The Merits and Faults of Alternative Investments
A Sense for Money
Several of our readers have asked about the merits of alternative investments, such as antiques, gold, jewelry, stamps, collectables or wine. This week, we take a look at the excitement, and the pitfalls, that can accompany some of the more esoteric investment choices. Our aim is to give you some tips on which, if any, alternative investments are suited to your particular financial situation, personal taste and risk profile.
You need to think about the income or capital gain potential from your alternative investments. Many provide no income at all. When did you hear of income from stamps, wine or diamonds? On the other hand, each of these gives good potential for capital appreciation. In these cited examples, it is the rarity value that gives the potential for capital appreciation. There is a supply and demand consideration here, and in particular whether the supply and demand is limitless or limited. Limitless supply includes pearls and diamonds – pearls are expensive but can be produced almost at will, and even 3 carat D flawless diamonds keep being dug out of the ground. On the contrary, the supply of antique Chinese porcelain is limited and no more 1840 Penny Black stamps are being minted.
One key consideration is the bid-offer spread, or the difference between buying and selling prices. If you buy something at 100 today and sell it immediately, will you lose 1 percent or 50 percent? In fact, the answer can be either, depending upon the particular type of investment. It is always worth checking.
Liquidity is another factor. Can you cash in the investment at short notice? Liquidity is not necessarily correlated with bid-offer spread. For example, pure gold has very high liquidity and a narrow bid-offer spread while high street jewelry and branded handbags can be very liquid (if only at the local pawn shop), but the bid-offer spread can be shockingly high. Interesting to note that traditionally Indonesian women used to buy a gold bangle or earrings on a regular basis: it was how they could save and still enjoy their savings at the same time. And once the money was used to buy the piece of jewelry, it couldn’t be used for other things. Yet, if they needed extra cash, it was easy to sell or pawn. The only rules were to buy 22 or 24K gold, and buy from a reputable store. It would take about 5 minutes to sell a piece of jewelry. This is also why most Indonesians don’t consider 18K gold of any worth – it’s not pure, and more important, it’s difficult to sell.
Another aspect worth thinking about is the level of maintenance and care – which your alternative investment requires – and the associated costs. Vintage cars need regular maintenance; stamps and wines need to be stored in the right environment if you are to keep them all in tip top condition. Without the right love and attention your prized investment can be transformed into a rusty car, moldy stamps or vinegar wine – nothing more than worthless junk.
Security against both theft and accidents is also important. Many collectors love to display their works of art and antiques, which can be a wonderful talking point at dinner parties. On the other hand, a prominently displayed Picasso can be an easy target for opportunist thieves and a Ming vase can easily be ruined by a clumsy cleaner. Insurance can give some comfort here but it can be expensive and the small print can often disappoint in the event of a claim. One pitfall of alternative investments can be fakes and frauds. Yes, we all know the Mona Lisa on your dining room wall is a decoration rather than an investment but some things are harder for an amateur to spot. For example, in the emotion of the moment doting lovers can often be convinced to pay first grade prices for third rate diamond engagement rings. At times, this is more akin to fraud than a reasonable retailer’s mark-up.
You should always expect the value of alternative investments to behave in a volatile manner rather than to show steady growth. Such investments are not for the fainthearted.
In summary, before taking the plunge and dabbling in the alternative investment market, you should run through a standard checklist, including: Income and appreciation potential, rarity value, bid-offer spread, maintenance and care, security, insurability, fakes and frauds and volatility. Many of the items on the checklist coincide with the factors you would consider for a normal investment, but there are some nuances. The particular feature that differentiates alternative investments from normal investments is the potential to enjoy them. It will probably give you great pleasure to take your 1960 Ferrari out for a spin and it may give you a real thrill to showcase your antique vase to your society friends.
On the other hand, showing them a spreadsheet with your equity and bond holdings is unlikely to be a thrilling experience either for you or for your friends. A beautifully displayed wine cellar is something that is becoming increasingly fashionable in Asia although all too often the danger is that the wine is more likely to end up being consumed by the owner than being sold for gain, despite all good intentions at time of purchase.
Probably the most important piece of advice is not to rely upon alternative investments as the backbone of your nest egg or retirement planning. The alternatives can bring a bit of spice and excitement but there’s always a chance they will end up worthless and you cannot live on spice and excitement alone.
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