It’s fair to say that Bitcoin has been one of the best assets to own over the past 12 months. It recently broke above the $40,000 barrier for the first time, up from around $8,000 at the beginning of 2020.
Following this performance, it’s understandable that some investors might be interested in buying into the asset ahead of further gains. I think this could be a mistake.
Warren Buffett’s approach
I think Warren Buffett was right when he advised investors to stay away from Bitcoin several years ago. He believed the cryptocurrency market was built on nothing more than hype, which would quickly unwind when investors realised what they were buying. That hasn’t happened yet, and it may never happen. But I believe Warren Buffett’s advice is still relevant.
The Bitcoin price is determined by supply and demand. There’s recently been a surge in demand for the crypto asset, which has driven the price higher. This may continue, or it could pop tomorrow. We don’t know what the future holds.
I think this was the basis for Warren Buffett’s argument. There’s a lot of uncertainty that surrounds the Bitcoin price. That makes it very hard to try and figure out what it could be worth in a month, year or decade from now.
On the other hand, the outlook for many companies is a lot easier to predict.
For example, one of my favourite firms is insurance group Direct Line. This organisation is one of the largest car insurance companies in the UK. It’s a legal requirement for every car owner to have insurance in this country, and that’s unlikely to change.
As such, I believe it’s relatively likely the company will still be doing what it does two or three decades from now. That makes it easier for me to value the stock. What’s more, it gives me confidence that by investing my hard-earned money in the enterprise, I should see a positive return over the long run. The same can be said for very many listed companies.
Warren Buffett has been using a similar approach since the 1960s. It has helped him create a considerable fortune and one of the world’s largest investment companies. I think this tried-and-tested method will continue to work, but I’m not so sure about Bitcoin. That’s why I’m avoiding the cryptocurrency and following the billionaire investor’s thoughts instead.
Having said all of the above, if one wants to diversify by acquiring Bitcoin for one’s portfolio, there’s nothing wrong with that. Owning the cryptocurrency over the past 12 months, for example, would have yielded strong returns for all holders.
However, I don’t think it would be sensible to have a large holding of the asset. A small allocation would provide diversification while limiting risk if something went wrong. As there’s so much uncertainty surrounding the asset’s future, there are many things that could go wrong over the next few years. I’ll stick with share investing instead!
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.