Considering crypto? Here's what to think about

-- | 04/06/2021

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Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Dan Kemp from Morningstar Investment Management. Hello. 

Dan Kemp: Hello, Holly.

Black: So, Dan Kemp, the world is going crazy for crypto. What is driving all this interest?

Kemp: Well, there's so much driving it at the moment. As we know, you can't have a conversation with people in the investment world without it turning to crypto pretty quickly. And I think it's important to divide up the drivers between the initial drivers and the things that are now keeping the interest going. So, the initial drivers were a combination of a new technology, the Blockchain and Bitcoins originally and then obviously other cryptocurrencies and tokens along the way, and also concerns about Fiat currency, paper money and electronic money and the actions of central banks and then low interest rates and the fact that people are looking for returns in unusual places. That's what seemed to get cryptocurrencies going.

What's happened since then, of course, is that people appear to be making fortunes in cryptocurrency. And of course, that then creates momentum as more and more people get pulled in in the belief of a very fast, very easy riches to be had. And so, that's creating incredible amount of momentum and also interest around the asset class.

Black: Well, that's it. Some people have seemingly become overnight millionaires. And the question is whether that can continue. So, obviously, you think about valuation first. How do you think about that with something like cryptocurrency that's all a bit new and difficult to judge?

Kemp: Well, the first thing to remember is that these stories of overnight riches are nothing new. We've seen many occasions in the past when these sudden enthusiasms have led to incredible increases in the price of a particular asset, be it tulips or South Sea stock or rail companies or all sorts of different things where there's been this incredible enthusiasm about one particular asset class. It's typically been accompanied by a change in technology and low interest rates. And what we see is, because the price rises so quickly that people become very wealthy overnight. The question is whether people can hang on to that wealth, and that's dependent on two things. The first is the underlying quality of the asset, but also the distance between what is a fair value of a particular asset and what the price is. The greater the difference between the fair value of the asset, the higher the likelihood that people can lose money or even worse, get sucked in at the top of the market before it falls. And we have to learn these lessons of the past when thinking about any new investment, not just cryptocurrency, but anything new and popular that comes along.

Black: So, here's the key question, Dan. Does crypto have a place in my investment portfolio?

Kemp: Well, Holly, I cannot comment on your investment portfolio, but I think most investors need to be very careful about including cryptocurrency in their portfolio for any number of reasons. The first thing is that I'm using a generic term cryptocurrency, which covers a huge number of actually different types of coins and different tokens and different technology. So, first of all, you have to know what it is that you are buying. And then, second, when you have established what it is you are buying, think about why it has a value. Some things appear to have a value just because they are popular. But as with all fashions, that popularity can disappear overnight and suddenly you find the thing that you thought had value doesn't really. And so, really understand why it is that something has any value at all, but then secondly, why it's as valuable as it appears to be at the moment.

And then, once you've been through that process, then there may be a case for having some diversifying assets in your portfolio which don't act in the normal way of stocks and bonds. But remember, the point of a diversifying asset is something that preserves wealth when traditional assets are falling in value. The purpose of a diversifying asset is not to try and make out overnight fortunes. That's not how investment works over the long term. And so, I would be very, very careful about holding crypto assets in your portfolio. Make sure that you understand the risk that it conveys. And remember that investing is really very boring. It's about making long-term decisions based on valuation and spreading your risk, and that never changes.

Black: Dan, thank you so much for your time. For Morningstar, I'm Holly Black.

This report appeared on 2022 Morningstar Australasia Pty Limited

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