Is Art an Investment?
We take a look at a frequently asked question from an investor's perspective
The Idea
“So, is art really an investment?” It’s a question we get all of the time. As a financial planning firm with roots in Bohemian leaning Portland, Oregon, it makes sense that local investors would have this in mind.
We feel this isn’t asking the right question from an investor’s standpoint- the question we always ask about any investment is always “is this a good investment.” Every investor will bring different criteria to the table to try to answer that question: Warren Buffett likes to remind investors that their first rule is to “never lose money.”1; investors and economist like Peter Lynch and Robert Shiller like to focus on value creation. No matter which criteria you use, the investor needs a thesis and a consistent analysis process.
With that in mind, we’re going to focus on asking a five questions that can help compare art to other investment choices. Our purpose is not to persuade or dissuade investors, but to add to the conversation as investment analysts.
1. Diversification
In 1952, the mathematician Harry Markowitz pioneered the idea that different risks and rewards exist for different assets. 2 He helped introduce the idea that it might be possible to create optimal portfolios of balanced risk & reward producing investments.
Since then, economists and investors have developed the concept of diversification: that in a given time period, different investments perform in different ways. Let’s say US stocks have a terrible year one year- bonds may perform very well at the same time, bringing returns in while other investments suffer losses. With that in mind, investors have sought assets that balance each other in their differing risk/reward profiles as well as diversity of relationships to each other.
As an investment, it is possible that art in any given year might perform quite differently from other investments. It might suffer accelerated declines during a stock market fall or it might do the exact opposite. It might increase in years where most assets lag, or it might lag all value creating assets.
To our thinking, this is likely the best reason to own art as an investment. We like to think of it as an alternative investment- one that has a different relationship with broader markets from the core of a portfolio. There are as many approaches to building a portfolio as investments to purchase, but we find it difficult to justify an alternative investment like art making up more than a small share of a portfolio. Our best hope for most alternative investments is that in especially bad years for other assets such as stocks and bonds, these alternatives might eek out especially large returns to make up for some losses. At worst, they can fall even faster than other core investments.
2. Tax Inefficiency
You may have seen this coming from us at Investment Annuity- after all, we’re obsessed with tax smart investing by nature. One of our chief concerns with art as an investment is the way it’s taxed. It is taxed considerably higher than other investments we commonly use outside of a tax shelter.
According to the IRS, the maximum tax an investor will pay on Federal Long-Term Capital Gains for collectibles such as fine art and coins is 28%. As tax-shelter oriented investors, that is a considerable amount. However, as Forbes pointed out in a recent article, this is not the only tax many collectors will pay. After Net Investment Tax and local and state taxes, they found a California collector may pay as much as 45% in taxes. 3
As an investor, this should be a concern when analyzing a prospective collectible for investment purposes. How much more must you demand on a consistent, annual basis from an investment taxed at such a considerably higher rate than other investments? It helps to look at why it’s taxed this way: the government has an interest in seeing capital pour into productive markets that create new capital, new employment, and generally grow the economy over something that simply exists as a rare object. 4 This is an excellent segue into our next consideration…
3. Value Creation
Back in 2011, Warren Buffett told his shareholders at Berkshire Hathaway what he thought about gold and similar assets in a letter. He said they “will never produce anything, but are purchased in the buyer’s hope that someone else will pay more for them in the future.” 5
What Buffett told shareholders then echoes an observation we’ve made about art and collectibles many times: though stores of value may create wealth at times, they will never create value. That is, they will never create a new technology or service that shapes the future of production or consumption. They won’t branch out into new markets, take advantage of new regulatory landscapes, etc.
As useful as stores of value (such as art) can be during different inflationary or deflationary broad economic conditions, they are not part of new growth. Their fluctuating values are more of a function of fear, greed, and how much excess capital is spilling over from other capital markets. How heavily investments in things such as art and collectibles should be weighted can be seen as partially a question of how much exposure to opportunities in new value is desirable versus owning stores of existing value.
4. Liquidity
How quickly can you get the full anticipated value back from your investment? How close to what you expect are you going to get when a sale finalizes? If we’re talking about the stock market, most investors now receive very accurate quotes and execution at increasingly reasonable prices- a stock trade at a discount brokerage such as Schwab or TD Ameritrade may cost as little as $7. In reality, there are very few investors who can afford to disregard these questions.
According to Bloomberg, 2014 set a new record for art market sales: $66 Billion world wide in a year. That may sound like a large market, but $169 Billion are traded daily on the NYSE alone. 5 The global currency market saw daily trading volumes of $5.3 Trillion in 2013. 6
More importantly, different segments of the art market may have drastically different liquidity profiles. An exemplary Monet painting is going to have a very different ability to move on a market at a predictable price than your favorite regional painter. Etchings and Woodcut prints will have an even different liquidity profile- it may take months or years to sell a lesser known artist’s fine art prints. Generally speaking, it is far less useful to understand the broad art market’s liquidity for an investor than it is to know highly liquid markets’ depth of market.
5. Opacity
While valuation is a contentious topic among stock market investors, the basic premises of valuation are based on the same types of information across the philosophical spectrum: we look at business models, income, expenses, assets, liabilities, etc. We extrapolate different things based on different expectations, but our base of information is the same, and it highly regulated.
The same can’t be said for the art market. In a market based so heavily in what is fashionable, we have the taste-makers and brokers to look to for key market information. It’s not for us to determine how credible, transparent, or reliable their information is- it’s up to market participants. What we do know is that there are radically different standards of public information to develop expectations between collectibles markets and most major capital markets- the US stock market, the US bond market, European stocks, etc. It’s something that serious investors should weight appropriately when considering making investments, in our view.
Conclusion
While art may not meet our criteria as a desirable investment, it’s an asset that will continue to garner some attention. We hope that investors interested in art as an investment will treat it as any other investment- that they will interrogate its merit relative to the entire universe of marketable investments.
We’ve posed a few questions here, but this is not meant to be a comprehensive list. We mentioned above that we treat art and collectibles as an alternative asset. We encourage readers to investigate the other assets in that class as well- for example, we tend to prefer using Real Estate Investment Trusts inside an Investment Only Variable Annuity to a collectible outside of a tax shelter, given that it meets our criteria as an investment and avoids the heavy taxation we’d be exposed to. There are many other alternatives and strategies of deferral to investigate. In any case, we highly recommend consulting with qualified tax consultants and investment advisors when considering investing.
Meet the Author & Portfolio Manager
Victor Schramm is a Certified Fund Specialist (CFS®), with expertise in Mutual Funds & Variable Annuity Separate Accounts. He focuses on long term investing geared toward our annuity clients as a Fee Only Investment Advisor. He lives in Portland, OR.
Victor Schramm, CFS®Analyst & Portfolio Manager
Disclaimer
This information is solely a representation of publicly available facts intended for educational use only. This is not a solicitation to buy or sell any public or private Security, in any city or market named in the article or elsewhere. Investments in marketable securities and alternative investments should be investigated carefully, consulting relevant qualified tax and investment professionals being highly recommended.