To the uninitiated, investing can seem like gambling. And in some cases, it is.
But when big-name investors make big returns look easy, it’s tempting to roll the dice yourself.
The latest craze to catch the attention of the mainstream investing community revolves around cryptocurrencies, such as Bitcoin and Ethereum. Jason Calacanis, an early investor in startups including Robinhood and Uber, recently tweeted a question about the appropriate percentage to invest in the volatile cryptocurrency Ethereum, as Business Insider’s Becky Peterson reported.
Chamath Palihapitiya, an early Facebook employee and Silicon Valley investor, responded simply: “1%.”
When it comes to these types of investments, 1% seems to be a common theme among successful investors.
Bill Miller, a portfolio manager and investor who famously beat the market for 15 consecutive years while at investment management firm Legg Mason, recently spoke to Forbes’ Antoine Gara about his decision to invest in Bitcoin:
“In 2014, he put 1% of his net worth into Bitcoin, judging that the digital currency’s potential for large-scale economic disruption outweighed the risk of a total loss. He’s up nearly tenfold, and Bitcoin is now a top holding of his hedge fund,” Gara reported.
Miller, as Gara reported, weighed the upside of Bitcoin against “the risk of a total loss” — a statement that surely wasn’t hyperbole. Despite coming to the conclusion that the potential reward of investing in Bitcoin was worth the risk, Miller still capped his investment at 1% of his net worth.
— jason (@Jason) July 8, 2017
— Chamath Palihapitiya (@chamath) July 8, 2017
There may be something to that advice.
Limiting the percentage of your net worth tied up in a risky investment such as Bitcoin or Ethereum can protect against devastating losses, while allowing for big returns if you get it right, as Miller did.
All investments stand the risk of going to zero — some more than others — so it’s wise to invest no more than you can afford to lose. Especially since investors miss the mark more often than not.
Among financial professionals, a staggering 92.2% of large-cap mutual fund managers failed to beat the S&P 500, their respective index, during the 15-year period ending in 2016, according to the SPIVA scorecard recently released by financial research firm Standard and Poor’s.
Individual investors don’t fare much better. As of July 20, the average investor is up 8.7% in 2017, a full three percentage points lower than the 11.83% return from the S&P 500 during the same time frame, according to Openfolio data.
In other words, your chances of making a killing like Miller did with Bitcoin aren’t very high. Capping your exposure to a relatively small percentage of your portfolio — by following the ‘1% rule’ — may be a smart way to try your luck without the risk of losing it all.
Just remember — if you’re buying, someone else is selling. And that person on the other side of the trade may know something you don’t.
When in doubt, there’s always Warren Buffett’s advice to stick with a simple S&P 500 index fund. You won’t beat the market that way, but then again most of the investing pros don’t, either.