Cryptocurrency has swept the globe, particularly in the last few years. According to Bloomberg, the total value of all these digital currencies has risen to more than $2 trillion.
Bitcoin is the most popular of them, with a market capitalization of over $1 trillion, according to CoinMarketCap.com. With little understanding and a lot of optimism, investors have flocked to this digital gold rush.
The rapid rise of cryptocurrency has many investors doubting the value of stocks in their portfolios. However, there are several distinctions between equities and cryptocurrencies.
The most significant difference is that a stock is an ownership interest in a firm (supported by the company’s assets and cash flow), whereas cryptocurrency is almost always unbacked.
When purchasing cryptocurrencies, it’s critical to understand what you’re getting and how it compares to traditional investments like equities, which have a proven track record over time.
Should you put your money into cryptocurrencies or stocks?
Any astute investor must understand exactly what they’re getting into. It’s critical to consider the dangers and benefits of investing, as well as the factors that will determine the investment’s success. They can’t make the calculation if they don’t have this information. It’s not truly investing in this scenario; it’s more like gambling.
Here are the key things investors need to know about stocks and cryptocurrency.
A stock is a fractional share of a company’s ownership. If you get caught up in the fluctuating stock prices — and the potential for profit — it’s easy to lose sight of this.
The stock allows stockholders a claim on the company’s assets and cash flow because it is a legal ownership position in the company. These are the assets that back up your investment and serve as the foundation for its valuation.
Why do stocks increase and fall? Stock prices fluctuate as investors analyze the company’s future prospects. While short-term investors may become unduly excited about the stock, the stock price is ultimately determined by the company’s capacity to grow earnings over time. That is, a stock rises over time as a result of the underlying company’s success.
The underlying company must do well overtime for a stock to be a good investment. (To learn how to invest in stocks, follow this step-by-step approach.)
You may be able to use a cryptocurrency to complete particular tasks, such as transmitting money to another person or using smart contracts that execute automatically when certain circumstances are satisfied.
Because bitcoin is not backed by assets or cash flow, the only thing that moves cryptocurrency prices is speculation fueled by sentiment. Prices fluctuate when public opinion shifts, sometimes dramatically.
As a result, bitcoin is only motivated by the prospect that someone would acquire it for a higher price in the future – a concept known as the “greater fool theory of investment.”
To make a cryptocurrency a profitable investment, you must be able to sell it for a higher price than you bought for it. That is to say, the market must be more optimistic than you are about it. (For more information on cryptocurrency investing, see this beginner’s guide.)
Cryptocurrency and stocks: What to consider
Risks and safety
If you’re considering investing in a market-based asset like bitcoin or stocks, you should think about your risk tolerance first. Can you deal with the high volatility of these assets? How well do you respond to investment gains and losses?
Because stocks represent an ownership interest in a corporation, their long-term performance is determined by the success of the underlying company.
If investors dislike a stock, they can sell it and drive the price down, but the stock must eventually go out of operation for it to be worthless.
Equities have a high level of volatility, with many stocks rising 100 percent or more in a year and falling just as quickly.
In general, the stock market is a well-established method of investing with a proven track record.
Investors who don’t want to buy individual companies can invest in mutual funds based on the Standard & Poor’s 500, which has averaged a 10% annual return over the years.
Because bitcoin is not backed by assets or cash flow, it relies solely on positive sentiment to drive up its price.
Because bitcoin isn’t backed by anything, it might plummet to zero if traders decide they don’t want to hold it.
Volatility is extremely high in this market, with cryptos frequently gaining or dropping by 50% or more in a year.
Countries could outright prohibit the use of cryptocurrencies, as China did in 2021.
Cryptocurrency has yet to establish itself as an asset class due to its infancy.
Cryptocurrencies, as hazardous as equities can be, are considered riskier.
A significant criterion is your time horizon, or when you need the money from an investment. The safer your asset should be, the shorter your timetable, so it’s there when you need it. The more volatile an asset is, the less suitable it is for people who have a limited time frame. In general, experts recommend that investors in risky assets such as equities wait at least three years to weather the storm.
Stocks are typically volatile, but they are less so than cryptocurrency. Individual equities are more volatile than a diversified stock portfolio, which benefits from diversity.
Stocks are better suited to those who don’t need to access their money and can leave it alone. In general, the more time you have to commit, the better.
Some equities have a higher level of volatility than others. Growth equities, for example, are substantially more volatile than value or dividend stocks.
When investors need to access their money, such as they approach retirement, they may switch from more aggressive equities (growth stocks) to safer stocks (dividend stocks).
While equities are unpredictable, cryptocurrency is even more so. In 2021, for example, Bitcoin dropped more than half of its value in a few months before gaining 100 percent. Crypto is unsuitable for short-term investors because to its high volatility.
Crypto is better suited to traders who are willing to tie up their funds and wait for them to recover. Instead of weeks, consider years.
When it comes to building your portfolio, you don’t have to choose between cryptocurrency and stocks — or between other types of assets like bonds or mutual funds. It’s all about balancing your portfolio to match your risk tolerance and time horizon.
Because of its inherent hazards, bitcoin should only represent a small part of your overall portfolio. Consider a percentage of less than 5%.
If cryptocurrency takes off, even a tiny investment might make a big difference in your portfolio.
Limiting your allocation to a limited amount also prevents you from a complete loss if crypto fails. If crypto becomes a large component of your portfolio, you can re-allocate more of your funds to stocks to reduce the total risk of your portfolio.
A diversified collection of equities should make up the majority of your portfolio, especially if you have decades until you need to touch it, given stocks’ great long-term track record.
If you’re investing in individual stocks, you’ll need to do a lot of research in order to get a high return. If you’re investing in funds, you can buy a broadly diversified fund like an S& P 500 index fund and reap the benefits of high returns without doing much research.