To take a chance or not take a chance? That is the question many investors are asking themselves about diversifying using cryptocurrencies. You may have dreams of being a cryptonaire or nightmares of losing the bulk of your retirement savings.
So this poses the question, should you diversify into crypto? In this article we answer just that and much more!
Crypto is an Alternative Investment
If you haven’t already, now is the time to develop your guiding principle for the role cryptocurrency should play in your investment portfolio. It was January 3, 2009, when the Bitcoin network first emerged publicly with block number 0 and a reward of 50 bitcoins. That was more than 12 years ago. In comparison, Tesla stock had its IPO in June of 2010. Tesla stock is not an alternative investment. Does that mean because crypto has been around longer, it should not be considered an alternative investment? Crypto is an alternative investment because although Tesla is a forward-looking technology company, crypto is inventing an entirely new technology.
Traditional vs Alternative Investments
Still, cryptocurrencies have a long enough history that these are no longer considered the “wild west” of alternative investments. Two of the primary differences that seasoned investors use to distinguish between alternative and traditional investments are liquidity and return on investment.
Rental houses are alternative investments because it takes weeks or months to liquidate real estate. And historically, rental houses have a higher and more consistent rate of return compared to a traditional investment such as an S&P indexed mutual fund.
For instance, to liquidate a house, it must appreciate in value, be sold, and then go through closing before the owner can access the profits. But this doesn’t mean that it isn’t worth investing in houses. An alternative investment is best made with funds that an investor can afford to wait longer to access for cash and profits.
To its advantage, crypto is one of the easiest alternative investments to liquidate. There are multiple financial services, in several countries, that convert cryptocurrency to cash. Every day, more businesses are accepting cryptocurrencies for the payment of goods and services.
Today, it is much easier to convert cryptocurrency to cash or spend it.
That leaves return on investment as the other major factor when considering an alternative investment. You could become filthy rich as an early investor in crypto or you could lose everything if you invest too heavily. Fortunately, the performance of crypto technology is working in your favor. Cryptocurrencies and the closely related blockchain industry are consistently growing stronger. The increasing pace of adoption is a clear and strong sign that crypto is maturing. Major financial institutions and well-established investors consider it safe enough to invest large sums of money.
However, competition is fierce among thousands of different crypto brands. Although, their cutting-edge technology reliability holds unreliable in real world scenarios. The sheer volume of money involved assures that scammers will look for ways to deceive vulnerable parts of the industry. These are good reasons to hitch your investment to the right cryptocurrency. That will take astute due diligence on your part.
What you want is a crypto with a high rate of adoption and use along with a limited supply. As an example of this, the chart below demonstrates how Bitcoin has limited volatility paired with an extraordinary rate of return.
Ultimately, only a small number of cryptocurrencies are most likely to flourish long-term.
A Brief Portfolio Analysis
A diversified portfolio remains important to successful investing. It would not be wise to put all your eggs in the crypto basket. However, a balanced and diversified investment portfolio is less vulnerable during times of financial crisis and economic events. Cryptocurrency should react differently to economic factors than traditional investments in a portfolio.
Crypto is about investing in a growing market.
Many companies with an established history of high-tech innovation are already on board. Companies such as Google, Microsoft, Apple, JP Morgan, and Mastercard have embraced the blockchain technology behind cryptocurrencies with a view towards a large number of uses across multiple industries that include the financial sector. These notable companies clearly don’t want to be left behind by this promising innovative technology.
Other financial giants such as PayPal and Square have made it easy to buy and sell cryptocurrency on their popular platforms. Several of these companies have taken it further by investing hundreds of millions of dollars in Bitcoin and other crypto-assets. For instance, Tesla purchased $1.5 billion worth of Bitcoin in early 2021.
While the success of a particular crypto cannot be assured, if a crypto project achieves its goals, the early investors can expect to be richly rewarded over the long term.
But first…
Don’t jump in with your retirement funds until you are financially ready. Crypto is a growth investment with a higher than average risk. First, you want to assure that your savings, emergency reserve, and basic retirement funds are relatively secure. Also, consider your investing time horizon. Generally, younger investors can afford to be more aggressive with their investments.
Being young and more aggressive might mean exploring cryptocurrencies other than the best-established such as Bitcoin or Ethereum. On the other hand, investing in an established crypto could be the best decision for an investor approaching retirement age. In both cases, it’s probably wise to make it a smaller slice of your investment pie rather than the bulk of it.
Understand that cryptocurrency isn’t an investment in the same way a stock is. Much like investing in gold and silver, it doesn’t pay interest or dividends. To the degree that cryptocurrency will be a promising investment depends entirely upon its price increasing significantly like real estate – and staying there for a while.
The IRS tax treatment of cryptocurrency has created a favorable tax environment for Solo 401k and Roth Solo 401k accounts.
Your Solo 401k plays well with a crypto tax strategy. Cryptocurrency and other crypto assets are allowed inside your Solo 401k just like gold, real estate, stocks, bonds, and ETFs. In notice 2014-21, the IRS states, “virtual currency is treated as property for U.S. federal tax purposes” which also means any profits made on selling those currencies result in “general tax principles that apply to property transactions apply to transactions using virtual currency”.
As long as the cryptocurrency remains in your Solo 401k, it can grow tax-free until withdrawn. In the case of a Roth Solo 401k, the gains that you withdraw are tax-free. You will have to pay taxes on the traditional Solo 401k portion as it is withdrawn as retirement income.
Logical Next Steps
When you are ready to invest your Solo 401k in crypto, one of your first steps is determining how much you want to invest. This is part of your acceptable risk assessment based on your current investments and retirement strategy. For most people, the acceptable risk level may be relatively small at between 1% and 15% of their portfolio.
Another early decision is whether to make your investment a one-time event or have a plan for regular purchases going forward. A one-time event may become a smaller portion of your portfolio going forward as you add more funds to other investments. Planned future purchases can be used to keep your portfolio balanced or increase the percentage of your portfolio as you gain confidence. Either way, you can follow this guide to set up the account needed to invest your Solo 401k in a cryptocurrency.
Be sure you know how to access your cryptocurrency and keep the needed information in a highly secure location. This is especially important for hardware wallets for cold storage such as Trezor, Ledger S Nano, and more! Cryptocurrency lives in a decentralized peer-to-peer network. If you lose your private key, there isn’t a help desk to reset your account. So, backup your backups.
One of your best choices is opening a crypto exchange account in the name of your Solo 401k trust or through a Special Purpose LLC.
Contact a Nabers Group team member today to see if the Solo 401k is right for you. We’re happy to answer your questions about crypto assets and help you put together a plan so you can move forward thoughtfully, efficiently, and in full control of your retirement funds.
For even more insights about investing in crypto and how it fits with your Solo 401k, check out these other links:
