Decoding Crypto Investing
A Certified Financial Planner offers four principles to remember if you decide to invest in digital dough
Bitcoin, Litecoin and many other name brand cryptocurrencies can be bought through specialty brokers like Coinbase or Robinhood. Famous athletes and actors are touting digital currency and draw us into the exciting concept. You can buy, sell or spend cryptocurrency, often called simply crypto.
But what are cryptocurrencies? They are a kind of money that exists only in electronic form. Cryptocurrency accounts are not insured by the Federal Deposit Insurance Corporation and the digital money itself is neither issued by nor backed by the Federal Reserve (or any other central bank).
Before you spend your hard-earned cash on any cryptocurrency, you should consider how it will fit in with your investment strategy, estate planning, risk tolerance and income taxes.
And, unlike the U.S. dollar, which has a relatively stable value, the market for cryptocurrency has been remarkably volatile. According to Coin Desk, a crypto trading platform, the price of one Bitcoin peaked at $64,972.24 on November 10, 2021, and traded for $26,107.57 — 60% less — on August 20, 2023.
Think Before Buying
Investment laws do regulate the sale of crypto. And the federal government is trying to educate investors and savers on the pitfalls and scams associated with this investment.
You may be confident and have figured out mining, where to buy crypto and which one you are going to buy, but you are not ready to make this purchase. Before you spend your hard-earned cash on any cryptocurrency, you should consider how it will fit in with your investment strategy, estate planning, risk tolerance and income taxes.
Here are four important financial planning concepts and how you need to look at them in light of a crypto investment:
1. Investment Strategy: Does a crypto purchase fit with your investment strategy? Many people jumped on board as a "sure bet" heard on the street and made the purchase on-line. The investment becomes a personal and emotional decision. Yet, there are investment reasons to pause and rethink.
Consult With a Pro
If you have always been a conservative investor, adding crypto to your portfolio is very risky. Consider your risk tolerance. Whether a crypto or Robinhood or other discount broker account, knowing how it fits into your overall plan can be the difference between a rational decision and a reactionary one on the day your currency declines.
Yet, if you do have an investment advisor, make them aware of your purchase, as they can only do their job well with all your information. With this addition to your portfolio, they may ask you to adapt your profile or make the assets under their management safer to offset the added risk you are taking on.
2. Estate Planning: Does crypto fit with your estate plan, practically and legally? Many people invest in crypto and have accounts with passwords but never provide the details to their family or loved ones. Lacking this information, the asset could be lost to the digital world no matter how much it is worth. Be practical. Share the details to protect this asset from your disability or death.
Complicates Estate Planning
Legally, if your lawyer has created a trust for you and everything you own is in the trust, then a crypto account may wreak havoc when it comes time to settle the estate. When you set up your account on-line, the system is easy, smooth, and quick, but it is not personalized. No prompt asks if you have a trust or a specific designation to align with your estate plan, which may cost time and money in probate.
Plus, if your legal documents do not grant authority to your executor to handle your digital assets, your heirs could be facing an unnecessary hassle with the crypto provider.
3. Risk Tolerance: Are you really prepared to watch this investment go up and down? Making money is fun. And earns bragging rights. Crypto can be a fun diversion but consider the rest of the factors in your financial life. Cash in the bank may not earn much but it has FDIC backing.
Using cash to buy crypto is short-sighted if your safety account is not strong.
Even your investments in brokerage firms are guaranteed up to limits. Securities Investor Protection Corporation insurance covers you if the company, not your investment, goes under. There is no such assurance from Coinbase, Gemini or other cybercurrencies.
Using cash to buy crypto is short-sighted if your safety account is not strong. First things first. Consider cryptocurrency within the whole picture of your financial life to know what suits your goals and cash flow.
Anticipate a Tax Bill
4. Tax Policy: Are you following the tax rules? Whether it is cryptocurrency or stocks under your control, when you sell, keep cash available for taxes. If you have done any selling of crypto the past few years, your CPA may have asked you this question, which now appears on the 1040 form itself. Starting in 2023, crypto retailers will be required to issue 1099 tax forms telling you and the IRS how much you made or lost on cryptocurrencies. Keeping records and planning for taxes are essential.
As an experienced investor, taxes should come as no surprise. However, bear in mind you need to have cash available for upcoming taxes otherwise you could cause undue havoc on your cash flow. The company who sold and bought your currency has no responsibility to remind you to put aside cash. You do not want to have to sell crypto to pay the taxes thereby creating a cycle of more sales and more taxes.
Crypto can be a great investment for the right people. It will serve you best if you go in with your eyes open and remember that the above details matter.