Want to invest in bitcoin? Do this first.
Bitcoin? Gamestop? FAANG?
It feels like it’s easier than ever to make money and everyone is looking to get in on the fun. And it’s not just the reddit crowd. Even billionaires are trying their hand with Gamestop and bitcoin.
The narrative behind the meteoric rise in value of these two investments are very different, but the way many people are treating them are similar: speculative bets.
Is it okay to make these types of speculative bets in hopes of making quick money? Depends.
Investments have a risk/return trade-off. The more risk you’re willing to accept, the greater the chance of a higher return. For example, if 99 out of 100 investments are likely to fail, the one investment that succeeds will have a high return. On the other hand, if 99 out of 100 investments are likely to survive, the return on the 99 investments is likely to be modest.
Speculative bets are extremely risky bets - so most will fail, but a select few will make a killing. Amateur investors tend to focus on returns and make speculative bets based on the promise of the killer returns. Professional investors also look at returns, but we tend to focus just as much, if not more, on risk. If you want to make a speculative bet like a pro, ask yourself, “Will I be financially (and emotionally) good assuming this investment goes to zero?”
My definition of financially good has 3 components:
3-12 months of emergency savings in cash & short-term bonds
Maximizing retirement savings
Progressing towards your most important financial goals
Let’s take two examples of my typical clients:
Amy was an early employee at a start-up that had a successful exit last year. She retired at age 40 with roughly $12m in net worth. We estimate that $10m is enough to cover everything she wants to do for the rest of her life and then some. She holds roughly $500,000 in cash, $2m in bonds, and $7.5m in stocks. She has enough cash to last 2 years, and if she needs more, we will sell bonds or stocks, whichever is more favorable at that time. She considers the rest, $2m, as the cherry on top and is willing and able to make risky investments. Even if all $2m goes to zero, she is financially good.
Emmitt is a high earner making $500,000 with an established company. He has 6 months of emergency savings ($60,000), maximizes his 401k including the use of the mega backdoor contribution ($58,000), backdoor Roth IRA ($7,000), HSA ($3,600), and saves another $50,000 in a brokerage account for his other financial goals. Emmitt has another $2,000/month left to invest after his expenses, and is willing and able to make risky investments with it. Even if all of it goes to zero, he is financially good.
Even investing in the biggest US companies fail over time, so it's reasonable to assume that speculative bets will usually not work out. I noted in my webinar last month that the top 10 companies have changed significantly over time… then Warren Buffet said the same thing during his annual conference! If anyone sees Warren, please let him know I said it first.
For the lucky few, their speculative bets turn out to be a homerun. If you enjoy the thrill of speculative bets and want to participate, get yourself to a good financial position first. Then review both the return and risk and make these bets only if you can make it a part of a balanced financial portfolio.
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