Investing For Dummies - Eric Tyson

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both can be used as gambling instruments. Futures, for example, can deal with the value of commodities such as heating oil, corn, wheat, gold, silver, and pork bellies. Futures have a delivery date that’s in the not-too-distant future. (Do you really want bushels of wheat delivered to your home? Or worse yet, pork bellies?) You can place a small down payment — around 10 percent — toward the purchase of futures, thereby greatly leveraging your “investment.” If prices fall, you need to put up more money to keep from having your position sold. (Note: Futures on financial instruments like stock market indices and interest rates are generally cash settlement rather than physical delivery, and they’re an increasingly large part of the market.) My advice: Don’t gamble with futures and options.

The only real use that you may (if ever) have for these derivatives (so called because their value is “derived” from the price of other securities) is to hedge. Suppose you hold a lot of a stock that has greatly appreciated, and you don’t want to sell now because of the taxes you would owe on the profit. Perhaps you want to postpone selling the stock until next year because you plan on not working or because you can then benefit from a lower tax rate. You can buy what’s called a put option, which increases in value when a stock’s price falls (because the put option grants its seller the right to sell his stock to the purchaser of the put option at a preset stock price). Thus, if the stock price does fall, the rising put option value offsets some of your losses on the stock you still hold. Using put options allows you to postpone selling your stock without exposing yourself to the risk of a falling stock price.

      Over the millennia, gold and silver have served as mediums of exchange or currency because they have some intrinsic value and can’t be debased the way paper currencies can (by printing more money). These precious metals are used in jewelry and manufacturing.

      As investments, gold and silver perform well during bouts of inflation. For example, from 1972 to 1980, when inflation zoomed into the double-digit range in the United States and stocks and bonds went into the tank, gold and silver prices skyrocketed more than 500 percent. With precious metals pricing zooming upward in the decade that began in 2000, some feared the return of inflation.

      

Over the long term, precious metals are lousy investments. They don’t pay any dividends, and their price increases may, at best, just keep up with (not keep ahead of) increases in the cost of living. Although investing in precious metals is better than keeping cash in a piggy bank or stuffing it in a mattress, the long-term investment returns aren’t nearly as good as quality bonds, stocks, and real estate. (I discuss bonds, stocks, and real estate in detail in Parts 2 and 3.) One way to possibly earn better long-term returns is to invest in a mutual fund or exchange-traded fund containing the stocks of gold and precious metals companies (see Chapter 8 for information).

      From time to time, you may see some ads or articles touting investing in currencies such as the British pound, Swiss franc, Japanese yen, and so on. Because such currencies have the backing of their particular country’s government, they are usually somewhat stable unless the country has a problematic economic situation (really high inflation) or troublesome finances (extremely high levels of government debt that will make repayment difficult).

      

But I shouldn’t really call placing your money into a specific currency in the hopes it will rise in value relative to other currencies investing because it’s more akin to gambling. Currency movements are influenced by many factors and near impossible to predict, even for investment experts who follow them far more closely than you would.

      In recent years, a whole new collection of so-called digital or online “currencies” known as cryptocurrency have been promoted by those who created them and hoped to make quick money. I find that far more young adults know about Bitcoin (and other cryptocurrencies) than older folks do. That makes sense since it’s a digital currency used for internet transactions.

      So, what exactly is Bitcoin (and other cryptocurrencies)? For starters, it’s not actually a coin — calling it a coin is a marketing gimmick to make it sound like a real currency. Bitcoin and other similar cryptocurrencies only exist in the online world. Bitcoin’s creators have limited the number of Bitcoins that can be “mined” and put into online circulation (more on mining follows).

      As its promoters have talked up its usefulness and dizzying rise, many people who have Bitcoins continue to hold onto them in the hopes that the price will keep rising. People don’t hoard real currencies with similar pie-in-the-sky hopes for large investment returns.

      Online Bitcoin transactions can be done anonymously, and they can’t be contested, disputed, or reversed. So, if you buy something using Bitcoin (or most other cryptocurrencies) and have a problem with the item you bought, that’s too bad — you have no recourse unlike, for example, a purchase made on your credit card. The clandestine nature of cryptocurrencies makes them attractive to folks trying to hide money or engaged in illegal activities (criminals, drug dealers, and so on).

      So, what is a given cryptocurrency like Bitcoin worth? Cryptocurrencies have no inherent value. Contrast that with gold. Not only has gold had a long history of being used as a medium of exchange (currency), gold has commercial and industrial uses. Furthermore, gold costs real money to mine out of the ground, which provides a floor of support under the price of gold in the range of $1,300 per ounce, not far below the recent price of gold at about $1,950 per ounce. (Bitcoin does have a made-up mining process whereby you need special computer equipment and end up using a bunch of electricity to solve complex math problems.)

      The supply of Bitcoin is currently artificially limited. And Bitcoin is hardly unique — it’s one of thousands of cryptocurrencies. So, if another cryptocurrency or two or three is easier to use online and perceived as attractive (in part because it’s far less expensive), Bitcoin will likely collapse in value even more than it already has in recent years.

      Even though Bitcoin has been the most popular cryptocurrency in recent years, few merchants actually accept it. And, to add insult to injury, Bitcoin users get whacked with unfavorable conversion rates that add greatly to the effective price of items bought with Bitcoin.

      I can’t tell you what will happen to Bitcoin’s price or that of any other cryptocurrency next month, next year, or next decade. But I can tell that it has virtually no inherent value as a digital currency, so those paying thousands of dollars for a Bitcoin will probably eventually be disappointed. With more than 6,600 of these cryptocurrencies, the field keeps growing as creators hope to get in on the ground floor of the next cryptocurrency, which they hope will soar in value.

      Recently, a number of online articles and videos (from people with an agenda) suggest that Bitcoin will replace gold because it has attributes and qualities that are as good as or better than gold. For those putting money into cryptocurrencies like Bitcoin, this is an appealing marketing pitch with the total market value of gold around $8 trillion and the value of Bitcoin about $210 billion. Bitcoin and cryptocurrency advocates reason that if just a few percent of the money that’s in gold moves into Bitcoin and other cryptocurrencies, it could move their

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