art and investments

Ethan and Sharon are taking an art history class this semester. The first session was this morning. When Blair and I picked them up after class, they told us about a conversation. The professor was talking about art as an investment, and said that it’s like stocks, bonds or any other investment. Ethan said something along the lines of “not really…” And they were off to the races.

Ethan is absolutely right. As investments go, there absolutely is a fundamental difference between art (or other collectibles) and stocks, bonds or other financial instruments. But I suspect that he didn’t do a good job of explaining it; he and Sharon reported that he didn’t convince anyone. With that in mind, I’m going to take a shot at the explanation. Of course, brevity will require some oversimplification.

Financial instruments such as stocks and bonds produce income. Or at least that’s the hope. Bonds represent debt, and the issuer is obligated to pay the borrowed money (with interest). A share in common stock represents an ownership interest in a company and, with it, a share of that company’s future income. The value of a stock or a bond is, essentially the present value of future cash flows. It gets complicated because there can be considerable uncertainty around those future cash flows. And a hundred different investors may have a hundred different assessments of the value. And those assessments may be constantly changing. But stocks and bonds have value because, fundamentally, they are expected to produce income.

A painting doesn’t produce income. Its only value is in people wanting to own it for its sake. I suppose there may be people who buy art to rent to others, or to display for a paying audience. But that’s not what the professor was referring to.

To put it more simply, if you buy art to collect with no intention of ever selling it, you will never make any money from it. If you buy a share of stock with no intention of ever selling it, you still expect to get cash flows from the dividends it will pay.