With Bitcoin allegedly beating all benchmarks in 2021, a new investor or financial independence hopeful would probably consider the question: “should I invest in crypto or stocks?”.
If you can only afford to invest in crypto or stocks, a conventional approach would be to invest in stocks through a fund. This is because stocks are backed by real-world companies, and a fund will contain so many stocks that it’s unlikely for them all to fail. Plus, the price changes less dramatically than crypto.
Of course, if you can afford to invest in both… maybe you have more to consider.
Here are the reasons why you would only want to invest crypto after investing in stocks.
I’m saying “stocks” here, but I mean “publicly traded shares”. They’re also called “equities” or “equity securities”. “Stocks” is just a common name and refers to something that doesn’t really exist in English law anymore. A stock exchange sells shares.
1. Concentration risk
There isn’t a way to buy a big index of crypto. This means that buying a single token (e.g. buying Bitcoin) only goes into one thing.
The impact of this failing – or dropping in value – is higher than if you bought a fund. That’s because when you buy one unit of a fund, your money is buying a tiny portion of all of the stocks in that fund.
For example, I buy the Vanguard FTSE All-World ESG fund (V3AG) in my pension. That fund uses my money and all of the money pooled by other investors to buy stocks in over 1,000 different companies. The chances of them all going bust is small.
This spread is called diversification. The opposite of this spread – putting a lot of your money into a few things – is called concentration.
Concentration generally means that gains are better. Unfortunately, it also generally means that losses are more severe.
It makes sense that if you can only invest in one of stocks or crypto, you probably don’t have that much money to lose. Logically, it makes sense to start with stocks by buying a fund.
You can always buy crypto later, after you have a decent amount of savings and investments that you’re comfortable with. That’s what I did.
2. Volatility risk
Not only is crypto more concentrated, it likes to move in price. This price change is called volatility.
Volatility is a problem when you want to cash out. When you achieve financial independence, you will want to cash out on your terms. The more volatility you have in your investments, the more you need to time when you want to cash out according to when is good for them.
Now, VanEck – a well-respected investment fund company – have spotted that Bitcoin is less volatile than 22%-29% of stocks in the US S&P500 index. This means that Bitcoin would have had price highs and lows that were closer together than 22% of these individual company stocks.
However, if you had bought a fund of the whole S&P500, you would have had all of the stocks. Your volatility would have been lower.
It is usually a good idea for small investors to buy funds, like ETFs, rather than individual stocks. This makes the volatility risk a lot smaller but should still mean that your money grows in the long term faster than inflation.
Volatility is stressful, especially in the beginning. It can often look like you’ve lost money, especially in the first year. Over time and with regular purchases of a fund, the volatility smooths out to an average, and you’ll find that you don’t often lose money as long as the volatility isn’t too high.
So, unless you can deal with looking at a big red number on your portfolio, you’re probably better to start by investing in stocks through funds.
3. Underlying assets
I’ll admit: I believe that crypto is revolutionary. I’m a big fan. Even then, I still put most of my money into stocks by buying funds.
This is because we know that companies have value. They have had value for hundreds of years. You can go to a court if your company closes down, and the law will help you get it.
Well, unless the company goes completely bust, but a lot of companies are simply sold or closed while still having cash in the bank.
You can’t do that with crypto. If the world decides that it doesn’t want to use Dogecoin one day, you can’t go to court and demand that the creator of Dogecoin buys your tokens back.
We can also tell what makes owning stocks valuable. We know that if a company has lots of assets, makes a lot of profits and is expected to make more profits in the future, it is worth owning. A share entitles you to those profits and assets.
We’re not sure what makes crypto valuable. It is a free market: crypto tokens are worth whatever people are willing to pay for them, but if no-one is buying them then they pretty much become worthless. This has happened to a lot of crypto start-ups in the past.
This means that it’s easier to work out a fair price for stocks than it is for crypto.
Some simple examples of working out a fair price are the Price to Earnings Ratio (P/E) and the Price to Book Value.
4. Regulation
Stocks are regulated. There is only so much a company can do with its shares without getting a vote from shareholders.
There are also limits to how many individual shares a company can issue each year. The stock exchanges ahve rules about this.
Companies must keep public records and public companies must have their accounts audited.
Things can still go wrong, but on the whole there are checks on the quality of a stock.
Crypto has no real regulation. Crypto exchanges, where you buy crypto, are regulated to check that customers aren’t using them for money laundering, but that’s it. There is no standard that a crypto token needs to meet.
Some crypto exchanges will have their own regulations about what counts as a good crypto, but that isn’t as good as a legal standard. There are also regulation on certain types of token, but these are very specialised.
Ultimately, if you can only buy stocks or crypto, you might be safer with stocks.
In conclusion: should I invest in stocks or crypto?
In conclusion, if you can only afford to buy stocks or crypto, you would probably be wiser to buy stocks through a fund.
This will give you diversification, lower volatility and a claim on something underlying in the real world. They are also more heavily regulated, so there is a smaller chance that you buy one that is a deliberate fraud.
If you can afford to buy stocks and crypto, you might want to buy both. That’s a decision for you though, and you should only invest if you feel comfortable to do so.
Usually it’s not considered a smart move to invest if you still have debts. It’s also a good idea, especially when you don’t have much money, to build up an emergency fund in cash first. That way, you can ride out any volatility in your investments if you need money in a hurry.
I take a lot of risk in my investments, because I feel comfortable doing this and I have a while before I need to cash out. Even then, I didn’t buy any crypto at all until we had an emergency fund, a good amount of equity in our house, a good part of a pension and I think £3,000 in a stocks and shares ISA.
