What’s your passion? Early Ming vases? Hepplewhite chairs? Art Nouveau jewelry? One in three Americans collects something. Even antique collections that start as hobbies can quickly build in value to thousands, or even millions, of dollars. Once the collection becomes a significant part of your net worth, it should be considered in any wealth management strategy. But few collectors or advisors take this view.
In addition to satisfying an emotional need, collections of antiques, fine art, or stamps may offer financial benefits and risks similar to those of other assets. Over time many collectibles have earned higher returns than traditional investments like stocks. They can be used to diversify an investment portfolio or hedge inflation. But they also involve costs, risks, and tax liabilities that are different from other assets.
Thinking Like an Investor
For many people, their collections are like the homes they live in — becoming investments when their values rise. When values decline, the same collections morph back to simple passions. By permanently including these assets on their balance sheets, collectors can work with their wealth managers to ensure that they maintain an appropriate mix of risk, return, and liquidity.
Treating collectibles as an asset class is tricky, however. There are many widely available indices for equities and bonds that show how they affect potential risk and return in a portfolio. Finding reliable data for collectibles is more difficult. Pricing guides list auction results and “expert” opinions on value, but do not reflect prices from private sales. Most indices available for tracking market trends only cover sub-categories of collectibles, such as “fine art” or “rare coins.”
Some of these indices have relatively short histories. Others, like the Antique Furniture Index published by Antique Collector’s Club in England, has been calculated annually since 1968 using retail prices from shops, fairs, markets, and auctions. Over the 40 years ending December 31, 2008, this index returned 7.5 percent, on average, annually versus 5.7 percent for the S&P 500.
The graph above shows how each of the collectible areas of coins, art, stamps and wine performed against stocks between December 2001 and June 2009, as researched by the Robert W. Baird & Co. investment firm of Milwaukee, Wis. The firm then constructed a basket of collectibles that weighted the indices based on estimates of annual global sales and compared the performance of the basket against performances for stocks and bonds. The graph below shows the correlation between collectibles, stocks, and bonds, with collectibles outpacing both stocks and bonds on returns.
Measuring Risks and Returns
To examine price trends in the overall collectibles market versus other asset classes, we constructed a “collectibles basket” based on the following indices:
Liv-ex 100 Fine Wine Index — which tracks the 100 most popular French, German, and Italian wines with a secondary market, weighted for scarcity, Artprice Global Art Index — which tracks the Artprice auction database of more than 25 million auction results from more than 2,900 auction houses worldwide, PCGS 3000 Index — which tracks 3,000 rare copper, silver, nickel, and gold U.S. coins, Stanley Gibbons GB30 Rare Stamp Index — which tracks 30 rare British stamps.
Further analysis showed that our collectibles basket is positively correlated with most other asset classes – with the exception of bonds. This means the prices of a collection will likely move in the same direction as these assets and in the opposite direction of bonds. We also found that collectibles are positively correlated to the U.S. economy.
On the surface, collectibles seem to offer an attractive balance of risk and return. However, collectors should be aware that a lack of liquidity may smooth out volatility and make collectibles appear less risky than they are. One must also consider the opportunity risk in tying up money that might earn better returns in the equity or fixed income markets — or the risk that a collectible will fall out of favor and earn little, if any, return. Additionally, actual returns may be reduced by costs for purchasing, holding, and selling items in the collection.
Finding the Right Allocation
Most collectors, of course, are not trying to hedge inflation or diversify their portfolios. They simply have a deep connection with rare Chinese porcelain, baseball cards or bottles of wine. That said, incorporating sizable collections into a larger wealth management plan can help to assure adequate liquidity and avoid over-exposure to risk.
Developing a precise asset allocation strategy for collectibles can be difficult. This requires a history of accurate valuations or reliable benchmarks that can be used for modeling — which, as we have noted, may not be readily available. Research by Ibbottson Associates sets 10 percent as the maximum allocation for private equity investments in a well-diversified portfolio. Given that collectibles have similar liquidity and appraisal risk, a 10 percent ceiling seems to make sense. Lack of ready liquidity in a collection may make it tough to rebalance a portfolio overweighted in collectibles, however.
Since collectible markets generally seem to be sensitive to the economy, albeit with a time lag, an investor with a large collection might simply lighten up on other economically sensitive assets. Given the lack of cash flow from collectibles, it is also important to make sure there is sufficient income from other sources — especially if the portfolio includes other illiquid assets such as real estate or a family business. To maintain the appropriate balance, an advisor needs to know when there is a substantial addition to the collection or something of high value is sold.
Minimizing Income and Estate Taxes
Collectibles also have unique tax considerations. The IRS does not typically view collectibles as investments. There is a significant body of law and legal precedent dealing specifically with collections that make their tax treatment different from other assets.
Unlike buying shares of stock, the purchase of antiques through an auction house or private dealer may involve a state sales tax. Collectors may also have to pay a use tax on items purchased outside the states where they live. While any short-term gains on the sale of your antiques are treated as ordinary income for tax purposes, long-term gains are taxed at a 28 percent rate, versus 15 percent for other investments.
In addition, the IRS requires proof that investment is the primary reason for owning a collectible in determining the deductibility of costs related to a collection. Accurate record keeping is critical here — along with establishing a pattern of behavior, such as tracking a collection versus its market or other investments. A similar case must be made to use a loss on the sale of antiques to offset long-term capital gains. Collectors must also follow specific guidelines to claim deductions for the full market value of antiques donated to charity.
The role of collectibles is equally important in estate planning. When purchasing life insurance to handle potential estate taxes, for example, you must be sure there’s enough to cover a collection so that heirs have a choice in deciding whether to liquidate those assets.
For these reasons and others, sufficient due diligence is required before buying and selling pieces of a collection. Maintaining detailed, up-to-date records and obtaining expert tax and estate planning guidance will further ensure that the value of a collection is efficiently transferred to heirs or other beneficiaries.
While most people start collections for very non-financial reasons, treating them like other assets can maximize their potential returns and help collectors follow their passions for years to come.
Christopher G. Didier, CFA, is Managing Director, Private Asset Management Group with Robert W. Baird & Co., an employee-owned, international wealth management, capital markets, private equity and asset management firm headquartered in Milwaukee, Wis. He can be reached at 414-765-7095 or firstname.lastname@example.org.
To download the full study, “Picasso, St. Gaudens or Lafite: Does Passion Have a Place in Wealth Management?” visit www.rwbaird.com and search for “passion.”
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