Investing in Art, Can Art be an Investment?
Investing in Art – Masterworks® carves up the masterpieces
Investing in art has long been seen as a symbol of wealth and sophistication, but it isn’t always the best financial decision. For starters, investment-quality art can carry stratospheric price tags, far above what most investors would be able to afford. And, at those prices, an investor would have to have significant assets in order to maintain a diversified portfolio.
Enter Masterworks®, a new company that allows investors to buy shares of blue-chip artwork. In this blog post, we’ll discuss why Masterworks® may not be the best investment for many people due to high fees and the absence of a guarantee that the artwork will be sold, as well as the higher capital gains tax for illiquid assets.
Masterworks® allows investors to buy shares in famous artwork, such as pieces by Andy Warhol, Claude Monet, and Pablo Picasso. Investors may be able to buy a share of the artwork for as little as $1,000 in exchange for the chance to earn a return if the artwork is sold for a profit. However, there are several drawbacks to investing in art through Masterworks®.
One of the biggest drawbacks of investing in Masterworks® is the high fees associated with it. The company charges an annual management fee of 1.5% and an additional 20% commission on any profit made when the artwork is sold2. These are fees that are similar to hedge funds4, a private fund that is managed by investment professionals, but with Masterworks®, you are the investment manager picking which art to invest in while paying fees as high as hedge funds ran by investment professionals. Fees eat into an investor’s return, making it harder to earn a profit while also requiring you to be making smart decisions on which artworks to invest in.
Another concern with investing in Masterworks® is the lack of a guarantee that the artwork will be sold. The art market is notoriously fickle, and there’s no guarantee that a particular piece will sell for a profit. Investors could end up holding onto their shares for years without seeing any return on their investment while still paying 1.5% in management fees.
Finally, investing in illiquid assets such as artwork can lead to a higher capital gains tax. When an investor sells a stock or mutual fund outside of a retirement account, they’re subject to capital gains tax up to 20% at the federal level (as of 2023)1in addition to additional Medicare Surcharge and state tax. However, the tax rate for illiquid assets such as artwork is higher (28% federal in 2023)1, which can significantly impact an investor’s returns.
To further break down this math, selling art for $100,000 that was purchased for $50,000 (doubling your money) results in a 20% fee from Masterworks® on the profit of the sale plus a 28% capital gains tax on the profits from the sale of the artwork (assuming you are in the top capital gains tax bracket) plus any state capital gains taxes that may apply. This means that excluding the 1.5% management fee from Masterworks® you still pay ($50,00020%)+($50,00028%) equaling a total of $24,000. Meaning that you would walk away with $76,000 which is a substantial difference from what it may initially seem you would walk away with before digging into the numbers more.
Investing in art can be an attractive option for some investors and carries a certain cashé in some circles. Masterworks® may not be the best choice due to fees, no guarantee of sale, and higher tax on profits. Investors should carefully consider their investment goals and risk tolerance before investing in any type of asset, including artwork. There are circumstances where Masterworks® may be a valid investment option for a portion of a portfolio. As with any complex financial decision, talk with your financial advisor before making a decision.
References:
- https://www.irs.gov/taxtopics/tc409
- https://thecollegeinvestor.com/23435/masterworks-review/
- https://www.masterworks.com/?utm_source=google+brand&utm_medium=platform&utm_campaign=Brand_Masterworks&utm_content=masterworks%20minimum%20investment&gad=1&gclid=Cj0KCQjwsIejBhDOARIsANYqkD0rYEqtOFfj_zSCKw99kGnCrF42X3aHmwJADHV0IWP-J00jbv51Uh8aAgveEALw_wcB
- https://corporatefinanceinstitute.com/resources/capital-markets/2-and-20-hedge-fund-fees/#:~:text=The%2020%25%20performance%20fee%20is%20the%20biggest%20source%20of%20income,year%20surpass%20the%208%25%20level
Jack O’Brien CIMA® is a Certified Investment Management Analyst educated at Chicago Booth School of Busisness and Virginia Tech. EVOadvisers is a fee-only financial advisor based in the Scott’s Addition area of Richmond, Virginia. EVOadvisers also has an office in Irvington, Virginia to better serve clients in the Northern Neck of Virginia. If you have any questions about financial planning and would like to talk with one of our Certified Financial Planner professionals, check us out at www.evoadvisersdev.wpengine.com or call (804)794-1981.