You’ve been hearing about bitcoin for years and thought, “Well, perhaps I should get in on that.” Bitcoin investing for beginners can be quite confusing, so how do you even get started? As a brand new asset class, 99% of the world doesn’t know how bitcoin works, where to get some, how to hold it, etc.
This article is meant to give you the broad overview of how to get all that done and actually get some bitcoin into your investment portfolio.
But first, the thing to understand about bitcoin is that bitcoin is not just an investment. Bitcoin is a tool for sending money over the internet. All this price speculation stuff stems from the fact that bitcoin works, and early bitcoin investors believe the rest of the world will eventually “wake up” to the fact that bitcoin is an incredibly useful tool for digital payments.
Bitcoin’s inherent properties as digital money, it makes it an attractive investment opportunity.
When looking at Bitcoin’s potential, it can be an appealing addition to any investment portfolio, but you need to do things correctly. Because bitcoin is such a new technology, there are plenty of ways to footgun yourself.
I am not an investment advisor, and I can’t tell you things like when to buy bitcoin or how much bitcoin to buy, but I can give you some basic guidance to start your journey investing in bitcoin as a beginner, including:
- Why bitcoin has value
- The bull case for bitcoin
- Why invest in bitcoin instead of stocks, ETFs, or index funds
- Where to buy bitcoin
- The difference between “real bitcoin” versus “bitcoin-like” products
- How to hold bitcoin securely
- How to get bitcoin into your retirement accounts
So, let’s dive in and explore the intrinsic value of Bitcoin before considering adding it to your investment portfolio. The first step to bitcoin investing for beginners is understanding the asset you hold. Without this basic first step, you’ll likely end up just another schmuck who buys at a high price during bull market euphoria, then sells during the bear market doldrums.
Lastly, this guide is meant to be a beginner’s guide to investing in bitcoin, and I’ll link to more resources with details if you wish to dive deeper.
Bitcoin Investing For Beginners: Adding Bitcoin to Your Portfolio
Understanding Bitcoin’s Value
For many, the allure of Bitcoin remains clouded in a certain kind of mystique. In truth, a variety of factors gives Bitcoin its value. As we peel back the layers, we can start to appreciate the potential it presents.
One of the most fundamental factors that shapes Bitcoin’s value revolves around supply and demand. Bitcoin’s protocol was designed to limit its supply to 21 million coins. These coins can be divided into subunits, called “sats” (short for Satoshi), but the point is that you cannot issue more bitcoin than is allowed by the network.
This scarcity can drive demand, propelling its value upward. Add to this the increasing acceptance of Bitcoin as a means of payment and store of value worldwide, and you have a recipe for growth potential.
But let’s take a step back even further.
Why do bitcoin and satoshis even have value in the first place?
How Did Bitcoin Gain Value?
Bitcoin’s original value was $0. Yes, you could actually mine bitcoin with your laptop and get some bitcoin for free in 2009. Nobody knew what it was or how much it was worth, so it had a value of $0.00 USD.
Eventually, the first price of bitcoin was determined by the cost of electricity that was used to run the laptop. Just two guys across the world wanted to trade some bitcoin for currency, so they settled on the most logical exchange rate. That meant the price of bitcoin was a fraction of a penny, but it set in motion the dominos that lead to the bitcoin price we see to day.
Slowly, folks in the bitcoin and investing space began to connect the dots and see bitcoin as a new type of money. It had all the typical characteristics of money, including:
Not only did it exhibit the properties of money, but it did it even better than traditional types of money.
Bitcoin As Money VS Other Types Of Money
Now, let’s see how Bitcoin stacks up against other investment vehicles like gold and fiat currencies.
While gold has long been a store of value and fiat currencies like the dollar serve as our everyday means of transaction, Bitcoin seeks to blend the best of both worlds. It’s like gold in the sense that it’s scarce. Yet it also has the potential for wide use in transactions, similar to traditional currencies.
Absolutely unique to bitcoin, however, is that it, exists outside the confines of governments and central banks. It’s not locked up in bank vault underground, and it can’t be printed with a computer keystroke.
It’s decentralized nature means its value isn’t directly tied to government decisions or the health of a specific economy. This unique characteristic gives Bitcoin a potential hedge against inflation, making it an interesting alternative for diversification in one’s portfolio. One of the main reasons anyone would want bitcoin in their portfolio is that it’s simply different from everything else. It’s not the only reason, but it’s a hard one to argue against.
Investing in Bitcoin Verus Stocks
Now let’s explore investing in Bitcoin versus stocks, and understanding Bitcoin allocation in a portfolio that include stocks and other traditional assets.
When investing in stocks, you are essentially purchasing a small piece of ownership in a company. As a shareholder, your investment’s value is tied to the company’s ability to execute their strategy and generate profits.
Investing in an Exchange Traded Fund (ETF) or Index Fund provides more broad market exposure, diversifying your risk across many companies or a particular market index. The value of these funds is determined by the net asset value of the securities they represent.
An ETF would represent a particular industry, like oil & gas, marijuana, tech software, semiconductors, or commercial space development. An index fund would be a basket of stocks from an even broader spectrum like the entire US stock market, European stocks, or emerging market stocks.
While stocks, ETFs, and Index funds offer diverse investment opportunities, they are tied to the performance of specific companies, sectors, and the overall economy.
Bitcoin, on the other hand, offers an alternative asset class that’s not linked to a particular company or sector. Though bitcoin’s price movements correlates with certain asset classes over short periods of time, it’s not fundamentally tied to any particular source of liquidity, profit, or market sentiment outside of itself.
Bitcoin Portfolio Allocation For Beginners
Ultimately, we’re interested in Bitcoin as an investment, so the next logical question concerns portfolio allocation.
When it comes to investments, diversification for risk management is standard advice. The age-old adage, “don’t put all your eggs in one basket,” is the way to go for beginners. You don’t get the insane price gains of investing in a single, successful asset, but you also don’t risk your entire portfolio going to zero. Most beginner investors in bitcoin or otherwise would do best diversifying across different asset classes.
How does bitcoin fit into the picture?
Adding a small allocation of bitcoin to any portfolio of investments could offer increased potential for higher returns, while still adding minimal downside risk.
How much bitcoin? What’s the magic number?
No one-size-fits-all answer exists, and the “right” percentage varies by individual circumstances and risk tolerance. However, some financial experts suggest a Bitcoin allocation ranging from a conservative 1% to a more aggressive 5% for those willing to stomach the volatility. Personally, I think you can go as high as 10%, but I’m a major bitcoin bull, and I’m also not a professional asset manager.
1% Allocation To Bitcoin To Start
Let’s discuss the 1% allocation first. This relatively low exposure to Bitcoin serves as an entry point for cautious investors dipping their toes into the crypto world. The benefit here lies in the limited downside. If Bitcoin were to take a substantial tumble, the damage to the portfolio remains contained.
However, if Bitcoin prices rocket, this small allocation could still yield a significant return, adding a boost to portfolio performance. Bitcoin is an asset with a potential to 10x or 100x over the coming decades, and finding that type of return with typical equities is really a difficult task to achieve. This conservative approach could appeal to risk-averse individuals or those nearing retirement, seeking to maintain portfolio stability while still participating in potential upside.
5% For Those With High Risk Tolerance
On the flip side, a 5% allocation to Bitcoin offers greater potential for profit, but comes with heightened risk. When Bitcoin’s price soars, this increased exposure could deliver a more substantial boost to the portfolio’s overall performance. Holding 5% of your assets in bitcoin during a bull market could fundamentally change your lifetime returns.
Nevertheless, this higher allocation also means increased exposure to Bitcoin’s volatility, which could lead to larger short-term losses if the market takes a downturn. Could you stomach seeing one of your largest individual holdings down 80% for a number of years?
Such an allocation might be more suitable for investors with a higher risk tolerance, perhaps younger individuals or those with a more extended investment horizon who can withstand potential short-term losses for the possibility of longer-term gains. As of 2023, anyone who has held bitcoin 5 years or longer has not lost money. If your time horizon for investing in bitcoin is longer than 5 years and you understand the fundamental investment case for bitcoin, then you may have the mental toughness to withstand such a downturn!
Example Of A Conservative Investment Portfolio With Bitcoin
An example portfolio for a 60-year-old investor might look like:
For a 60-year-old investor nearing retirement, the focus is typically on preserving capital and generating income. In this hypothetical scenario, the majority of their portfolio is allocated to bonds, which can provide steady income and tend to be less volatile than stocks.
A relatively smaller portion is allocated to stocks, which provides some growth potential. Bitcoin, given its higher risk, has the smallest allocation. 60 years old isn’t the end of the line! Many people live into their 90’s, so that’s 30 years of growth you can still capture. The remaining portion is kept in cash for stability and liquidity.
Example Of An Aggressive Investment Portfolio With Bitcoin
An example portfolio for a 25-year-old Investor might look like:
For a 25-year-old investor, the focus is generally on long-term growth. With a longer investment horizon and a potentially higher risk tolerance, they can afford to have a significant allocation in stocks, which provides substantial growth potential over the long term. They can also have a much smaller cash reserve on hand because they would be working, able to leverage cash flow from their jobs to pay for unexpected costs and weather emergencies.
Bitcoin has a larger allocation than in the older investor’s portfolio, given the younger investor’s capacity to withstand short-term volatility for the potential of high long-term returns. Bonds and cash serve to balance out the portfolio’s risk. Personally, I’m not sure if young people still look at bonds and a realistic investment option (I don’t), but I’m just looking at standard investment advice here.
These are simple examples and may not take into account other potential investments such as real estate, commodities, etc., that many investors might include in a diversified portfolio.
What Do Experts Say About Bitcoin Portfolio Construction?
Constructing a successful investment portfolio requires a careful balance, and an eye for both the details and the big picture.
Suppose you’ve thought about introducing a bit of Bitcoin, about 1%, into your well-curated investment portfolio. Some experts tout this as a strategy for boosting returns and enhancing diversification, given the inherent differences between Bitcoin and traditional assets.
Veteran investor Paul Tudor Jones argued for a modest 1-2% Bitcoin allocation, considering it a sound hedge against inflation.
MicroStrategy CEO Michael Saylor on the other hand, another notable proponent of Bitcoin, views it as a “good savings technology” and a long-term store of value. Though he’s not an investor or investment advisor, his allocation to bitcoin is somewhere in the range of 50% up to 100%.
Really, how much you should invest in bitcoin depends on a lot of factors, including your knowledge about bitcoin and outlook on the world. The 1% to 5% bitcoin recommendation is generic investment advice based on the average investor who wants to gain some price exposure to bitcoin during bull markets with minimal exposure to bitcoin during bear markets.
Where To Buy Bitcoin
Now that you have an idea of how much bitcoin you want to buy, where do you actually get it?
Though there are many ways to get bitcoin, the easiest way, and the way that most people get bitcoin, is through a bitcoin exchange. This is a website or app that is explicitly dedicated to helping people buy and sell bitcoin. I recommend using a bitcoin-only exchange, where the only cryptocurrency available to buy and sell is bitcoin.
Why go bitcoin-only instead of using one of the more popular crypto exchanges?
From a technical perspective, when an exchange is able to focus on delivering only bitcoin-related products and services, the quality of product and level of security tends to be better. Bitcoin-only exchanges are focused on delivering the best possible bitcoin experience, rather than chasing hot new coins for their users to trade.
From an investment philosophy, it makes sense to work with companies who will be around long term. Many other crypto exchanges are embroiled in lawsuits related to selling illegal unregistered securities, so it’s unclear how things will pan out for them long term.
The process of signing up for and using an exchange is quite simple. I won’t spend too much time or detail explaining how it works. It’s pretty much like signing up for any type of financial account.
You can expect to enter an email address and other personal information, then link a bank account. Thanks to modern banking technology like Plaid, you can probably buy some bitcoin within the next few minutes after reading this article. Alternatively, you may be able to enter your account and routing number, and have a deposit clear in 1-3 days.
Depending on how much bitcoin you want to buy, you may have to give additional information like home address, social security number, or even do a facial scan using your phone or computer camera. There are more private ways to buy bitcoin, but if you’re a beginner and buying bitcoin as an investment, those options are probably not very practical right now.
How To Hold Onto Your Bitcoin
Once you buy bitcoin, what do you do with it?
Ultimately, the goal is to hold your own keys.
Though bitcoin is stored on the bitcoin ledger, to secure your bitcoin from theft, you need to do something called holding your private keys. In practice, what that means is you must keep 12-24 words secret from anyone in the world.
These words are your “seed phrase”, and are generated by a bitcoin wallet. They are they keys required to spend and receive bitcoin. If someone discovers your seed phrase, they can get your bitcoin.
The Risks Of Holding Your Bitcoin On An Exchange
The first instinct of a bitcoin beginner is to simply leave their bitcoin on an exchange. This habit is inhered from legacy finance, where banks hold our money, and brokerages hold our stocks. However, in bitcoin world, this comes with some major risks you should be aware of.
While keeping your bitcoin on an exchange seems “safe” and “easy”, it means they control the private keys to your bitcoin.
In the past, this has resulted in many bitcoiners losing their bitcoin. The risks of keeping your bitcoin on exchanges include:
- exchange hacks
- illegal or incompetent handling of user funds
- restrictions on withdrawal amounts and times
Bitcoin exchanges are honey pots for hackers. Numerous exchanges have been hacked in the past. If your bitcoin is stolen, you are reliant on the exchange to have insurance or company treasury to cover the loss. In some cases, the exchange may fold, and you may get nothing.
In some cases exchanges have been caught commingling user funds with investments that went bust. That means they took their customer’s bitcoin, invested it, and lost them money. Though the owners may go to jail, your bitcoin is either gone, or locked up in litigation for decades.
Keeping your bitcoin on an exchange isn’t as safe as you might think.
The Benefits Of Holding Your Own Keys
The idea of being responsible for your own bitcoin is pretty scary, especially if you have a significant amount invested. Realistically, however, it provides you with the best assurance that your bitcoin will be available to you when you need it. One of the most important lessons while learning about bitcoin for beginners is that holding the keys to your bitcoin will actually prevent you from a lot of headaches and worry in the future.
With $100-$200 for a hardware wallet, and $50-$100 for a steel plate to etch your seed into, you can secure any amount of bitcoin.
Your hardware wallet and bitcoin software will be your portal to interacting with the bitcoin network. Just plug in your wallet, paste in a bitcoin address, and you can send bitcoin to other users or send it to an exchange to sell for cash.
The steel plate will be used as dummy-proof backup for your 12-24 words. Fire proof. Water proof. Disaster proof.
It takes a while to get comfortable with the idea of holding your own keys, but eventually, you’ll learn to trust yourself more than you trust any bitcoin company to hold your money.
How To Transfer Your Bitcoin From And Exchange To Your Own Wallet
To hold your own keys, you’ll need to transfer your bitcoin from the bitcoin exchange to your own wallet. There are software wallets and hardware wallets, but so we don’t get off into the weeds too far, let’s assume you want the best security possible, and are using one of the popular bitcoin-only hardware wallets. I’m working on a full list of bitcoin wallets for beginners, but it’s not complete yet. For now, I’ll let you make your own choice, and add an updated link when the list is ready.
First, you’ll need to plug in your hardware wallet to your computer, and connect it to the bitcoin software. Your hardware wallet may have its own software, or it may connect to a generic bitcoin software like Sparrow or Specter. Use the Hardware + Software combination to generate a receive address.
From there, go to your bitcoin exchange. Find the “withdraw” or “send” bitcoin tab, and paste in the address generated by your wallet. It will be a long string of numbers and letters, likely starting with a “bc1” Double check the address. Look at the first and last 5 characters or so to make sure the address you paste into your exchange matches that of the wallet software.
You’ll be asked to verify everything on the exchange side. You may need to check your email for a verification code or verify with your 2-Factor Authentication app. After you click send, the transaction is sent out the bitcoin network.
Waiting For The Transaction To Confirm
Congratulations! You just sent bitcoin to yourself using the bitcoin network.
In the next few minutes, you may see a pending receive transaction in your wallet software, but that doesn’t mean the bitcoin is actually there yet. Blocks are mined by bitcoin miners every 10 minutes, and it may take 30-60 minutes to “confirm”. In times of high network congestion (lots of people sending transactions), it may take longer, depending on the fee rate you paid (higher fee rate means faster confirmation).
Best case scenario is that your transaction will confirm in 30-40 minutes. Worst case scenario is that it might take a day to confirm. With some technical skills, you can check on the status of your transaction, but let’s leave that for a more advanced tutorial.
Tax Implications of Bitcoin Investing
Standard Taxable Events For Bitcoin
Uncle Sam wants his share of the profits, even in the world of cryptocurrency. Like any investment, there are tax considerations when you dip your toes into Bitcoin. Making money in bitcoin is great, but don’t forget to track your purchase price and sell price so you can pay your taxes correctly.
First off, the Internal Revenue Service (IRS) views Bitcoin not as currency, but as property. That means it’s subject to capital gains tax, just like your stocks or other assets. If you sell your Bitcoin for more than you bought it, the difference is taxable.
Generally speaking, if you hold bitcoin for less than a year and sell it for a profit, it’s taxed as regular income. If it’s been held for over a year, it falls under long-term capital gains tax, which is taxed at a lower rate.
But what if you sell at a loss? Well, it’s not all bad news. You can offset other capital gains or deduct the loss from your income, up to certain limits. That loss can be carried over multiple years in many instances.
Tax Implications Unique To Bitcoin
Unique to bitcoin at this point (2023), is that you can actually sell bitcoin at a loss, then buy it immediately after. In other asset classes, this is known as a wash sale, and has no tax benefit. Bitcoin is currently treated differently in that you can sell your bitcoin at a loss to offset profits in other areas, but immediately buy back into bitcoin so you don’t miss out on any future price gains.
Furthermore, when you use Bitcoin to buy goods or services, it’s considered a taxable event. Bitcoin is unique that you can can buy stuff with it. You can’t exactly go shopping with McDonald’s stock, can you?
The downside is that you could end up owing capital gains tax based on the value of Bitcoin when it was bought used. This is a major pain point for bitcoin adoption. Tracking taxable events for spending bitcoin can be a real chore. This is one reason many bitcoiners have their “investment stack” and their “spending stack”.
Investing In Bitcoin In Retirement Accounts
There are even ways to invest in bitcoin in your retirement accounts. This can provide you with some tax benefits, and is an investing strategy worth looking into if you expect bitcoin to go parabolic in the coming decades.
If you have bitcoin in a Roth IRA, you’ll eventually be able to sell it with tax-free gains, so this is something many bitcoiners do. Though it’s not very cypherpunk to do all the paperwork involved and doxx yourself and your bitcoin holdings, getting tax-free bitcoin is a pretty good incentive to do so.
I’m currently writing a beginner’s guide of options to get bitcoin into your retirement accounts, but again, it’s not finished yet. I’ll link to it when it’s ready.
Final Thoughts On Investing In Bitcoin For Beginners
In every financial journey, having a sound understanding of the terrain makes a big difference. As we’ve gone through the somewhat mystifying landscape of Bitcoin, we’ve uncovered the crucial importance of self-custody and the perks and pitfalls of including Bitcoin in IRAs.
We’ve taken note of the inherent risks, the unique tax implications, and how Bitcoin can put a unique spin on traditional portfolio construction.
Yet, as with every investment, a bit of prudence goes a long way. Bitcoin, while fascinating, is notorious for its wild price swings and a level of uncertainty that would make even the most stalwart investor’s head spin.
Given the vast terrain that Bitcoin investing covers, we’ve barely scratched the surface in this introductory guide. In forthcoming articles, expect a deeper plunge into Bitcoin IRAs and other crypto related topics.