March 7, 2022
Maybe you've heard about Bitcoin or Ethereum and you feel like you're missing out on something.
And the truth is, you might be.
A lot of people have made a lot of money within cryptocurrency.
However, the rewards don't come without a heavy amount of risk. Cryptocurrency is an extremely volatile asset class, meaning the prices could drop or go up by 15-30+% on any given day.
So, how do you invest in crypto without taking on so much personal risk?
By carefully and strategically planning out your regular personal finances, and these are 8 things that I believe investors should do before considering investing in crypto.
When it comes to investing in cryptocurrency there are a lot of complexities, even more so than traditional investments, like stocks or ETFs.
When you open a standard investment account you have to enter in your personal information and then create a password and maybe create a backup 2-factor authentication to keep your account secure. With cryptocurrency, you generally have to create an account, enter in your personal info - but then to be able to use and move your crypto, you need a wallet. And wallets have their own separate passwords and security measures to keep your crypto secure. Then you have to educate and protect yourself when engaging with the crypto environment to ensure that you don’t fall victim to scams.
In addition to the technical aspects, the crypto environment operates similar to regular businesses in the sense that there are competitors, competitive advantages, and new companies and technology being built every day. However since the crypto space is still so young, there's a lot of competition and a lot of development that still has to play out - and this is one reason why some people consider it speculative rather than a true investment.
It's impossible to know what the industry will do or look like in the future but by becoming educated about how these companies in crypto are innovating and solving real-world problems, you'll begin to understand the role that crypto and DeFi (decentralized finance) can play in the bigger picture.
To help with this, I wrote The Crypto Guide to make the crypto and digital asset world make sense from a beginner level.
Before investing in cryptocurrency, it's important that your personal financial foundation is built and one of the first things to address is debt. If you have high-interest debt, which is generally anything over 5%, such as credit card debt, it's wise to pay these off first because by doing so, you're effectively getting a return of whatever the interest rate is.
Debt is flat tire on the road to financial freedom so before investing in cryptocurrency, make sure you control what you can control and get debt off your plate.
An effective way to ensure personal financial stability is by establishing an emergency fund. This is one of the first accounts you should focus on building up because the only thing more stressful than having 7 missed calls from your boss is financial stress.
I'll use myself as an example here - in November 2020 (4 months after starting my business) my car was stolen and at the time, I was using it to do DoorDash to help cover my personal expenses. Luckily, my car was found about a week later. Unfortunately, it was wrecked, torn up, and barely drivable. However, I had an emergency fund in the background for situations exactly like this so I took it to the shop, got it repaired, and was good to go.
My point is you never know what can happen in life. But by being financially stable and having backup savings, you'll feel a lot more confident in your money and can begin doing more things with your extra cash flow.
If you want to take the deep dive into cryptocurrency, it’s generally recommended to take care of traditional retirement first. This can be done by maxing out your Roth IRA (or traditional IRA depending on income levels) and other tax-advantaged accounts.
Currently it is possible to invest in crypto in some retirement accounts, but this brings up a whole different conversation about diversification and risk management. By putting retirement funds in a volatile asset, you're not only taking on a higher risk, but you're also limiting your ability to diversify amongst accounts.
Since there are only a few accounts designed for retirement savings, if you use them to invest in crypto, you won't be able to properly diversify and allocate your retirement portfolios into other investments, which can lead to problems and headaches down the road.
Adding on to the last point, if you're employed and your company has a 401(k) match, it's typically recommended to invest as much as you can up to the company match. If you're financially able, it might make sense to max out contributions to take full advantage of the tax benefits 401(k)'s can provide.
Don't neglect your retirement savings to try and get in on the latest gains on a crypto that nobody's ever heard of..
One of the final things I believe you should do before investing in cryptocurrency is to make sure you're on track for things you want to accomplish or need to take care of in life. Common savings goals are buying a home, funding your kid's college, or saving for future travel.
If you don't know what you should be saving for, maybe it's time to take a few days or weeks to think about it. A few questions that can help spark some ideas are:
The main takeaway from this lesson is that you should prioritize saving for other life goals and shouldn't throw your savings towards cryptocurrency in hopes that you can double or triple it to reach them quicker. The chances of that happening are very, very, very... very slim.
A general rule of thumb I like to use when approaching crypto is "don't invest anything you can't afford to lose". Meaning if that money should be going towards actual expenses, savings, or retirement, it does not belong in crypto.
Just like with any investment, you should know why you want to invest in it. The reason is that it helps you begin to establish your plan, which we'll talk about in the next point, and requires you to think about the investment before just throwing money into it.
If you invest in a cryptocurrency and someone asks you this question, you should be able to answer it:
"Why are you putting money into _____?"
For example, a common reason that people put money into bitcoin is that they believe that it's a store of value (like gold) and acts as a hedge against inflation.
But if you asked someone why they put money into Dogecoin, the only answer was probably "I hope it goes up" - and that's why the crypto space can feel like a gamble if you don't take the time to learn about it outside of headlines and social media trends.
If the coin doesn't serve a purpose or have real-world utility and problem-solving capabilities, I would personally think twice before putting money into it.
The last thing I believe you should do before investing in cryptocurrency is establish your plan.
This means: Defining your goals for investing in crypto, thinking through your exit strategy, and determining what role these investments will play in your overall financial picture.
This goes back to your "why" and lays out your purpose behind investing in crypto.
These kinds of questions should be answered in your plan and will help dictate the future decisions to be made.
One of the easiest ways to determine if you should be investing in cryptocurrency is knowing whether or not the money you contribute would have an impact on your financial situation if it went to $0. Meaning if you only have a little bit of money saved for retirement and don't have an emergency fund, you probably shouldn't be investing in crypto because there are more impactful things to be doing with your money.
Remember: Crypto assets are a new and developing space so it's important to be careful with where you put your money and if necessary, talk with a financial advisor who has knowledge around cryptocurrency (note: they're tough to find) who can help educate and determine the right moves to make for your situation.
Investing in cryptocurrency carries more risk than traditional investments and it's important to evaluate your own financial situation and risk tolerance before going down the crypto rabbit hole.
Written by Treyton DeVore, CDAA™
Disclaimer: This post is for education purposes only and should not be considered financial or investment advice. Consider talking with your Certified Digital Asset Advisor before implementing any financial strategies.