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Finance Cosplay In the Secondary Watch Market

Among some participants in the secondary watch market, I've noticed an interesting trend towards using the term "trade" or "trading" to describe watch transactions. They'll say stuff like "the 5711 was trading at $110,000 last week."
Top: a well known watch dealer self-styled as a trading desk. Bottom: a real trading desk.
This small bit of language suggests, to me, that people are cognitively drifting towards a belief that watches are one of many assets that do actually "trade," such as stocks and bonds. I think there are a lot of problems when it comes to this trend and I'd like to highlight them here. Honestly, this "false equivalance" between watches and financial securities is so bad, it probably should just end. I'm somewhat tempted to tell buyers that if you hear a seller use the word "trade" or "trading" during your transaction, you should probably walk away.

Full disclosure: I am an economist and not a financial advisor. This post is not financial advice. Rather, it contains my observations based upon teaching and researching topics such as money, banking and finance over multiple decades. Incidentally, it is rare to hear that kind of disclaimer when commentators start discussing watches as investments. ;)

How Watches Are Not Securities, Let Me Count the Ways

We'll begin by laying out the many reasons why watches are not securities. We'll then go into one of the most extreme examples I've seen of comparing watches to securities and I'll describe why it is problematic.

1. Credentialling

When you buy or sell stocks or bonds, or other assets like real estate, you typically interact with people who have passed some kind of test and / or hold some kind of license. That license can be revoked if certain professional standards are violated. The licensing process itself educates the practioner on laws pertaining to how an asset is bought or sold. This means there are typically boundaries that financial services professionals will not cross because they don't want to lose their license.

As far as I know, there is no such credentialling in the watch trade. There are organizations that grant some kind of "credential," but it does not have the force of law or government behind it (there is at least one embarrassing example of a "credential" holding watch dealer who publicly engaged in all kind of dubious behavior). In this sense, the risk that certain ethical or even legal lines might be crossed is much greater in the watch market.

2. Heterogeneity

Securities are uniform and homegenous. They are contracts, you can read them and you will know everything about the contract's details.
A stack of $5,000 Treasury bonds. Every Treasury bond of this type is the same as every other. That is not true of watches.
Every contract is the same as all the others. If you buy one share of Disney (of a certain type), it is the same as all the other shares when it comes to "terms and conditions," as it were.

Preowned watches are DEFINITELY not homogenous. They are probably some of the most heterogeneous products out there, considering that the condition of a given watch changes a great deal over time. That condition is very subjective: one watch dealers' "unpolished" may not be the same as another's. The parts in a watch may not be original. A watch could have been serviced every two years or, perhaps it was never serviced. The list goes on and on. Similar to the used car market, there is a major "lemons" problem in the preowned watch market. There is a big risk that something about a used watch may not be disclosed and you will end up buying a watch that is not really valuable because of that undisclosed condition. We call this risk "adverse selection" in the field of economics, and it is definitely real.

True securities have much lower adverse selection risk. Companies (the issuers of securities) have disclosure requirements when it comes to their financial condition, and these requirements have the force of law. The companies are typically audited by a third party. No such disclosure or audit requirement exists in the watch market (there are piecemeal attempts, such as eBay's "authentication" service, but that is really an exception rather than the rule).

3. Securitization / Investment Vehicles

It is possible for a person with a very modest sum of money to hold a stake in all the publicly traded companies in the United States. They could also hold real estate scattered across the country. The reason is securitization and / or investment vehicles. These forms of finance involve a large pool of money buying an equally large, and comparatively diversified, portfolio of assets. Smaller investors can buy a piece of this diversified pool. Mutual funds are probably the most well-known example of this practice.

I've done some research and writing about luxury watch analogues to securitization / investment vehicles. There are certainly some fledgling examples. However, the watch industry doesn't offer anything even close to the level of diversification offered through traditional securitization and investment vehicles. Watch dealers, themselves, are typically diversified if they hold inventory across a large number of brands and vintages. But there really isn't an opportunity for "retail" watch collectors to own a piece of that pool. If a typical person does place a lot of savings in a high-priced watch collection, they will probably end up holding very few watches. Their savings will not be diversified and their risk will be higher (if the brands in a collection become unfashionable, the owner will lose a portion of their investment).

4. Transaction Costs

In many ways, this is one of the most important isssues when it comes to growing a pool of funds. Transaction costs are the fees that a saver is charged on their pool of assets. In traditional finance, there is extensive discussion of how important it is to consider transaction costs when evaluating different assets (see, for example, the book A Random Walk Down Wall Street). It may be true that a flashy fund manager can double your return, but if they also double your fees, it often isn't worth it. They get the flash, you get nothing in return.

In the watch industry, there is inadequate discussion of how transaction costs impact the "return" on watches. Watch transaction costs are HUGE in comparison to traditional finance. If you put $10,000 in the Wilshire 5000, a very well diversified index fund, you are charged roughly .7% per year. That is less than 1%. If, instead, you bought a $10,000 watch and then sold it at a traditional auction, you would perhaps pay a 15% fee (auction houses sometimes state that this fee is not paid by a seller but it is reasonable to assume you would receive a higher price on your item if the buyer did not pay the fee). It would take more than two decades for the index fund fees to be as expensive as the auction house fees.

In short, it is very costly to "cash out" your savings when it comes to watches. This expense is falling a bit due to healthy competition from novel watch selling platforms, but the point remains. Since traditional finance is almost entirely digital, while watches still have to move around and exist in the analog dimension, it is extremely unlikely that transaction costs in the watch industry will ever approach what we see for traditional securities.

5. Hedging

Derivatives are a class of assets than can protect savings from risk. For example, if you buy shares of Apple (this is called "going long") you can also buy a corresponding derivative that will protect you (or payoff) if Apple shares lose value. To my knowledge, there is literally no corresponding asset in the watch market. If you try to employ a watch collection as an "investment," you end up taking an unhedged (or uncovered) long position in those watches. If the watch prices go up, you win, but if the prices go down, you lose. There is no way to use a "watch derivative" to hedge the downwide risk.

Traditional securities have all kinds of derivatives that you can use to hedge risk. There is no corresponding opportunity when it comes to watches (that I am aware of).

Beware Watch Dealers Bearing Reports

There has been recent coverage of a "report" attempting to compare Rolex watches to traditional securities and assets. For the reasons mentioned above, this comparison is not valid. The main focus of the report is one watch dealer's exerience with increasing Rolex watch prices. The title of the report, "Rolex Outperforms Other Assets for 10 Years," gives away the main point.

The main claim in this report is that, "The average price of a used Rolex watch has gone from less than $5,000 in 2011 to more than $13,000 by the end of 2021." At first blush, this does definitely seem like a pretty fantastic price increase. But there are a number of reasons why it actually isn't as impressive as it seems. First, this breaks down to a 10% return per year before fees. Remember the Wilshire 5000 I mentioned earlier? This is a measure of the total market value of all publicly traded stocks in the United States. It returned 16% per year over the same period of the "study." The return on American stocks was 60% higher than the reported return on Rolex.

Why is the report wrong when it comes to these comparative returns? Why does the report claim that "the stock market (based on historical Dow Jones Industrial Average ...) offered similar returns [to Rolex] over the course of the last decade." As I've indicated, the US stock market, in its entirety, handily outperformed the reported "Rolex" rate of return. The report errs because it equates a collection of certain companies (often referred to as "large cap") to the entire stock market. The American stock market as a whole, contains well more than these companies. Moroever, if we account for the extremely high transaction fees in the watch market, US equities and Rolex watches aren't even in the same ballpark. The US stock market wins, hands down.

There are even more problems. How would one achieve this claimed 10% annual return on Rolex?
The watch creating a 1/2 Datejust, 1/4 Day Date, and 1/4 Milgauss return.
How does one buy "the Rolex" offering this return? The answer is: you can't. The report is based upon 16 different models and there is no meaningful way in which you can take 1/16 of a Datejust and combine it with 15/16 of the other watches in order to generate the return in the report. Instead, you would have to buy one of each watch. At an average of $5,000 per watch, we're talking about sinking $80,000 into a Rolex collection in 2011. If you only had $20,000, you literally could not replicate this return. You could, however, place that $20,000 into an index fund and own a small piece of every publicly traded company in the United States. The reason: equities are actually securities, Rolexes are not.

Even if you had $80,000, you probably could not achieve the reported return of 10%. You would need to somehow channel the mind of the dealer who bought and sold these watches, let's call him Dan. Dan has extensive experience in the Rolex market. He probably turns away a lot of fakes and a lot of watches with condition issues that your average collector may not catch. The report would have been more accurate if it claimed "the watches Dan bought and sold increased in price by X." But this does not mean the watches you and I buy and sell will do the same, unless we can perfectly replicate Dan's decision process. I don't think that is likely.

Conclusion

I'm not entirely certain why some secondary market watch retailers adopted the language and style of the finance industry. The most likely explanation: many of their clients come from this industry and / or interact with this industry. It probably makes the clients feel comfortable when they can think to themselves "oh, this is just another broker or financial advisor, I know how this works!"

Have you ever attended a Rennaisance festival? If you have, you'll notice that the employees speak in accents that we typically think of as "medieval British." I'm sure the idea is that this will "transport" you back in time to the days of mounted knights in armor. I have fun when I attend, but I usually don't forget that I'm actually living in the 21st century. I'd recommend that if you encounter someone in the watch market deploying the language of finance, don't forget that you're not actually in the financial market. The industries are very, very different.

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  4. Excellent blog! There has been a few attempts in Europe to create "watch investment fund" but did not end up well. Lots of watch lovers including myself want to justify spending money on watches by comparing this hobby to investment in securities. Watches, particularly Rolex sport watches are indeed an asset class as they can turn into cash fairly easily and appreciate in value in long run, but they are definitely no financial securities. I have not seen any non-watch-lovers who invest in watches for financial profit except for professional quick flippers.

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  5. Well Said... they say there is a thin line between the 2 industries but there really isnt even a line to begin with, these are just two totally different sectors.

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