Finance media headlines tend to focus on dramatic highs, sudden crashes and bold predictions – especially when cryptocurrencies are involved. For reporters and media executives, that makes sense! After all, emotion, especially extreme emotion, attracts attention.
But the same emotions that make a story compelling can lead to impulsive investment decisions. When retirement savings are involved, there’s a better starting point. Not excitement, fear or a price forecast.
It is a plan.
The problem with emotions in investing
Investing always involves uncertainty, but a long-term plan can help prevent short-term emotions from over-ruling rational financial decisions.
Emotion is not irrelevant to investing. Your priorities, responsibilities and comfort with risk all matter when defining your goals. The danger comes when a dramatic headline or sudden price move overrides the plan built around those goals.
A written process can’t eliminate uncertainty, but it can make decisions more deliberate and less reactive.
A disciplined process is less dramatic than reacting to every headline. Its value is that it offers investors a consistent framework for making decisions, even when prices and emotions are volatile.
Emotions are helpful in figuring out what you want, but they tend to be d in helping you to get what you want. Rational, methodic planning and execution of that plan are what help you to achieve that goal that emotions help you to decide on.
Of course, this rational, methodical way of going about managing your portfolio isn’t what you’ll tend to see from the media. It’s not exciting. It’s not sexy. It’s not glittery, dramatic, or visually stunning.
What it is is effective and workable by average, everyday people as well as wildly successful investors.
The same framework used to evaluate any asset also works for crypto:
- Define the objective
- Understand the risks
- Consider your time horizon
- Establish how the asset fits into your overall savings strategy
For some investors, that process may support diversification with cryptocurrencies. For others, it will likely lead to the conclusion that crypto isn’t appropriate.
Now let’s take a practical look at how this process works…
Four steps to take before making a decision
Sahil Vakil, writing for Investopedia, explains that crypto curiosity should be handled as a planning decision rather than a price-prediction exercise:
The goal is to make room for learning and limited experimentation without letting volatility, taxes, or fear of missing out disrupt the long-term plan.
His framework can be distilled into four practical steps.
1. Protect the rest of the plan
Start by considering the obligations and priorities that should not depend on crypto’s performance. Emergency savings, near-term expenses and other retirement objectives should remain intact even if a crypto investment declines substantially.
2. Decide how much risk the plan can absorb
Consider what would happen if the value of the investment fell sharply. Would it affect your retirement date, spending plans or ability to meet another important obligation? The answer can help clarify whether the contemplated allocation is too large for your circumstances.
3. Establish your rules in advance
Decide why you would buy, hold, rebalance or sell before a major price move tests your discipline. Rules established during calmer conditions can help reduce the temptation to make an impulsive decision driven by fear or excitement.
4. Understand what you would actually own
Crypto exposure can take different forms, including direct ownership, exchange-traded products and assets held through certain retirement accounts. Before choosing one, compare custody, access controls, fees, liquidity and tax treatment – as well as the risks of the underlying asset.
Now, obviously, working through these four steps is going to take longer than it would to open up your Robinhood app and click “Buy.” There’s a reason for that!
Here’s why we need a framework
According to Daniel Kahneman’s great book Thinking, Fast and Slow, our brains make decisions in one of two ways. He calls them System 1 and System 2.
System 1 is the fast, intuitive and emotional part of our minds. Instincts and gut feelings.
System 2 is the slower, deliberate and more logical process.
Now, here’s the interesting thing: Our minds default to System 1 thinking. When presented with a situation, unless we force ourselves to slow down, that fast and emotional part of our minds will make the decision for us.
And, just as we mentioned earlier, that’s exactly what we don’t want! Emotions interfere with rational investing decisions. Vakil’s methodical approach forces us to slow down and engage System 2 thinking. That’s how I understand the process, at least.
That’s a good thing! Let’s face it: None of us can consistently forecast short-term price movements with any amount of certainty. For that very reason, a retirement strategy should be designed to remain workable even when the market behaves differently than we expect.
Maybe that’s obvious to you? Either way, take a moment and consider just how many people you know who simply don’t prepare for the unexpected. I’m not talking about a bunker buried in the back yard, I’m talking about simple things. Like a spare tire and a jack in the trunk of their cars. A fire extinguisher in the kitchen. A first-aid kit in the medicine cabinet.
Because if your retirement savings is based on a specific prediction about the future, what will you do if your prediction doesn’t match reality?
Many, many investors have experienced this challenge – and when tested, all too often, they fail. By “fail,” I mean they let System 1 take over. Under enough pressure, they simply break.
Consider Jason Zweig’s recent article in the WSJ, The Mind Game That Investors Can’t Stop Playing, for example. He begins by explaining that the majority investors in bitcoin ETFs have managed to underperform the fund itself.
Sound impossible? He goes on to explain why:
That’s because so many buyers of these funds bought high and sold low – a recurring pattern that says much more about human nature than about cryptocurrency.
We all know the whole point of investing is to buy low and sell high, yet we often do the opposite.
When they bought, they expected bitcoin price to keep going up – and when it didn’t, they sold.
That, to me, sounds exactly like an emotional reaction. The very thing we’re trying to avoid.
I’m not trying to dump on bitcoin ETF buyers specifically – every popular asset class attracts at least some investors who do the same thing. “A recurring pattern that says much more about human nature than about cryptocurrency.”
Understanding this particular facet of human nature will, I hope, prepare you to deal with it in the future.
Separate what we can control from what we can’t
There are so many aspects of investing that are simply out of our control.
We can’t end the Iran war and get energy prices back down.
We can’t make the Federal Reserve take the inflation fight more seriously.
We can’t demand the federal government stop the multi-trillion-dollar annual budget deficits.
We can’t lock Congress in a room and refuse to let them out until they finally pass the Clarity Act.
So let’s focus on what we can control.
We can start by deciding what you want our savings to do for us. Do we need capital appreciation? Wealth preservation? A little of both?
From there, we can assess the different assets available. We can look at their past performance and forecasts for the future, their Sharpe ratios and valuations. We can analyze their performance as a group – their correlations, betas and so on. Then we can decide which assets will best contribute to accomplishing our goals.
We need a reality check here, too. No matter how much growth potential we need, we have to remember that, in investing, risk and return are joined at the hip. We have to realistically balance our desire for growth with our ability to tolerate volatility. If we neglect this step, we risk becoming the investors Zweig discussed previously – the people who “buy high and sell low.”
And don’t forget taxes! Although we can’t know in advance what future tax rates will be, I think we can agree that taxes won’t be going away anytime soon.
This process is the same whether we’re discussing cryptocurrency or any other asset. And I believe this is a process each of us must go through for ourselves. Rules of thumb and model portfolios are all well and good – but they’re no more than a starting point. (Remember, it’s your savings you’re managing in order to help you to reach your goals, not anyone else’s.)
If you’re a newcomer to cryptocurrencies and want more information and education as part of your due diligence, I recommend reading Crypto Made Simple: 5 Rules Smart Investors Swear By.
If you’ve already done your due diligence and are ready to diversify your retirement savings with crypto, you can open your digital IRA account online in less than 10 minutes.
