When we invest in anything, we are trying to maximize our return on that investment, given a certain level of acceptable risk. All financial investments involve a balance between return and risk. Investing in art is no different. We have to ask ourselves, “What is the expected rate of return and what are the risks? In addition to these criteria, investing in art offers other investment advantages. So let’s take a look at these issues in investing in art.
When we invest in anything, we are trying to maximize our return on that investment, given a certain level of acceptable risk. All financial investments involve a balance between return and risk. Investing in art is no different. We have to ask ourselves, “What is the expected rate of return and what are the risks? In addition to these criteria, investing in art offers other investment advantages. So let’s take a look at these issues in art investing.
Rate of Return
Calculating a rate of return on your art investment is difficult. The difficulty lies in devising a rate of return that accurately reflects the movement of art prices. Since we are concerned about investment, I am considering only what I call investment-grade art. This is the art offered by major auction houses such as Christie’s and Sotheby’s, not the art that can be found in a downtown gallery. It is true that this criterion is not accurate. Several indices have been created to measure changes in art prices. One of the most respected indexes of investment grade art is the Mei Moses All-Art Index. The index was developed by two professors at New York University and is often cited as the most reliable to describe fluctuations in art prices. This index indicates that art prices have almost equaled stock performance and that for some periods, the art rate of return has outperformed the stock market. This would bring the annualized rate of return to close to 6%.
Other estimates of art price growth have not been as optimistic. In fact, some estimates put the rate of return close to zero. A study conducted by Luc Renneboog in the Netherlands, the University of Tilburg estimates that the growth rate from 1970 to 1997 is around 4%. We can speculate that the long-term rate of return for investment-grade art is between 2% and 6%, with 4% probably a fairly decent estimate depending on the art package, in today’s economy where certificates of deposit are yielding close to 0%, a 4% return on fine art would seem attractive.
A fundamental premise of financial management is that asset diversification can reduce the overall risk of an asset portfolio. Adding new financial assets to any portfolio should reduce risk, especially if the return on the new asset does not correlate directly with other assets in the portfolio. Although stock and art price swings are often parallel, they are not always perfectly synchronized. Stock prices tend to reflect economic activity, while fine arts are not as directly affected.
Real estate can provide protection against inflation. While inflation can affect the value of monetary assets, such as bonds and certificates of deposit. Like real estate, coins and gold, art is real estate. While the supply of art continues to grow, the demand for investment-grade art is growing even faster. Renoir and Picasso have long since stopped painting. Periods of hyperinflation have always seen large increases in the prices of investment-grade fine arts.