cryptocurrency
Investing in any cryptocurrency such as Bitcoin or Ethereum is considered high risk and with zero certainties the value of each digital currency. Look at DogeCoin as an example; the meme currency rose to over $0.69 in the first quarter of 2021. But what is the value of it now?
Much like the stock market, cryptocurrencies go through their ups and downs. If looking for lower-risk investments, the following may be better options for you. As always, to find out what is right for you, contact a financial advisor for recommendations.
Mutual Funds
Mutual Funds are funds investing in a pool of stocks and/or bonds. Instead of having many shares of one company, mutual funds hold many shares in various stocks and bonds. The purpose here is to help spread your nest eggs and to create a lower-risk investment opportunity.
There are several categories of mutual funds, with each having different target goals and their investment. You might have heard advisors use the term equality funds instead of mutual funds. Equity Funds is a popular category that typically focuses on stock investment and growth through collections of publicly traded shares. Rather than looking at individual stock shares, equality funds are dipping into a group or shared stocks with small shares in multiple companies versus a large share in one company.
In Fixed-income funds or bond funds, the category focuses more on investing in government or corporate debt. You, the investor, will lend money to the debt as a bond and, in return, pay a fixed amount back on the initial investment. Fixed-income funds will look into options more under savings bonds rather than openly traded stocks.
Hybrid Funds or Balanced funds typically have two or more combinations of stocks, bonds, money market instruments, or alternative investments. According to Investopedia,” the objective is to reduce the risk of exposure across asset classes.” One disadvantage of Hybrid funds is that the fund controls the allocation of assets after predetermining the balance types.
Dividend-Paying Stocks
Did you know that certain stocks pay you back your investments in dividends? Traditionally companies will use the money earned back into their stock or share to increase value, whereas dividend companies pay out their shareholders the excess.
How do dividends work?
For example, Lisa has 100 shares from a company that pays 10% share dividends. This particular company pays its dividends annually. Therefore, if each share she had was worth $5 and 10% of 100 is 10, she will earn $50 in dividends at the end of the company’s fiscal year. Dividends then could be used to buy more shares from the company or kept into the investment account.
The above is only a simplified example, and actual dividends earned will vary depending on each private company and its policy or rate. Remember to advise your local financial advisor or investment advisor for a second opinion before taking action.
Savings Bonds
You can loan money to the Government or US Treasury to acquire a savings bond by purchasing from the US treasury or a reputable financial institution. Sort of like an IOU.
Bonds issued by a federal government are called Treasury bonds and are used to cover the federal debt. Municipal bonds are used for local or state-level funding such as roads, schools, and other infrastructures.
For example, you buy a $100 bond for a 10-year maturing date. You will continuously put in a small amount of money just like a savings account and yield interest from it over a 10-year time horizon. After your bond expires, the government distributes the money back to you bi-annually.
Treasury bonds are tax-exempt, whereas municipal bonds have some tax-exemptions depending on each state or local government law. While the tax exemptions are appealing, both have a lower interest rate compared to corporate bonds.
Private companies can issue bonds to investors as Corporate Bonds. According to Security Exchange Commissions, Corporate bonds make up the majority of the U.S. bond market even with a higher risk than the other bonds mentioned above. Companies offer the bond at a higher interest rate than Treasury bonds and municipal bonds to attract investors.
High-yield Saving Account
According to the FDIC, the national average interest rate on savings accounts is 0.04% APY. However, a high-yield saving account typically has a much greater interest rate between .1% to .5%. Thus, a high-yield savings account, like a money market account or certificate of deposit, is better for long-term cash, such as an emergency fund.
Difference Between Money Market and Certificate of Deposit
Banks and credit unions offer interest-bearing accounts called Money Market Deposit Account (MMDA), more commonly known as Money Market Account. A money market account is considered a deposit account under Federal Reserve’s Regulation D and is limited to 6 transactions per month. Much like a checking account, you can write checks or may be issued a debit card for the MMDA.
Certificate of Deposit (CD) cannot be used for transactions and works similarly to bonds. It earns interest on the money in the account over time but is not a bond and considered a saving account. A certificate of deposit’s maturity length can be as short as six months or as long as 15 years. When it reaches its maturity date, the money can be deposited back to another bank account or reinvested into a new CD. You can determine the length of your maturity; however, once the date is set, it can not be changed. In addition, money withdrawn before the maturity date may result in penalty fees and loss of earned interest.
Both money market savings accounts and certificates of deposits are products offered at a bank or credit union. An interest rate of certificate of deposit is determined by the length of time the account will be open. In contrast, money market savings account interest rates are based on the balance of the account. The more money in your money market account, the higher the interest rate. The maturity date and interest rate will vary between the individual banks, credit unions, and other financial institutes.
While it isn’t required to make deposits into both accounts, doing so is encouraged to waiver any banking fee that may be present. Check with your financial advisor or bank institutions for the details.
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CDs are insured by the FDIC and offer a fixed rate of return, whereas the return and principal value of investment securities fluctuate with changes in market conditions.
Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment. Municipal bond interest is not subject to federal income tax but may be subject to AMT, state or local taxes.
Income from municipal bonds is not subject to federal income taxation; however, it may be subject to state and local taxes and, for certain investors, to the alternative minimum tax. Income from taxable municipal bonds is subject to federal income taxation, and it may be subject to state and local taxes. Please consult an income tax professional to assess the impact of holding such securities on your tax liability.
Bitcoin issuers are not registered with the SEC, and the bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are very speculative investments and involve a high degree of risk.
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