Investing in Your Passions
By Michelle Black
Head of Capital Group Private Client Services Wealth Advisory Group
Investing in art, wine or any other cherished hobby would seem to blend the best of two worlds: You engage in a heartfelt pursuit while building a collection that can grow in value over the years. It’s often referred to as passion investing, and it’s become increasingly popular.
There are many good reasons to collect wine, acquire art, buy jewelry or even dabble in sports memorabilia. People typically don’t set out to become collectors, but what begins as a childhood fascination with dolls or baseball cards can segue into a lifelong interest in other forms of collecting. There are often intangible reasons, such as personal enjoyment or cachet, for investing in luxury items. The appeal of passion investments among ultra-high-net-worth individuals ticked up after the financial crisis. One study found 61% have become more interested in collecting items such as art, wine or classic cars. And, indeed, these pursuits can be lucrative when market conditions are favorable.
However, investing in your passions carries risks, and should not be relied upon as a way to build wealth. The collectibles markets can be volatile and it’s easy to overlook the costs of insurance, storage and other necessities that dampen long-term returns. As a result, in our view, passion investments should not be central elements of an overall portfolio.
Instead, it’s important to have a well-rounded asset allocation along the lines of our wealth strategy pyramid, which is designed to build and preserve wealth over the long term. The bottom of the pyramid is the base: money invested in cash or short-term securities representing up to two years of expenses that can serve as a financial and emotional safety net. Next is the core, a diversified mix of stocks, bonds and diversified alternatives tailored to your financial goals and long-term growth objectives, with a lower level of certainty than the base. Once your base and core holdings are established, anything beyond that, known as the surplus, can be viewed as a complement and earmarked for other interests. We believe that investments in art or wine should generally be made from this surplus portion of your portfolio.
A decline in the wine market demonstrates the risk of passion investing.
To understand the risks of passion investing, consider a recent episode in the wine market. After several strong years, demand for fine wine really took off in 2010. The Liv-ex Fine Wine 100 index, which tracks the prices of highly sought-after wines, soared while stocks were still recovering from the financial crisis. Driven by expanding global wealth, particularly in China, wine seemed to be on the verge of an extended run. And it was — but in the wrong direction. Almost as quickly as it had surged, the index peaked in mid-2011 as demand from China fell sharply, and it lagged for several years. And while the index took off in 2016, it abruptly leveled off in 2017, seeing only moderate growth since.
More recently, the art market has been on a tear. Global art sales surged to a record high last year, and there have been a number of high-profile purchases. In 2017, a da Vinci sold at auction for $450.3 million — one of, if not the highest prices ever for a painting. At least seven works broke $80 million in 2018. On a smaller scale, the number of art sales exceeding $1 million has risen as more people have been drawn to this pursuit.
On the other hand, the trade-offs involved in passion investing garner much less attention. For example, art, wine and other collectibles do not generate cash flow, and the markets for them are typically highly illiquid. In fact, the exact value of a specific bottle of wine or work of art can be difficult to gauge. The only precise way to determine the worth of an object is to try to sell it. Given the unpredictability of collectibles markets, a seller may not attain a hoped-for price when the market is weak or when a once-prized item has simply fallen out of vogue. For example, except for a relative handful of renowned artists, it’s virtually impossible to assess whether a painting that’s highly coveted today will stand the test of time financially.
Costs can add up when investing in collectibles.
It’s also important to consider the substantial costs for mundane but critical needs such as insurance, storage and general maintenance. To protect the long-term value of precious assets, insurance is typically advisable. Proper storage is also important. Especially for rarer or more expensive pieces of art, it’s critical to guard against damage from sunlight or dust. The same goes for wine. Despite the enjoyment of stowing bottles in a personal wine cellar, it’s far better from an investment standpoint to keep them in a professional storage facility that carefully modulates temperature and humidity. The value of even the most diligently assembled collection may suffer if bottles are housed in a personal cellar. For both art and wine, professional facilities can help attest to the authenticity of a specific bottle or piece of fine art when it comes time to sell.
Depending on the type of collectible, there can be additional expenses for shipping, installation or appraisals. Also, if you purchase art at an auction, there’s a fee, known as a buyer’s premium, that must be paid to the auction house. The fee varies, but often can range from 10% to 25% of the purchase price. Finally, note that collectibles are taxed at a maximum long-term capital gains rate of 28% at the federal level and are also subject to the 3.8% net investment income tax.
To avoid the administrative burdens and mitigate the risks of owning individual works of art or bottles of wine, investment funds have been established to provide diversification and access to professional management. There were many art funds globally. However, these vehicles present various risks, and the current number of funds is down considerably, reduced in part by stricter government regulation.
Many of our clients have significant collections of passion investments that are deeply meaningful to them and have appreciated in value over time. However, when choosing to invest in art, wine or other personal passions, it’s important to consider these holdings in the context of your broader portfolio, not to mention your own unique goals.
Michelle has 24 years of investment experience, 17 with Capital. She leads the wealth advisory group for Capital Group Private Client Services. She also serves as an asset allocation investment specialist. She earned a bachelors from USC and a professional designation in personal financial planning from UCLA. She also holds the Certified Investment Management Analyst and Certified Private Wealth Advisor designations.