We invest with our prehistoric lizard brains and our lizard brains see bitcoin as super high risk.
I have been working on an article I am pitching to a major publication about Baby Boomers investing in cryptocurrency.
For background, I asked my email list…
“If you aren’t invested in cryptocurrency, but you are interested enough to be on my list and reading my emails, what is holding you back?”
Most answers were variations of it’s too volatile, unfamiliar, not mainstream, used by criminals, going to be shut down by the government, subject to hacking or theft, etc.
Warren Buffett’s partner, Charlie Munger, says…
“There is a lot to be said that when the world is going crazy, to put yourself in a position where you take risk off the table.”
The great irony in these fears is that bitcoin actually reduces risk, not increases it
Tell your lizard brain to go take a powder for a minute and I’ll explain …
Bitcoin reduces risk in three ways:
- Diversification of your investments;
- Diversification of your money (not the same thing BTW) and;
- Optionality or what you have probably heard me refer to as Pascal’s Wager.
Risk reduction #1 - Diversification of your investments
Harry Markowitz won a Nobel Prize in Economics for what is today known as Modern Portfolio Theory (MPT). And the underlying concept, which was so ground-breaking in the 1950s, was the fundamental concept of diversification.
You could argue it was the financial equivalent of Newton’s discovery of gravity.
Modern portfolio theory says by investing in more than one stock, an investor can reap the benefits of diversification – namely, a *reduction* in the riskiness of the portfolio.
MPT quantifies the benefits of diversification, or not putting all of your eggs in one basket. So, taken further, people realized the same is true of different asset classes.
By holding a basket of assets that go up and down at different times, which we call non-correlated assets, you can optimize return for a given level of risk.
This doesn’t have to be hard
In a variation of Dr. Craig Isrealsen’s 7 asset class portfolio, my old investment firm often recommended a very simple portfolio of 20% stocks, 20% bonds, 20% commodities, 20% real estate and 20% cash, made up of low cost ETFs, rebalanced once a year.
This doesn’t make the investment advisors any commissions and it is hard to justify a high fee for such simple advice, which is why your financial advisor probably doesn’t recommend it. But nonetheless, it is very hard to beat for its efficacy and simplicity.
Where does bitcoin fit in?
The one fly in the ointment here, is that over time, with globalization and instant information, all these different asset classes have become more and more correlated. Meaning, you think you are diversified but mathematically, you really aren’t… or not as much.
Correlation is a mathematical equation and it is measured on a scale of 1 to -1, with 1 being highly correlated, meaning the assets go up and down together, 0 being uncorrelated and -1 being negatively correlated, meaning they will tend to move opposite to one another.
The three year Pearson Correlation Coefficient of the S&P500 to the NASDAQ, for example, is .95, meaning, as you would expect, they are very, very correlated.
The three year correlation of bitcoin to the S&P 500, Nasdaq, gold and Brent crude is -.01, -.02, .05 and .01 respectively… meaning it is uncorrelated with all of them and therefore provides mathematical diversification to the portfolio.
In other words, it doesn’t increase risk in your portfolio. It reduces it.
Risk reduction #2 - Diversification of your money
I am not an alarmist, by any stretch of the imagination. But I do have “hope for the best and plan for the worst” as a core financial philosophy.
There is evidence to suggest, based on what we have seen in other countries, that bitcoin does serve, as expected, as both a medium of exchange and store of value during periods of hyper-inflation, financial or geopolitical upheaval.
I don’t know about you but the world feels a little crazy to me right now
In a world where anything is possible, even if highly improbable, it makes sense to me to diversify your money.
By money, I mean the portion of your assets whose job is safety, as opposed to the portion whose job is to growth or income.
For me, this means holding some of it in fiat currency, which for me is US Dollars, some in cryptocurrency, which for me is bitcoin, and some in gold.
And, for extra measure, at least some portion of that should be safe and accessible to you if the crap were to ever hit the fan.
Risk reduction #3 - Outsized return potential
Quoting Charlie Munger again, he says…
“Risk to us (meaning he and Warren Buffett) is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return.”
The historical rates of return of bitcoin have been: 1395% in 2011, 200% in 2012, 5525% in 2013, then -59% in 2014, 36% in 2015, 124% in 2016, 1307% in 2017 and in 2018, YTD, we are down something like 60%.
Is that volatile? YES!
But note Charlie Munger said ‘permanent’ losses of capital, not temporary losses of capital. That is the hardest thing for a lizard brain to grasp.
And inadequate returns are a massive risk. Far bigger than the risk of losing the money, so long as you don’t let your lizard brain invest too much.
The Babe Ruth Effect
In an article by Tren Griffin about the work of Harvard economist, Richard Zeckhauser, he writes…
“David Ricardo made a fortune buying bonds from the British government four days in advance of the Battle of Waterloo. He was not a military analyst, and even if he were, he had no basis to compute the odds of Napoleon’s defeat or victory, or hard-to-identify ambiguous outcomes. Thus, he was investing in the unknown and the unknowable. Still, he knew that competition was thin, that the seller was eager, and that his windfall pounds should Napoleon lose would be worth much more than the pounds he’d lose should Napoleon win. Ricardo knew a good bet when he saw it.”
Zeckhauser is describing what Michael Mauboussin calls “The Babe Ruth Effect.” Mauboussin writes:
“…in any probabilistic exercise: the frequency of correctness does not matter; it is the magnitude of correctness that matters…. even though Ruth struck out a lot, he was one of baseball’s greatest hitters…. Internalizing this lesson, on the other hand, is difficult because it runs against human nature in a very fundamental way.”
Bitcoin checks all the right boxes
As Seth Klarman has said, “The three best ways to reduce risk are diversification, hedging, and buying with a margin of safety”.
Bitcoin inherently checks two of those three boxes.
And you can check the third by putting your lizard brain in a box and not letting it out no matter how loud it screams at you in fits of fear or greed.
How to control your lizard brain
In fact, that is the very reason the Sane Crypto Mastermind is so valuable.
The system puts your lizard brain in the box and having accountability keeps you from letting it out when you’re tempted.
As always, I hope you found that helpful.
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If you’d like to learn more about investing in cryptocurrency for retirement, I would encourage you to register for my free online training, How A Little, Little Bit of Bitcoin Can Make Your Retirement Savings Go A Lot, Lot Further.
If you have any questions at all, about this topic, or anything else, just email me at [email protected]. I read and answer every email personally. Or leave it in the comments below.
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Dive Deeper Into Resources On How Bitcoin Reduces Risk
Money Answers Show Episode with Kim - Jordan Goodman
Modern Portfolio Theory: Why It’s Still Hip - Investopedia
Risk, Uncertainty and Ignorance in Investing and Business – Lessons from Richard Zeckhauser - Tren Griffin
H1 2018: Crypto Report - Coin Shares Research
Sane Crypto Podcast Episode 31
Sane Crypto Podcast Episode 31
How A Little, Little Bit of Bitcoin Can Increase Returns AND Hedge Against Financial Crisis
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