Bitcoin’s price recently reached an all-time high of $68,000. This represents a nearly 350% return for holders of the cryptocurrency over the past year. By contrast, the S&P 500 has risen by a far more modest 30% over the same period despite experiencing a relatively strong performance.
However, the virtual currency’s gains have been built solely on improving sentiment among its holders. Unlike stocks, bitcoin has no intrinsic value. Its price is not linked to the performance of a business or the value of assets. Instead, it relies solely on one individual being willing to pay more for the virtual currency than another.
While this situation could remain present in the short term, it is unlikely to continue uninterrupted over the long run. This could mean that the virtual currency’s price is subject to relatively high levels of volatility should sentiment deteriorate. This may result in significant losses for its holders.
This subject has previously been highlighted by Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio). As he once said, “You're just hoping the next guy pays more. And you only feel you'll find the next guy to pay more if he thinks he's going to find someone that's going to pay more. You aren't investing when you do that, you're speculating.”
Investing versus speculating
Of course, it is also possible to speculate on stocks. Not all holders of company shares are long-term investors. The average holding period of shares in 2019 was less than nine months. This has gradually declined over recent decades. Indeed, a 14-month holding period was the average among retail investors in 1999. This suggests that an increasing number of investors are looking to make a quick profit on stocks before moving onto another opportunity.
This type of short-term behavior is likely to have been exacerbated by the stock market’s 100% rise since the March 2020 crash. High returns in a short span of time can prompt investors to continually switch from one stock to another in the hope of replicating recent gains. However, the track record of the stock market shows that no bull market lasts forever. Therefore, short-termism is ultimately likely to lead to a loss at some point in future, when bull markets inevitably reach their end.
A long-term approach
Unlike bitcoin, stocks also provide the chance to invest for the long term. A company’s share price generally responds positively to an improving financial performance. Therefore, investors who focus on buying stocks with solid fundamentals, such as a sound balance sheet, a high return on capital employed and a wide economic moat, may be in an enviable position to capitalize on their long-term growth.
Clearly, such a strategy may be less exciting or impactful in the short term compared to speculating on bitcoin, but it is likely to be far less risky and potentially more profitable over the long run. The impact of compounding and the increasing appeal of high-quality businesses to a broader range of investors could lead to relatively generous returns.
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