Interesting in investing in speculative investments like Bitcoin without losing lots of money? You're not alone. With Bitcoin and other speculative investments reaching all-time highs, everybody is feeling investing FOMO and wanting to get rich quick.
In late 1999 I had my Bitcoin moment. I was a 22 year old first year analyst working on the international trading floor at a major investment bank. The internet boom was peaking and I had just gotten my year end stub bonus of $20,000. Although the $20,000 magically turned into $12,000 after paying New York City taxes, for the first time in my life I no longer felt poor.
I took $3,000 of my bonus proceeds and invested in a company called Vertical Computer Systems Inc (VCSY). I didn't know much about it. All I remember was that it was a China internet play with a telephone dial pad as its home page. I was on the Emerging Markets team and spent all my time looking at Asian and Eastern European companies. Surely, VCSY was going to be the next Yahoo!
In a couple weeks, VCSY went from around $3 to $6. It had an inexplicable 20-for-1 stock split and then went up to around $9. In other words, within six months it went from $3 to $180 pre-split and I had 1,000 shares.
The stock’s 6,000% move was ridiculous as everybody I knew on the Street started piling into the name. I eventually got out of the stock at around $156 a share, netting a cool $153,000.
Realizing VCSY was 95% luck and 5% being in the right place at the right time, I sat on the cash for a couple years, watching the NASDAQ implode before finally getting the guts to use all my after-tax proceeds to buy a $580,000 condo in San Francisco with a $464,000 mortgage in 2003.
Hesitant To Invest
In retrospect, I should have kept hunting for new investment ideas like VCSY's every year. However, while my wealth continued to grow, I was too afraid to lose even small amounts of money. I didn't yet have these strategies for investing in uncertain times.
The dotcom crash had scarred my investing psyche. I personally knew many people who lost both their jobs and their paper fortunes. The subsequent housing bubble crash was even more devastating because so many more people were affected.
I wished there was a system I could follow that would give me the confidence to consistently swing for the fences without losing my shirt.
Invest In Speculative Investments Without Losing Everything
We know we can get rich by gaining Maximum Exposure to risk assets in a bull market. We also know we can get rich by building a business where we own all the equity. The downside with leveraging up to buy property and stocks or forsaking a steady paycheck to start a company is the potential to lose A LOT of money and time.
Many Bitcoin investors sure took a hit they never saw coming. And they weren't the first. But, what if there was a way to strike it rich without taking any risk? I never really thought about this possibility until a reader brought it up. Previously, I've always just allocated between 5% – 10% of my investable assets and swung for the fences.
Utilize Your Risk-Free Investment Income
Here's what DoneAt53 wrote to another reader who is worried about current market valuations:
Start going to cash. Find a long term CD that pays 2.5% or toss money into savings bonds. With the proceeds buy S&P500 options. With 100K, you can use the $2,500 – $4,000 interest, depending on your risk free choice to purchase Dec 2018 265 options for 1400 each. Two will cost you $2,800 and you’ll have a 53% participation ratio, buy a third for a total of $4,200 and sell 2, Dec 2018 295’s for $200 credit each. You’ll have a 78% participation ratio up to 295 (11%) and 26% participation ratio above that and it will cost $3800 of your interest.
If the market tanks, you lost the interest on your money and very little of if any of the principle. If Mr. Market keeps going up, you get a nice percentage of the gain designed at your comfort level with (almost) none of the risk.
Understanding the options jargon is less important than understanding this concept:
With your risk-free investment income, invest in the most speculative investments that have the potential to give you the highest returns. Even if you lose your entire investment, you will never go to the poor house because you will never lose principal.
Examples Of Speculative Investments
- DoneAt53 discusses buying out-of-the-money options that provide higher returns on a specific stock or index versus buying the actual stock or index. The downside is that if your options expire out of the money, they are worthless.
- Cryptocurrencies like Bitcoin, Ethereum, and Litecoin are the hottest speculative investments at the moment and finally attracting mainstream capital. Bitcoin could easily collapse by 80% next week. But Bitcoin could also continue to go up multiple times because of a surge in liquidity and world-wide adoption. You can buy your slice of Bitcoin on an exchange like Coinbase.com.
- Internet and tech stocks in emerging markets. Buying the Googles, Facebooks, Ubers, Apples, of XYZ emerging markets is a straightforward investment thesis. Buying the next “Yahoo of China” was my investment thesis in 1999 when I bought VCSY. I continued this thought process in 2013 when I wrote, Should I Buy Chinese Stocks? Sina, Baidu, and RenRen have all done really well since.
- Angel investing where you provide seed stage capital is another way to earn massive returns. The problem with angel investing is that companies often have a minimum of $25,000 – $100,000. That's unaffordable for most people, especially if you need to make $25,000- $100,000 in risk-free income. I'm no longer angel investing partly because of bad experiences. But if the minimums come down, I might do so again.
- The crappiest small cap IPO that has gotten bludgeoned since going public for whatever reason. One example is Blue Apron that IPOed at $10 and fell all the way down to $2.97/share. I decided to pick $10,400 worth up at $3.15 a share. They found a new CEO, lowered guidance, and fired a bunch of people since. The bar is low now and the stock shot up to $4.15 at one point. I hope they get bought out.
More Examples
Another example is Snapchat. It went IPO at $17, got foolishly hyped up to $27/share and then disappointed repeatedly in its quarterly results and fell to $12 a share. The problem with my SNAP purchase at $12.24 is that even at current levels, it's still valued at $18 billion. It's harder to move rapidly or get purchased for a large premium when the company is already huge.
A crap IPO I missed was Funko (FNKO), a maker of toys. They priced the stock at $12, gapped up to $19.93 and closed that week at $7, all before reporting results. Then the stock rebounded 40%. You've really got to pay attention if you want to capture such opportunities.
- Original works of art from unknown artists who you think have the potential to go mainstream. If they don't go mainstream, at least you can enjoy the work. Or you could invest in fractional shares of art through a platform like Master Works.
Speculative Investing Framework Example
To provide clarity, I've created a Speculative Investing Framework. If you want to invest in Bitcoin and the like, this framework can help. The person below has $650,000 of low-risk capital returning $28,000 a year, or 4.3%. He proceeds to invest $28,000 in various speculative investments with a potential return of -75% to +625%.
The example has several assumptions that should be noted:
- The low risk income is not required for survival,
- Rental income may or may not be considered low risk,
- The time frame for the potential returns is unknown or up to the investor to decide,
- To deploy such a strategy, you must save aggressively and stop spending like a knucklehead, and
- It's up to you to figure out what else beyond CDs and muni bonds are considered low risk and invest accordingly.
Even if this person loses his entire $28,000 of low risk income in speculative investments, he'll be fine. The key is to not get carried away by cutting into principal, much like a gambler does when he pulls out his wallet or goes to the ATM machine for more cash.
For those of you who think this framework is only for financially independent people, it's not. You're overly focused on the dollar amounts, and not the framework. Besides, when you are not financially independent, it's better to invest with less money and learn from your mistakes.
It's Hard To Get Rich Quickly Investing In An Index Fund
Although earning a high teens return on your S&P 500 index fund is good in a bull market, it's a relatively slow way to earn a fortune since the stock market averages around 8% – 9% a year long term. After all, one of my mottos is achieving financial freedom sooner, rather than later.
If you want to get rich quicker, it's worth carving out 5% – 10% of your investable assets and/or reinvesting your risk-free income into speculative investments that complement your plain vanilla investments each year.
Just make sure your high risk capital is capital you can afford to lose, because you will lose quite often. Also make sure you have a comfortable cash buffer to provide for you and your family in case Armageddon strikes again.
Because I hate losing money, I decided to invest time in my 30s building a lifestyle business. I figured worst case, I'd become a better communicator and learn something about the online publishing world. I knew I would not regret putting in an extra effort while I still had the energy.
The Value Of Time Vs Money
My problem now is that in my 40s, I hit an inflection point where time is much more valuable than money. The desire for more time is why I'm happily farming out my capital to people who spend their careers looking at investments.
For example, I'm investing in eReits with Fundrise and in private venture debt funds. It's the same reason why I'm highly amenable to hiring a property manager the next time my tenants give me hell.
If you are lucky enough to strike it rich with a speculative investment like Bitcoin, do your best to turn the funny money into a real asset that generates stable cash flow. If not, use some or all of your lucky winnings to pay for a better life.
Barring a natural disaster, the $580,000 property I bought in 2003 with my VCSY money will still be there generating $4,000+/month in rent indefinitely. And if not, maybe I'll turn it into the Financial Samurai office or have my parents or sister live in it for free one day.
Remember: You only need to get rich once! Turn your lucky break into a gift that keeps on giving.
Related posts:
Investment Ideas At The Top Of The Market
The Canadian Housing Bubble Is Huge
Readers, have you ever invested in Bitcoin or other speculative investments? What method did you use to determine how much to invest?
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Very good points. I have been playing around with speculative investments as well. Over the past two or three years, I’ve played around put options on certain stocks during earnings season.
I figured that even if I’m right half the time, the upside (2-3x) will amortize all the losses (which it has).
Ive been very successful in speculating in a niche form of real estate. Its a form of real estate where the natural resources present cover the full purchase price of the land. My rule of thumb is to never purchase the property without a buyer lined up for the natural resources that will be extracted. This is done prior to the purchase. Also, a purchase is never made without first insuring that the resources present will cover the full purchase price of the land.. My approach is strictly analytical and ruled by numbers. If the numbers don’t work – we pass on the deal. It isn’t how many deals you do that’s important , its how much you make on those deals is what counts.
I always prefer value investing which involves that you carry out fundamental analysis of a stock before you put in your money. The returns may be slow but if you have long term perspective, you will enjoy good returns except there is stock market crash.
“Barring a natural disaster, the $580,000 property I bought in 2003 with my VCSY money will still be there”
This caught my attention for reasons entirely unrelated to speculative investments but having to do with risk.
Do you have earthquake insurance on your SF property? I’ve not carried it for some time. It’s very expensive and the deductible is ridiculous but I always have this nagging feeling my properties are gonna fall into a pancake one day when SF gets hit again. Fingers crossed.
I don’t to do the cost. But I did sell the single-family home in the marina, which is a earthquake prone this year. So to me, that’s kind of like earthquake insurance.
Very well done article, and excellent points all should take heed. It is also interesting and worth noting the dynamics between the potential of Bitcoin (as a lead of cryptos) as it pertains to the global market place and other bubbles, from a long term perspective. While I am no expert in cryptos, I do believe cryptos (and Bitcoin specifically, at least at this point) represent a significant technological shift in the global economic landscape. This technological shift in the way monetary policy and trade is conducted, is of gigantic proportions. Moreover, only a very small fraction of the population has any exposure at this point, one of many reasons this could represent the very early stages of a revolution in commerce. Nonetheless, there still are so many uncertainties, that you’re right; it is prudent to not jump in within understanding the full dynamics.
Thanks for the quick emails Sam. I’ll keep the advice in mind when I pull the trigger to cash out.
Hi Sam, have you made more money overall with real estate and stock gains than with actual income from a job?
If you didn’t have that big windfall with that Chinese stock would you have bought a house so early in your career?
Luck does play a HUGE part in these things. I’m reading alot of San Fran and Silicon Valley guys are earning well over 6 figures out of school yet can’t afford to even buy a place.
Right place, right time.
Not sure, but probably not. Might be a good post! But I like to keep income and total net worth on the down low. How about you? Have you made more from your investments than your job?
If I didn’t have the VCSY windfall I may have still bought RE in 2003 b/c I had a 2000, 2001, and 2002 bonus. Ever since college, I’ve been infatuated with real estate.
I attribute any money I’ve made to 90% luck, 10% work ethic. It all starts with being born in a nurturing household with two parents. And because so much is due to luck, I can’t take things for granted, which is why I continue to work.
How about you? What percentage do you attribute to luck?
Related: To Get Luckier, Realize Success Is Mostly All Due To Luck
My money was “A Series of Unfortunate Events”, kinda.
I’m FIREd and attribute mine, like Sam to family. My father was an amazing tradesman, could fix/make anything. Never finished high school, GED to get into military. Mom can make money last for ever, she must of had a dollar stretching machine ;). They bought several old properties and fixed them up. Guess what I did in the summers with dad? Mom pushed for my engineering education. With out the knowledge of how money works (mom), how stuff works (dad), would not be me and would not have purchased investment property and would not understand investing.
Taking advantage of an opportunity may appear to be luck. I believe one’s luck is enhanced by their knowledge and experiences. I was given and created great experiences.
Can luck be improved by your past experiences?
Lucky plays a much bigger factor than we realize. I personally haven’t made more from investments because I haven’t bought a house yet. But if you factor in the parents house which has increased more than 10x in a few decades and is well over 7 figures, and when they pass it will be passed on to me and siblings, I won’t be hurting.
Now like many young people it’s too expensive to buy a house in my city even if you have a 6 figure salary.
With so many younger folks like you inheriting their parents houses, why do you think there’s so much angst against housing? You guys are going to inherit the most amount of wealth in the history of mankind.
Related: https://www.financialsamurai.com/a-massive-generational-wealth-transfer-is-why-everything-will-be-ok/
I wouldn’t say there is angst, but to see the huge run up in real estate makes people wonder if there is a bubble. I mean, I don’t expect to get this windfall for another 20 yrs or more. in the meantime I have very little chance of buying into the housing market myself.
The salaries just don’t match housing prices. I hear in San Fran it’s a similar situation. How do normal young people even live in that city?!
It’s triple balance sheets: two incomes plus parental down payment. Answer for first time homebuyers in the city, parents help by around 50 percent.
Sam,
Thanks for taking the time to thoroughly explain the synthetic indexing strategy. As many of the commenters have written, it’s not for everyone.
Interesting is that the comment we had about folks having difficulty combining the two piles of cash into one low risk market indexed investment seemed to come up. The irony is that people buying into EIUL policies don’t realize it, but this is very similar to what is happening under the covers. The insurance company hides the two products in a single product so as not to show the 100% loss of option premium in the down year.
As with all investing and life, moderation is important, one can go overboard with the strategy and “swing” harder the one should and take on a sprain with similar associated…pain.
The astute investor will note that market participation can be controlled from fractional participation to multiplicative ratios. Want some gold, use GLD options, want some emerging market, use EEM.
Since 1988, S&P largest number of contiguous down years was 3 in 2000.
Retirees that suffer a large loss early run a much higher risk of having more time than money.
Sam, do I get some royalties from the hits off of this article ;) ?
Bitcoin is like the quintessential bubble. I feel like in a several years, people will use Bitcoin as a case study for bubbles, just like tulips and the dot com bubble. As with the dot com bubble, it was founded on a real potential of the internet, but the timing was off. We see the amazing fruit of the internet now, 20 years later, but at the time, the internet was not as valuable. Now with bitcoin, sure, it might become some type of major currency in the future, but is that really going to happen so quickly? It’s fun to be witnessing a bubble in my adulthood – just seeing the euphoria and literally hearing my barber talking about buying bitcoin is almost surreal. I always heard people say the barber anecdote is the indication of a bubble, but actually experiencing it in the midst of a bubble is akin to checking something off my bucket list.
I’m not saying it’s not a bubble.
But the valuation being so high doesn’t necessarily mean it’s getting ahead of itself. Think of it as a probability-weighted outcome. If bitcoin actually becomes a widely accepted currency that accounts for a meaningful portion of the world’s value, then this valuation is a drop in the bucket.
If we think there’s a 5% chance that bitcoin becomes HUGE then the current valuation of $200 billion represents a possible future value of $4 trillion.
Sounds a little nuts, but there could be a lot of room to go.
I agree with your statement but never said the high valuation was the reason this is why I’m considering bitcoin to be a bubble. The dot com bubble happened based on real potential. We are far beyond the top of that dot com tech bubble because the potential of tech has been realized. The potential was not the problem, but the psychology of everyone buying into it. Things went up too far too fast I believe because of that state of euphoria when everyone is long a certain asset class and can only see and talk about the huge potential of it. Could it be that everyone piling into it is right? Yes they were in the dot com bubble, many years later, but not before the markets seriously corrected. But do people actually realize what they’re buying right now? I don’t think many people do. They see bitcoin going up and everyone else getting into it so they need to get in on this opportunity.
For example, how many buyers actually think past the point you made in your comment? Most people stop at “it’ll be a huge valuation and will become a widely accepted currency one day”. But take the goggles off for a minute here. Why is everyone Really buying bitcoin? Is everyone truly a believer or is this their opportunity for making millions in cash? I believe at the end of the day, bitcoin is only being bought in droves because it gives potential earnings in real currencies. If I told you you can buy bitcoin but never cash out back into USD, would people still want it hand over fist? I don’t think so. It’s not widely accepted enough for people to want to hold it like they would hold gold for example. So my point is if the promise that we buy into is that Bitcoin will become a widely accepted currency in and of itself one day, and that it will account for a huge percent of international transactions, thereby realizing its potential value, we need to also accept that the potential has not yet been realized and right now, in the midst of this euphoria, 90% of buyers are just trying to get rich quick in dollar terms by trading it. If you’re a true believer in bitcoin, then you should definitely buy it now and you wouldn’t regret if it dropped 50% in USD terms because the value proposition for you is far more than what it’s worth in dollars in the short term. You are buying to own the next big currency and there’s a potential of using it to buy goods with it one day.
But if you’re just trying to ride this thing until you make a million Dollars and cash out, then it’s a game of hot potato and everyone thinks they won’t be holding that potato at the top. Many won’t be and have gotten rich already, but there are also many who may be in it at the wrong time for the wrong reasons. Know why you buy something and truly accept the risk that comes with it. As hard as it is to see right now, Bitcoin could become worthless one day. It could take decades for it to become accepted too. Have we thought about how tax laws could affect it? What if the US government started taxing bitcoin more or regulated how businesses can use it in a detrimental way? It could happen. Also banks and institutions are getting in now too. While that is widely seen as a good thing, it also means they can manipulate it more. They will probably create hundreds of securities and derivatives based on Bitcoin and who knows what how that will affect it? Of course, anything can happen and it’s all random, so all we can do is truly accept that anything can happen to our investments and only then will we make rational decisions.
But back to your point, if the valuation potential is realized, everyone who is holding the potatos will come out a winner in the long term, if and when the true potential is realized and they hold through the roller coaster.
This reminds me of Nassim Taleb’s barbell strategy. Low-risk core with high-risk for returns. It’s just a choice between getting gutted occassionally when you’re 100% stocks and the volatility that brings, versus Taleb’s slowly bleeding to death through purchasing options that expire.
Unfortunately in our part of the world, we have higher inflation (c6%) but higher interest rates (c10%) so we earn a good risk-free yield for speculation, but we pay 40-50% on the nominal interest, so net-net we come out with a negative real yield and the longer it takes for your speculative investments to take off it smashes your principal in the risk-free portion. Makes it a little harder to pull this strategy off – I think it works well in low inflation countries.