Should You Jump on the Bitcoin Bandwagon?

April 18, 2013

Last week, I was asked what I thought about investing in the new digital currency  “bitcoin.” This got me thinking about what successful investors do in general when deciding what to invest in and how to make a rational decision as opposed to being caught up in a herd mentality. Here’s a great process to go through before investing your hard earned dollars in the latest investment trend (or fad):

Do you have the money to risk? It goes without saying that unless an investment is guaranteed there is a chance to lose the money you invest. Make sure that you have an emergency savings account in place before you invest.

Pay off your high interest debt first. By paying down debt you are letting your money work the hardest for you. Think of it this way: invest in the latest craze and have the possibility of earning a decent return or pay down credit card debt, which could have an interest rate of 29.99%, and definitely see your debt and interest payments go down.

Contribute enough to your retirement plan to get your employer match. If your employer is going to match some of your contributions, that is a great return on your money and it’s guaranteed. Need I say more here?

Do your homework. It doesn’t matter whether it is a stock, precious metal or something like bitcoin, never invest in something you don’t understand. Make sure you know the potential risks, returns, and costs involved and how it would fit into your overall investment strategy. If it’s something you’ve never heard of, check sites like sec.gov to be aware of any investment scams that may be out there.

What is driving the investment decision? Is it simply being swept up in the public craze or is there a legitimate reason why you are considering the investment? Don’t fall prey to rationalizing your way into buying something based on emotion. Ask yourself if there truly is a good reason (diversifies your portfolio for instance) and if you are willing (and able) to sustain the possible losses.

Don’t over-invest. If you’ve done all the previous steps, it can be tempting to think that you’ve thought through everything, but even the smartest investors make mistakes. Just don’t allow any mistake to become too costly. In general, you don’t want to have more than 10% of your portfolio in any one investment no matter how promising it may look.

Finally, have an exit point. For example, you can set up a rule for yourself where if your investment loses x% you sell, then stick to it! You can also do this on the profit side as well by setting a point where once your investment return is positive by x% you sell. THAT takes the emotion out.

So applying this methodology, how would you assess investing in bitcoin? Is it a smart investment or a more modern version of the Dutch Tulip? Leave your thoughts in the comments section below.