Diamonds in the rough when it comes to investing

While returns are hard enough to predict in most investments, they are nearly impossible to figure for diamonds.

diamond biz 88 224 (photo credit: Bloomberg)
diamond biz 88 224
(photo credit: Bloomberg)
MarketWatch: In-depth global business coverage Most people aren't shopping for the holidays thinking of the investment value of what they are buying. But William P. from Boston's suburbs figures that as long as he's shopping for jewelry for his wife - she'll celebrate her 30th birthday on Christmas Eve, a week before the couple's fifth wedding anniversary - he might as well keep the portfolio in mind. "This is something I want to do, but we're also young and there's no doubt that we could use the money for other things," he said in an e-mail. "I was going to put a few more dollars into the 401(k), but now I am thinking that I will use the money to pay for the diamond earrings. Diamond prices keep going up, so if we ever really need the money, we could cash them in for a little profit. ... I'm not so sure I could buy a stock and be so sure it will be worth more the same way I can with diamonds." Alas, William and many other shoppers who overspend on diamonds because of the jewels' investment value are making a bad decision. It is the emotion that a diamond purchase is laced with and not its investment prospects that is the right reason to buy jewels. "There are many places where you can put your money where your returns are more immediate and much greater," says Antoinette Matlins, author of Jewelry & Gems: The Buying Guide. "Buying a diamond is a valid means of preserving wealth over the long-term, because you can expect that diamonds will hold their value over the long-term, but buying something today thinking you can sell it at a profit if you need the money is a mistake because that's not going to happen for most people." As an investment in emotion - love, hope, faith, commitment, romance and trust, to name a few - diamonds may provide a terrific return, albeit not a monetary one. But try to cash in a diamond for a profit and you have all sorts of potential for trouble. While returns are hard enough to predict in most investments, they are nearly impossible to figure for diamonds. Diamonds are appraised and graded, but prices move based on consumer sentiment. Moreover, prices frequently are set or influenced by the same experts sitting at the table discussing the quality of the purchase or evaluating the stone. While the grading systems are based on set standards - so that a dozen experts looking at the same stone should draw identical conclusions on carats, color, cut and clarity - there is a lot of wiggle room. Several gemologists suggested that they may agree with their colleagues on grades, but that there is a difference between the highest edge of the grade range and the lowest. Think of it like school grades, where a "C" is "average," but the closer that grade gets to a "B" the better it looks; the more it drops towards a "D," the closer it is to failing. Gemologists say that buyers frequently pay for grades without knowing where the stone falls in the spectrum of the mark. From an investment standpoint, that's like coming up with a fair-market value without ever being able to look at precise financials. A little swing either way can dramatically change the potential profit or loss. As a result, diamonds face inestimable "dealer risk," the potential to get fleeced by an unscrupulous dealer. (Even in collectibles meant for investment, like coins, dealer risk poses a big potential problem.) "Pricing risk" is also a part of the equation. If you buy a diamond at three times the true wholesale price - even if that is roughly the appraised value - you'll have no shot of selling it at that price for a decade or more. Diamonds do hold their value well - so long as the stone is real, it's not going to zero like a company headed for bankruptcy. Next, there is liquidity risk. While stones retain their value, you won't have a lot of bargaining power if you must sell to raise cash. Dealers who buy jewelry don't pay retail and the nation's pawn shops are full of expensive gems that were turned in for a lot less cash than they were purchased for. And because emotion generally is attached to a jewelry purchase, it can be mighty hard to part with under the best of circumstances; if William P. ever gets overdrawn on the credit cards, chances are the earrings won't be the first thing jettisoned to ease the burden of bills. In the late 1970s, diamonds boomed as sellers suggested that diamonds would replace gold as a safe investment option; buyers snapped up stones thinking they would hold their value, and prices skyrocketed. The bottom fell out in 1981, and while jewel prices have risen at a slow, steady pace ever since, the buyers who thought they were getting a gem of an investment still couldn't sell those stones at a profit. Since that time, most people have looked at gems more as gifts than investments, despite the temptation to think of it as both. Recent price increases, coupled with the stock market's current volatility, seem to be priming the investment pump again. Matlins says that would be a mistake. Focus on what the gift means, not what it might be worth to some future buyer. "It's nice to do something for pleasure, that's very romantic and very sentimental, but that also retains its value," she says. "There are a lot of values attached to buying jewelry that go beyond the money. And it's better than giving her a car, where the value will be going down every day. But if you're looking at this as an investment in anything other than your relationship or your family, you're probably going to be frustrated if you ever really need to cash it in." MarketWatch: In-depth global business coverage