I had an interesting conversation with a relative last week during which we explored whether Microsoft (MSFT) or Bitcoin is the better investment right now. While both are outside my focus area of small-cap stocks the conversation was still entertaining. I think we closed our adventure with a pretty good idea of what the answer is.
For starters, comparing Microsoft and Bitcoin is a ridiculous exercise.
They are totally different types of assets, have different risk profiles, and on and on. I don’t think anybody’s going to argue that this is an apples-to-apples comparison. It’s clearly not.
That’s why it was both fun and interesting to talk about.
So how did the conversation start?
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While talking about the crazy market my relative said he’s pleased to have recently learned about the tax loss harvesting benefits of crypto. His crypto holdings are now worth about $8,000. It’s mostly Bitcoin, but there’s some Cardano (ADA) and Ethereum (ETH) in there too.
He went on to say that, while he had gotten into crypto at a decent time, he was now down about 50% across his positions. He said, “So I just found out I can sell it and literally buy it right back a few minutes later. Doing so allows me to get the benefit of the tax loss but stay in the same crypto holdings.”
Winning!
(Editor’s note: Because cryptocurrencies are an unregulated asset class, they are currently not subject to the wash sale rules you may be familiar with for stocks and bonds. IRS guidelines may change as the regulatory environment evolves and you should consult with a tax professional to answer any questions around the tax treatment of your investments.)
My response: “That’s awesome. Or maybe don’t buy it back and buy something else instead?”
His response: “You know, I never even thought of that.”
From here our conversation meandered for a while before we got to the nut of it. Which is this. If you were to get totally out of crypto today, what would you buy instead, if you had a 10-year time horizon?
With the table set, I proposed the following. “Ok let’s go with something with decent upside that’ll most likely still be around in a decade. A basket of blue-chip tech stocks. How about Microsoft, Apple (AAPL), Amazon (AMZN) and you pick one more.”
Him. “Hmmm. Interesting idea. You know I just saw Rich from college. I remember going into class once and he was on a computer buying Microsoft, which I think he had been doing well before college. I think he’s semi-retired.”
Me. “Is there a lesson there? Anyway. What do you think is a reasonable return expectation for a basket of those stocks over the next ten years? I have an idea for how we can break this down.”
Him. “400%.”
Me: “What probability do you assign to that return?”
Him. “95% chance.”
Me: “OK. So, let’s take $8,000, multiply by 400% return and assign a 95% probability. In this scenario, your holdings would go up by $32,000, so $40,000 total. Factor in the 95% probability and you could have $38,000 in ten years.
Him. “Hmm. Not going to change my life.”
Me. “OK. How much do you think your current crypto holdings could go up?”
Him. “1,000%.”
Me. “OK, same exercise. With the crypto portfolio and a 10-times return, you could expect to have $88,000 in ten years. What do you think is the probability of this outcome?”
Him. “Probably about 5%.”
Me. “You don’t sound very confident.”
Him. “Well, crypto is in freefall. It might all be a scam and evaporate. I’m along for the ride baby.”
Me. “I need a beer. But let’s wrap this up. So, with a 5% chance of a 1,000% return, your crypto portfolio could be worth around $4,400. That’s about half of what you have now. And roughly $35,000 less than the blue-chip tech portfolio.”
Him. “Yeah. Hmm. It could also go to zero. Or, it could go up 5,000%, or 10,000% or more. It could be a lottery ticket.”
Me. “Totally. So, what’s the call?”
Him. “Get the tax loss benefit and get back in these crypto holdings. I don’t know where it’s going. But this is play money. I’m all in with that. Upside is I retire early. Downside is I’m out $8,000. I can live with that.”
We went on to talk about other things. About how crypto is really about software and technology platforms, how the lack of regulation is a risk, etc.
At the end of the day, my takeaway from this conversation was that, and admittedly this is my own personal bias here, a lot of the draw for crypto investors is the hope of fulfilling a dream to hit it big.
No problem there. That’s the same as with a lot of stock investors, especially those that get into small-cap stocks, micro-cap stocks and more aggressive options strategies.
Personally, Bitcoin, Ethereum, and other cryptocurrencies aren’t for me. Not now, not when they were soaring, and (I don’t think), not in a decade (though I reserve the right to change my mind).
The reason is that I see so many small-cap stocks that represent an ownership interest in a real business, generating real revenue and, if not now then later, real profits.
The pursuit of “the dream” through these types of stocks, to me, seems more attainable. And I can choose to ramp up or ramp down the risk, depending on how I construct a small-cap portfolio. I know other people feel differently, and respect that. Crypto is just not for me.
My next conversation with my relative, later this week over leftover turkey and a few beers, is going to be about what small-cap stocks I think he could buy that could do far better than the blue-chip tech stock basket we talked about last week.
Maybe, or maybe not, this small-cap portfolio will do better than his crypto holdings. I’ll draw heavily from positions in the current Cabot Small-Cap Confidential and Cabot Early Opportunities portfolios.
If you’re interested in what I think can beat crypto, and Microsoft, etc. in the decade ahead, grab a subscription to one, or both, of these advisory services now.
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