Investments you can consume

Possessing passion assets can help generate both income returns, capital appreciation

There is something about real assets that makes them interesting. We are not referring to only real estate and gold. Consider art, paintings and antiques, collectively referred to as passion assets.

In the last 10 years, mass-affluent investors (middle class if you are an economist) have increased their allocation to these assets. In this article, we discuss why we should consider allocating some proportion of total investments to such assets and the risks associated with such investments.

Value drivers

An investment in an asset can generate two sources of returns — income returns and capital appreciation. For instance, if you invest in equity, you can earn dividend income and then capital appreciation when you sell your investments. Similarly, you can derive value (again, utility if you are an economist) on your investments from two sources — monetary returns and consumption.

Financial assets provide only monetary returns; you cannot consume such assets.

On the other hand, you can derive value from both sources on real assets. That is one reason why real assets are preferred investments for many.

Consider antiques. Suppose you successfully bid for an antique furniture (more than 100 years old) at an auction. You may have bought the furniture because you collect antiques. But you can consider the cost of the furniture as an investment. Why? Typically, the price of such assets increases with age. So, in the event you want to sell the asset, you may be able to generate profits from your investment.

You can consume (derive value by displaying) the asset as long as you have it in your possession. It becomes an investment when you are ready to part with it for a profit. The question is: will you be able to sell such assets?

If you collect antiques, it is natural to buy such assets, but difficult to sell some of your existing collections. Behavioural psychologists refer to this as the endowment effect. Simply put, you are reluctant to part with such assets because you overvalue your possession.

But the endowment effect could diminish with time as the value (ie, the emotional satisfaction) you derive from owning such asset declines over a period. That means if you have a chance to buy, say, a rare eighteenth-century desk, you may be less reluctant to sell your rosewood desk.

That said, investing in passion assets has its issues. For one, such assets require lumpy investments.

For another, buying and maintaining some of those assets could require skill and effort. For instance, antique furniture may not require high maintenance, but keeping your rare painting in pristine condition does. So, you may want to consider the kind of passion assets that you want to invest in.

Importantly, if you are collecting paintings, you have to develop the ability to spot artists whose paintings may sell for higher prices in the future.

‘Investments later in life’

It is best to invest in passion assets after five years into your career. Why? Moving from one job to another is likely to be more frequent during an early career than in the later years. Therefore, your investment portfolio should consist of financial assets during the early part of your career; it is difficult to move physical assets (read passion assets) when you move places.

Finally, it is optimal to allocate not more than 20% to passion assets. Remember, it is not easy to sell such assets. Importantly, the value is based on perception and your ability to find knowledgeable buyers. So, you cannot invest in such assets for your goal-based portfolios.

(The writer offers training programmes for individuals to manage their personal investments)

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