Have you seen this thing called Bitcoin? It is up a gajillion percent since January and people are getting rich! They say these crypto-currencies are the money of the future.
Does this sound familiar? It rhymes an awful lot like the tech boom of the late 1990’s. The time where anything with “.com” after the name had to be the next best thing.
There were doubters then too. I can still remember syndicated columnist George Will speaking about current events. He spoke of Amazon, which at the time was unprofitable. He made a statement about how he had made more profit selling lemonade as a kid than Amazon had made.
Fast forward twenty years. Amazon has been a game changer in the retail industry. Its profits have likely exceeded those of Mr. Will’s lemonade stand. Since its offering, Amazon has been the third best performing individual stock. It is up over 38,000%. That is more than 100 times greater than the broader S&P 500 index.
The path to Amazon’s distinction has been anything but sunshine and lollipops. Reaping those benefits would have been a significant challenge for any investor.
Volatility for the stock has been extreme. In the past 20+ years, Amazon has had calendar year decreases of 30% or more 10 times. It has had calendar year decreases of 50% or more 5 times. Buying and holding Amazon meant riding through a 95% decrease in value. Imagine waking up one morning and seeing a $10,000 investment worth only $500.
Bitcoin and the other crypto-currencies may be the next big thing. At some point, they may replace national currencies like the dollar or the Euro. And they may turn out to be a tremendous investment which generates amazing returns. In other words, it could be the next Amazon for investors.
But you have to understand the emotional challenge with something so speculative.
Big declines create big challenges for investors. People are willing to be patient for a little while. And most understand the basic concept behind “temporary declines.” But as the losing streak continues it becomes harder to stay on track.
The chart above demonstrates a common trait we see with many investors. They notice how well something has done in the recent past. They figure it will continue doing well, so they buy. The trend may continue for a little while, but something happens.
Things change and prices and values fall. Many people underestimate the emotional stress caused by prolonged declines. They sell after most of the damage is done, only to miss on the eventual recovery. Unfortunately, many get stuck in the cycle of buying at high points only to sell at lower ones.
Bitcoin’s volatility makes stocks look like a boring family dinner topic. Our concern is those who start buying now are doing so near the top of the cycle. It may continue to increase for a while, but at some point things will change. Then the real challenge begins.
You have to ask yourself can you ride through a 50% decrease in value? What about 75%, or even 95%? Can you endure the emotional stress of those types of declines to reap the potential rewards? Remember those rewards are unknown, not guaranteed, and may be far less than you expect.