The Risks of Platforms For Investing in Commodities and Art

Public market investors are facing high inflation, low yields, and volatile markets.

Even those who diligently followed the "gold standard" portfolio allocation of 60% stocks and 40% bonds suffered one of the worst years in recent history.

In the search for yield, there are now countless options to choose from.

An ease in regulatory restrictions, the growth of tech-enabled investment platforms, and even a growing number of accredited investors are all contributing to the rise of alternative investments. 

One such option is investing in art and other collectibles, like fine wine and luxury cars. But before you invest in these types of assets, it is important to understand the associated risks.

The highest tax rate on long-term capital gains is 20%. A married couple needs to earn over half a million dollars a year to be taxed at this rate, and most are taxed at 15% or less.

In sharp contrast, the capital gains tax on the sale of a collectible, if it appreciates in value, is a whopping 28%. If you sell a collectible in less than one year, it will be taxed as ordinary income. 

In other words, your tax bill could easily be twice as high as it would be for private equity, venture capital, or other investments.

Exacerbating the tax issue is the fact that fees associated with investing in collectibles can be significantly higher compared to other investments.

Investors in collectibles have to pay for authentication, appraisals, storage, insurance, broker fees, shipping, and more.

Collectible-investing platforms pass these costs onto investors. For instance, Masterworks is a leading art investing platform that charges a 150 basis point annual fee, as well as a 20% fee on any profits.

Vinovest, the wine investing platform, charges an even more extreme 285 basis point annual fee on its starter plan.

In comparison, Gridline is a leading alternative investments platform that charges a management fee of 50 to 100 basis points annually, depending on your assets under management.

Let's illustrate the impact of those fees with a couple examples.

Suppose you invested $100,000 in art. After one year, and the application of a 150 basis point fee, your investment is now $98,500.

If the art appreciated in value by a strong 10%, your investment would be worth $108,350. After a 20% profit fee, you'd end up at $106,380.

Finally, let's apply the 28% collectibles tax on your $7,880 gain, and you'd be left with $104,174.

Or, suppose you invested $100,000 in wine. After a 250 basis point fee, your investment is worth $97,500. If the wine increased in value by 10%, your investment would be worth $107,250.

If we apply the 28% collectibles tax on your $9,750 gain, you're left with $104,520.

Now, suppose you invested $100,000 in private equity instead. After one year, and the application of a 100 basis point fee, your investment is now $99,000.

If the private equity fund appreciated in value by the same 10%, your investment would be worth $108,900. Applying the 15% capital gains tax on your $9,900 gain, you'd be left with $107,415.

That's a nearly 80% higher return than investing in art with the same appreciation rate, and more than 60% higher than investing in wine.

As you can see, the fees and taxes associated with collectibles significantly reduce the amount of money you end up with.

A strong private market investment selection process is built on a foundation of data and hard evidence.

Professional screening tools are needed to analyze performance to public market equivalents and compare a fund’s performance to a customized peer group of funds with similar investment styles.

This kind of data-driven strategy is key to evaluating and selecting the right private market investments. But when it comes to collectibles, this analysis is not always possible.

For example, how would you compare a Van Gogh to a Picasso? While businesses are valued based on quantifiable metrics like earnings and cash flow, collectibles are often valued based on hype and emotion.

Speaking of Van Gogh, climate activists have recently attacked many of his paintings, including "Sunflowers" and "Peach Trees in Blossom."

Dozens of other works of art have been recently damaged in acts of protest and vandalism.

Collectibles like wine and whiskey are even more susceptible to destruction. In one case, a warehouse mishap resulted in the loss of around $700,000 worth of premium wine.

In another case, a Manhattan wine merchant accidentally dropped a $500,000 bottle of 1787 Chateau Margaux.

In comparison, you can't destroy a business by gluing your hand to it or accidentally dropping it on the ground.

At first glance, investing in wine or art may seem like an exciting way to diversify your portfolio and generate returns. But, as with any type of investing, it is important to understand the associated risks.

With significantly higher fees, taxes, and a lack of information and comparables, the return on investment in art and other collectibles is often lower than expected.

Additionally, there is always a risk of physical damage to the asset, or even counterfeit pieces entering the market.