Monday, August 25, 2008

Should I be investing in rare coins? (Part 2) - Coin Auctions

The Dow was down close to another 250 points on Monday and is officially in a bear market! Oil and gold are both down 20% from their recent highs and yet recently the U.S. Mint stopped selling gold American Eagles in the face of overwhelming demand! Natural gas is down over 40% from its recent highs! The low interest rates on CDs don't even match inflation! Heck, if you had listened to the financial experts exactly eight years ago today and put all your money into a S&P500 index fund, you would actually be down 16% over that time. That's right - negative 16% over the past 8 years! That's one heckuva bear market!

So people have asked me, "Should I be investing in rare coins?"

This is a question that I struggle on how to answer. While I'll admit that some people have profited handsomely from the rise in values of their rare coins in recent years, I believe the rare coin market favors the people that market, auction, and deal in rare coins. The average collector (and I am including investors when I use the term "collector") is at the mercy of these people.

Many collectors don't take into consideration all the costs and fees that are going to take a bite out of the value of their collection. You must think of rare coin investing as investing in a mutual fund with a very large front-end load, large 12b-1 fees, and a very large back-end load. My purpose is to look at some of these fees as they relate to building a rare coin collection.

With the growth of the internet and online coin auctions, it seems that many collectors are building their collections via auctions. So my focus is going to be on buying and selling via auction (this does not include buying or selling on ebay).

Front-end Loads

When buying coins at auction, the front-end load is equivalent to the buyer's fee, usually about 15%. There's pretty much no way around the buyer's fee. Would you invest in a mutual fund with a front-end load of 15%?

If the coin appreciates 15% a year, you can expect to at least break even if you sell it after one year, right? Well, not so fast. That's assuming the hammer price you paid at auction (final price minus the buyer's fee) was a fair price for the coin. Did you and another bidder get caught up in the excitement and bid the coin too high? Afterall, you were the ONLY person willing to go that high during the auction. The simple fact is, you may have paid too much for the coin.

One way to avoid overbidding is to get a trusted dealer to represent you at auction. One drawback is that they will charge a fee thereby increasing your front-end load. The positives are that the dealer can view the coin before bidding and let you know their opinion of what the coin is worth. I've had more than one occasion where the coin looked fine online only to get a call from the dealer telling me there was something wrong with the coin and not to bid at all. As for the fee, the industry standard is usually 5% of the final hammer price. I say "usually" because I've dealt with a dealer that charged me 12% above the hammer price on the final coin I needed to complete a set I was building. The dealer knew how bad I wanted the coin and may have taken advantage of that fact. I didn't know at the time that other dealers would have only charged me 5%. A costly lesson! Needless to say, I don't have that dealer represent me at auction anymore.

12b-1 Fees

These are what I call the hidden fees. They are the costs of holding your collection. If your collection is small, then you might not have any of these costs. But if your collection is large and high value, then you probably do have these fees.

The first is safety depost box rentals. At one point, my collection was so large that I had to store it in three separate safety deposit boxes. This was costing me around $250 a year. On a high value collection, this cost may be insignificant, but on a smaller value collection it may have more of an impact.

The more significant cost is insurance. My homeowner's policy didn't cover my collection so I had to get a separate policy specifically to cover the coins. For higher value collections, this could run into the thousands of dollars a year. One way to keep the cost down is to only have "vault" insurance. This means that your collection is only insured while it is in the safety deposit box. While this may lower your insurance cost, the problem is that you are uninsured any time you take the collection home.

Back-end Loads

After sticking it to you with a 15% buyer's fee, this is where they stick you again with a seller's fee, usually 5%. On top of that, some auction firms won't let you or will try to talk you out of putting a reserve on a coin. A reserve is basically the minimum bid you will accept before you're willing to sell the coin. What some auction firms want you to do is put in a buyback bid instead of a reserve. Basically, they make you put in a bid (your minimum) before the auction starts. If no one bids higher, you basically win your own auction. While the auction firms are nice enough not to charge you the buyer's fee for a buyback, the kicker is that they usually still nail you with the seller's fee.

But seller's fees are something you can actually do something about. This is important! If you are going to sell a coin by auction, you must do it through a trusted dealer. Dealers that do a lot of business with auction firms get special treatment when it comes to consigning coins for sale.

Basically, the deal is that they don't get charged a seller's fee and they share in the buyer's fee with the auction firm. For example, a dealer that consigns a coin may have a deal where they get 105% of the hammer price (some dealers get more so it pays to shop around). Basically, the auction firm is giving them one-third of the buyer's fee. The way this benefits you is that you can work out a deal with your dealer where you get 100% of the hammer price (or possibly a little more), and the dealer gets the 5% that came from his portion of the buyer's fee. One of the few win-win situations in numismatics. In addition, those auction firms that don't like taking reserves from individuals have no problem taking reserves from dealers. The end result is that you completely avoid the 5% seller's fee and possibly even get a little more than the final hammer price.

Another possible advantage is that it has been my experience that you will even get your settlement money from the auction firm quicker if it goes through the dealer. It seems that those dealers tend to get paid first when they issue the settlement checks. Maybe this has just been a coincidence, but I'm not a big believer in coincidences.

If you take nothing else away from this section, at least take away the fact that it is definitely in your interest to consign coins, especially high value coins, to auction through a dealer that has one of these deals in place. I know that I will never consign a coin directly to an auction firm again.

The Dealers You Trust

Finally, if you do decide to invest in rare coins, one last piece of advice that I have is to find a couple of dealers you trust to do business with and not just one dealer. If I had only dealt with one dealer, I never would have known about the 5% fee that is standard for having a dealer represent you at auction which would have saved me thousands of dollars. The only way to know if your dealer is treating you fairly is to be able to compare that dealer to others. After awhile, you will learn which dealers are treating you the fairest and you will tend to do most of your business with them.

Whether you consider yourself a collector or investor in rare coins, I hope this article has provided you with something of value in your pursuit of putting together a rare coin portfolio. The one thing I can honestly say is that if I had it to do all over again, I certainly would not do it the same.

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