Why Not Invest in Art? Continued
High Transaction Costs
One of the largest obstacles in making money in art is the high transaction costs. The transaction cost for purchasing stock can be under 1% whereas the transaction costs for art may be 25% or more. Auction commissions can be 20% or more. On very expensive acquisitions, this can be reduced, but it will always be significant compared to the transaction costs of other assets.
If the rate of return for fine art is about 4%, that means the investor will need to hold the painting for about five years before its value will exceed just the transaction costs. When an investor is working with a dealer, there is always an implied transaction costs. The dealer’s selling price obviously exceeds his acquisition cost. Occasionally, there are great “deals,” but when someone says, “I have a great deal for you,” you know that your risk has just escalated.
Insurance and handling
Displaying your art collection provides pleasure to the investor, but there are added costs to do this. Moving art from place to place can be expensive. Moving insurance can be 2% of the value of the piece. So moving a million dollar painting to your summer home or anywhere such as an auction house will cost $20,000. Although fine art insurance in the home is not quite as expensive, a major collection represents a large annual insurance expense.
The secondary market for investment grade art has greatly evolved over the past fifty years, and with internet technology in the last ten years, the process of selling art has become more efficient. Nevertheless, to realize full value for a piece of art requires placing the art in the right auction at right time. So if the investor requires immediate cash, he may have to sell the work at a discount. With high transaction costs plus a discount can significantly reduce the gain from any sale.
Since the art market is primarily unregulated, knowledge and expertise in art is crucial. Depending on a dealer or anyone else who is selling art is asking for trouble. Most people do not have the time that is required to develop this expertise, and hiring a consultant just adds another cost in the investment.
Diversification of asset portfolio is probably the most significant rationale for investing in art. Although art prices fluctuations often follow or parallel stock prices, it is not always the case. The larger issue is the cost of investment grade art. I would suggest that a piece of art priced under $100,000 is probably not investment grade. And to diversify the art portfolio within a larger asset portfolio would require several pieces. Thus, the total cost of an investment grade art portfolio is at least million dollars and probably more. There are other assets, such as gold, which allow diversification with more liquidity at a lesser investment. Art investment is not a middleclass pursuit.
Why not invest in art? There are plenty of reasons as I have indicated above. I would suggest that purely on financial considerations, investing in art is not the wisest of courses. However, when you add the pleasure of art collecting into the equation, art investment may be worthwhile when you combine both the financial and the aesthetic gains. For some investors, art also offers charitable opportunities that may also provide some tax advantages. Finally, many of us are intrigued with the more speculative components of art acquisition, such as the pleasure of finding and purchasing an early Pollock or Basquiat. Beware: “How do you make a small fortune in art?” “You start with a big fortune”