by Frazer Rice
Jewelry is similar to art as a collectible, except that a valuable commodity such as gold or silver is connected to jewelry. The biggest threat facing an investment in jewelry is loss or theft, and there is seldom an exit strategy when buying jewelry.
The resale markets for jewelry are stable and made up of a finite group of buyers. If you buy jewelry with both gold and gem components, it becomes increasingly valuable. It can also be a good store of value if there’s a unique artistic element to it, if it is made by a craftsman, or carries any other distinctive prominence. However, I would not say jewelry is necessarily a safe investment or that it will rise consistently in value.
For my clients who buy extremely expensive pieces of jewelry, I advise them to have a copy made for their public usage. You can still bring out the big guns for specific events, but it doesn’t take many prominent thefts (like the Kardashian episode in Paris) to prove that thieves are watching and waiting. Also, if you’re wearing the original jewelry at several events, it’s often worth the expense of having a security person with you if you’ve got the type of jewelry that merits that kind of expense. If you’re willing to wear a copy of the original, no one will know the difference, and you’ll be comforted knowing the real jewelry is safe and secure. I’ve been in an uncomfortable situation (for me) in the past, talking with somebody who’s just lost a $75,000 necklace.
I would not expect jewelry to be an investment to cash out in the short term or even the medium term. I believe jewelry is meant to be used, enjoyed, and appreciated. If it happens to be a good investment in the end, that’s great, but my experience has been that most people only sell their jewelry as a last resort.
Other Collectibles and Their Risks
Many other items—manuscripts, rifles, and more—can be considered collectibles. As an investment, a collectible’s value depends on the market of potential buyers that exist when you sell the collectible. Collectibles are often not liquid, but one way to use them to generate some liquidity (if need be) would be to find a financial institution that would loan money against your collectibles.
Collectibles can present a major risk to legacy wealth in the way of taxation. If a family patriarch or matriarch dies and the estate must be settled, it will be a tough scenario if collections comprise a majority of an estate’s value and there is not enough liquid cash to pay estate taxes.
For example, if an estate was worth $150 million, and $140 million of that was an art collection, it would seem as if the next generation would be in great shape financially. However, the estate could owe as much as $70 million in estate taxes, if no estate tax planning was previously done. To pay that obligation, the art would have to be sold, and the market timing could be bad. Imagine if the sale was forced right after a stock market crash and the collectibles brought half their original value. The $140 million in collectibles would bring in only $70 million, and what began as a $150 million estate is now worth only $10 million.
Liquidity, Transparency, and Yield of Collectibles
In the world of collectibles, each market has its own level of liquidity. For art, the liquidity of certain pieces will depend on the number of similar pieces available for sale, as well as the type of art, the size, and many other unique characteristics. You may need the equivalent of a title search to establish provenance, and then you’ll need to deal with the auction process, if there’s not a natural market for the collectible. Often, you’re only as good as the market that the auctioneers create.
With cars, even if it’s a popular model, there may not be enough buyers to liquidate the vehicle at the value you’d hoped for. The sale may not be complicated, but it’s certainly not as easy as hitting the “sell” button on a Fidelity web page and suddenly receiving cash in your account. Selling a collectible car is more like a real estate sale but in need of more complicated and higher-end appraisals.
Transparency also varies between different types of collectibles. In the world of cars, you have registrations and VINs, and you can usually track all the car’s parts back to the manufacturer. Cars offer fairly good transparency. Art, on the other hand, carries a lot of mysticism and less transparency. You can tap many people’s expertise, and at the end of the day, that’s all you’ll have to rely on. Jewelry is similar, although antique jewelry is easier to place a value on than modern jewelry, because the craftsmanship is generally specific and easier to ascertain (similar to antique furniture). Jewelry has other special considerations, such as whether diamonds are real or synthetic.
As far as yield goes, there is rarely any of it in collectibles. They carry costs for storage, maintenance, and insurance and rarely throw off any income or cash flow. As I’ve mentioned repeatedly, collectibles are future-value investments. You’re buying now and hoping the value rises in the future. To expect anything in the meantime is not wise, unless you’re using collectibles as collateral to borrow money.
With collectibles, values don’t always rise in the long term. Pieces of art, for example, can lose value if forgers are active and able to sell forged copies of your artwork. If there is a proliferation of high-quality forgeries, people will be inclined to pay less for the art, and it may be more difficult and expensive to authenticate the original.
As I’ve said before, the best investments in collectibles are made by people with a real interest in and enjoyment of the investment pieces, not those who invest purely for the money.
Back to Our Caller
We have taken a long look at the various factors to consider in putting together an asset allocation, as well as reviewing the asset classes that make up those allocations. Now that we’ve covered this, let’s check back in with my friend on the phone and give him a more complete answer.
“So how should I think about this app, Frazer?” my friend asked.
“Let me go through my thought process and restate the facts of your situation as I understand them. This may take a few minutes, so bear with me.”
[By this time, I’m hoping there is a beer in this for me at some point!]
“In determining whether to invest, there are several aspects to consider. The first step is to ask yourself, ‘Does my investment policy support making a concentrated bet on an unproven concept with an uncertain path to cash flow?’ Sometimes the answer is yes, for a limited portion of your portfolio. You have your wealth in stocks, bonds, real estate private equity, and hedge funds. You’ve got experts keeping an eye on those investments, and they have made projections that show that your goals are being met.”
“Yes, that’s right,” he said. “We’ve spent a lot of time getting the right mix.”
“Have you made an allocation of part of your wealth for high-risk opportunities like your brother-in-law’s app?” I asked.
“Not specifically,” he said, “but it has always been in my mind to be able to take part of my wealth and put it into some fun investments that I can follow—investments with the opportunity for me to take an active role in their management, maybe as a board member.”
“That’s not a problem,” I said. “I would go back to your advisory team and make sure this desire is spelled out in your asset allocation and your investment policy statement, so that you can keep track of where your investments are going and why you have them in your portfolio.”
“Okay, I’ll be sure to do that. Let’s assume that I can carve out part of my allocation for this type of investment,” he said.
“Okay,” I replied. “The question then becomes, how big an investment can you make and can you afford the amount of the investment if it goes to zero?”
“I’ll check with my people on this, but let’s say $100,000 is a good number for this type of investment,” he said. “It’s a meaningful amount of money but not so much that its loss threatens any of my larger goals if things go south.”
“That sounds reasonable,” I said. “Next, it’s time to evaluate the business and its liquidity, tr
ansparency, and yield as an investment in your portfolio. It’s also time to evaluate whether the other sources of impact (like helping your brother-in-law) are significant drivers for you.”
“Sounds good,” he said.
“Let’s start with the business,” I said. “Entrepreneurial ventures often come with good ideas but often lack adequate resources—funding, contacts, access, and so forth. Does the business itself have adequate resources? Is there more standing behind it besides your $100,000? Does it have enough cash to last for a year?”
“I have some financial information from my brother-in-law, but I’ll have to dive a little deeper on that,” he said.
“No problem,” I said. “Apply some of the same analysis used in growing your business, because many of the same principles will translate to this situation. As you know, good executive talent is needed to turn the good ideas and the resources into a scalable, drivable business. Who are the employees, managers, and board members? Do they have experience?”
“We’ve had some early discussions on that, but I definitely need to learn more,” he said.
“What are the terms of the investment?” I asked. “What’s the liquidity of this investment? When can you get your money out? My guess is that this is an investment requiring you to put in money you won’t see for a while, if at all.”
“Yes, that sounds about right,” he said.
“Is it transparent?” I continued. “Since it’s your brother-in-law’s venture, presumably he has extremely good access to critical information and will provide updates. This should be a relatively transparent investment, but you’ll want to test that before investing. Maybe you could tour the facility or business office and meet the seventeen-year-old programmer or the thirty-four-year-old brand manager. You could ask the marketing manager whether the company has a list of customers or a marketing strategy to reach the masses. If you’re not allowed to do that, or your brother-in-law has limited access to operational information, it’s a red flag regarding transparency.”
“I feel pretty good about my brother-in-law on this,” he said, “but I definitely need to do some research and due diligence and kick the tires.”
“As you know, as far as yield, don’t expect anything,” I said. “Yield comes from cash flow, and this company will almost certainly invest its cash flow into its continued growth. However, you should still ask your brother-in-law some hard questions about revenue and expenses. How many people do you hope will have access to the app? How will you reach them? Will they be willing to pay for the app? If not, how will the business raise money? Will it come from selling advertising, from strategic partnerships, or elsewhere? The answers to those questions are important.”
“No question about it,” he said. “It’s not a business unless you generate cash flow. It sounds like they may be able to start breaking even fairly quickly, but your comment is helpful. It’s a good reminder that cash flow should be top of mind.”
“Like I said, liquidity, transparency, and yield will help you determine whether this is a good investment for your investment portfolio,” I said. “In this case, there is an important fourth factor: impact. You’re helping your brother-in-law. This is essentially a form of impact investing and should be evaluated as such. Are you doing some good or helping to keep your brother-in-law busy, and if so, does that advance a personal or philanthropic goal? Maybe you’re offering this family member a unique experience that otherwise would be out of reach. Just be careful to not let the emotional attachment or qualitative measures steer you away from the analysis of the investment’s liquidity, transparency, and yield.”
“I wouldn’t be thinking about this if it weren’t my sister’s husband bringing it to me,” he said. “That said, there is a lot to like about him and his project. He has some good experience, and his enthusiasm could drive this to the next level.”
“The other consideration here, as you noted, is from a family and relationships perspective,” I said. “It’s possible that the fastest way to make an enemy of your brother-in-law may be to go into business with him. You’ll be taking this relationship, attaching real dollars to it (mostly supplied by you), and then closely monitoring the situation over time. By extension, this also means you’ll likely be directly or indirectly involved in a business with your sister. Is that where you want these two relationships to go?”
“You’re right,” he said. “I feel good about what he’s doing so far, my sister will really appreciate the support, and it’s a nice way for me to stay involved in a management or board capacity. However, I have to stay on top of things, especially since this is a little different from buying a stock from my broker.”
“Remember,” I said, “as you go through your research and due diligence, if you start to feel the heebie-jeebies, your investment policy statement can be used as a safeguard against entrepreneurial family members with good business ideas that are not a good fit for a large investment or any investment at all. You could set a limit to the total dollar amount you invest with family or a limit to the maximum invested per opportunity. You could decline the opportunity in a way that is respectful and nonjudgmental, or you could say, ‘My investment policy statement and advisors won’t let me go beyond $100,000.’ A straw man approach like this can save relationships.”
“That’s a good point,” he said.
“The investment policy statement, in effect, erects guardrails around your investment deals,” I continued. “The guardrails should shield against deals that sound groundbreaking and disruptive but, ultimately, may not deliver. The investing public today is grappling with fascinating new opportunities, but few of these opportunities deliver in the end.”
“Ha ha,” he laughed. “You’re conservative to the end, Frazer, but your advice rings true.”
Laughing with him, I justified my conservative perspective toward investments like this one. “Like every opportunity,” I said, “you just need to evaluate where it fits in your plan. If you’re overinvested in start-ups or you have to pull from other assets to make this investment, use care. This is the moment when you’re running up against the guardrails you erected—and you’re running up against them with an investment that is not very liquid, may or may not be transparent, and won’t be driving any cash flow to you. If any of these factors make this opportunity a bad fit for you, you should politely decline the opportunity. If you can’t say no with conviction to your brother-in-law, you’ll want to bring in a third party to help explain how this deal doesn’t match your investment policy.”
“It sounds like you’re telling me to grab my hat and run away as fast as possible!” he said.
“Not so!” I replied. “I just want you to think through what the investment means—where it fits and what the ramifications are in making this commitment. If part of your portfolio is earmarked for this type of concentrated bet—and you’re satisfied with the liquidity, transparency, yield, and impact of this investment—go for it!”
“Frazer,” he said, “you have earned a frosty beer on this one.”
[Whew! I was getting a little worried there.]
While this discussion was unique to this caller, this type of discussion is valuable for everyone. You should reach out to your wealth manager to have a similar conversation regarding any situation that involves a major investment or spending decision.
Chapter Six
6. Threats to Wealth
Letter to the Editor
Not being wealthy is the biggest fear that comes with being wealthy. After becoming used to the trappings of success, no one wants to go back to a lower standard of living. Wealthy families do not want to envision a scenario where their hard-won resources are taken away. However, the threats are real, and the statistics are true. Most families’ wealth disappears within three generations.
The dangers can come from many directions. This reminds me of a conversation I had with an actor who w
as introduced to me by his accountant. The actor had struggled for a long time, but his big break finally came, and his financial situation was going to be forever changed. Let’s listen in on the discussion I had with him during that critical time.
“Hey, man,” the actor said as he shook my hand. “It’s nice to meet you.”
“Likewise,” I said. “I’m a big horror movie fan myself, so I saw you in one of your first movies.”
“Oh God,” he said, rolling his eyes. “I was hoping that one drifted away.”
“Don’t wish it away too quickly,” I said. “Steve McQueen’s first movie was The Blob, Kevin Bacon got his big start in Friday the 13th, and Johnny Depp’s first movie was A Nightmare on Elm Street. Their careers turned out all right.”
“That’s what my agent tells me,” he said. “The good news is that my last couple of movies have been really good earners.”
“Yup, I noticed that when I was reading up on you. That has to feel great,” I said.
“You bet it does,” he said. “I’m flying around in private jets, going to cool places, and I just got this really sweet place in West Hollywood. What’s not to like?”
“Not much,” I said. “It sounds great—young, handsome, famous, and wealthy. It sounds pretty good to me.”
“Me too,” he said. “And I’m now pegged to be on this big-budget comic book franchise. I’m signed up for some big numbers.”
“That’s even better,” I said, “but something must be bothering you if you’re here to see me.”
“My accountant and manager said that I have to start getting serious about my long-term financial plan,” he said. “They say I’m burning through my cash way too quickly and that if I don’t rein it in, I could be setting myself up for huge problems later.”
“They’re right. Actors’ careers can have a really short shelf life,” I said. “I’m sure your advisors also told you that now that you’re big time, many of your old problems may have gone away, but you’ve now graduated into some new ones.”