Once again I want to get on my favourite hobbyhorse t his week and discuss managing r i s k when investing. This time it is spurred by the collapse of Mt Gox and Felxcoin, both Bitcoin exchanges (well, Felxcoin called itself a Bitcoin bank). Many people have lost cash or Bitcoins which they had at the exchanges. This article is not about cryptocurrencies but rather about some very disturbing reports that I have been seeing after the collapse of these two Bitcoin exchanges.
Apparently, a number of people (I’m not sure that they can be classified as Bitcoin investors) had their entire life savings in Bitcoin and with the collapse of exchanges, they have lost everything. With respect to these people, this struck me as insane. Putting your life savings into any single investment is absolutely as high risk as it can be, regardless what that investment or product may be.
We get suckered into an investment with the promise of massive wealth in a f lash and Bitcoin certainly had that allure, but any investment is about managing risk vs reward and anything offering huge returns equally offers huge risk. Unfortunately, as humans we most often get blinded by the reward side of the equation and ignore the risk – however, you can’t have one without the other.
But there is a bigger issue at play here – how we broadly manage risk. I have often spoken about diversifying across sectors, stocks and even asset classes to reduce risk. No matter what the investment, even the most bluest of blue chips is high risk if your entire investment is in a single stock.
We need to invest across different sectors to reduce the risk of a sector falling out of favour – witness what we’ve seen in the construction sector since the days of the boom leading up the 2010 Fifa World Cup.
We also need to invest in different asset classes. An obvious class is stocks, but we also need to have property and maybe even debt (such as Government bond ETFs or preference shares) to further reduce risk while also investing in different geographies. Again, we can use ETFs to get easy exposure to different global markets and asset classes reducing the risk of a single country or region.
The direct issue with Bitcoin is the regulatory environment. What sort of protection is offered if things get hacked, stolen or just close down? In the case of Bitcoin, nothing, hence the massive risk of putting everything into a Bitcoin exchange. Sure, this lack of oversight is a large part of the attraction of Bitcoin but this means that when things go wrong one has no recourse to authorities.
A local broker would be registered with the JSE, who in turn has a guaranteed fund offering protection to investors in the event of theft or bankruptcy.
That said foreign exchange (FX) and contracts for difference (CFD) trading platforms have no direct Financial Services Board oversight, meaning that these carry counterparty risk. Counter-party risk is the risk that you take when the counter party (FX or CFD issuer) goes bust and you’re left carrying the can. JSEtraded products have no counter-party risk and if you are trading FX or CFDs, you need to make sure that the platform which you trade on is above board and that you have done a thorough due diligence on these platforms.