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It’s been a good few days for Bitcoin investors.
The digital token is trading at nearly $ 50,000, its highest level in months. And many people who have stayed on the sidelines are probably wondering again: is it time to buy the cryptocurrency?
Before investing your money in the still very volatile asset, however, there are three helpful things to consider, according to financial and behavioral experts.
1. Suspecting it is a bubble will not save you
Many investors know what a bubble is: it happens when the price of an asset far exceeds its real value.
And many smart people have voiced their concern that Bitcoin is a bubble. Even so, many have invested in the currency with little caution, despite suspecting that its price is detached from its value.
It’s common for people to buy assets knowing they are overvalued “because they expect prices to get even higher,” said Bruce Mizrach, an economics professor at Rutgers University’s Rutgers School of Arts and Sciences.
And, he said, “they all believe they can get out before the bubble bursts.”
Remember: that’s what everyone else thinks.
“When most retail investors are making upward investments, it is often too late,” said Kent Baker, professor of finance at American University.
2. FOMO often backfires
Stories of crypto millionaires. People buy houses thanks to Bitcoin. How could you not be afraid of missing out?
Investors often fall prey to the social bias of “guarding,” Baker said. They do what the crowd does, believing that everyone else needs to know more than they do and that there is security in numbers. We can’t all lose all our money, you might think.
“In general, such investors are wrong on both counts,” said Baker.
In reality, the other people “in the crowd” are similarly influenced by the same illusions.
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3. There is just so much we don’t know
Trying to understand the fundamental valuation of a digital asset is “very difficult,” Mizrach said.
Most stocks, he said, can at least get a price / earnings ratio, which tells what investors are willing to pay for a company for every dollar of profits they make. This number can be used to determine whether a company is over- or undervalued.
With digital tokens you are mostly in the dark.
“The rise in cryptocurrencies is reminiscent of the early stages of the internet bubble when investors tried to value stocks with no profits,” Mizrach said.
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With cryptocurrencies being so new, there is also confusion about how to buy and sell them, how to protect them from loss and hackers, and how taxes work.
And so experts refer to ancient wisdom.
“There’s no free lunch with investing – higher expected returns come with higher expected risks,” said Baker. “The prices of cryptocurrencies are very volatile, which means they are very risky.”
Most financial advisors, however, say that investing a small portion of your portfolio in the assets does little harm – and potentially a lot to gain – from investing, usually no more than you could afford to lose.
Experts estimate that this number is between 3% and 5% of your investments.