The fact that diamond prices have risen 67% since 1978 might lead some to assume they’re a good investment. However, this 3,000-foot view of the market masks its true nature. Not only are prices extremely volatile – shooting up 249% from 1978 to 1980 before falling 77% by early 1986 – but the value of diamonds has also long been propped up by a number of artificial sources.
When you further consider that the S&P 500 has increased 2,080% since 1978, it becomes clear that diamonds are not investable under most traditional definitions, which typically necessitate safety of principal and a competitive return. That’s not to say diamonds aren’t valuable or important – especially as emergency currency and a means of abiding by societal conventions. They simply should not be purchased as an investment with the idea of retained value.
For more on how we came to this recommendation, check out the additional information below.
Too Much Price Volatility & Demand Uncertainty To Be Investable
As mentioned above, price volatility is one of the major factors inhibiting diamond’s investability. You simply cannot have a true investment when you lack a reasonable expectation that the amount you invest will be safe when you need to withdraw it. That’s why putting money into a savings account, certificate of deposit (CD), or blue-chip dividend-paying stocks would constitute an investment, for example, while buying a horse (or a diamond) would not be. That is what’s called “speculation,” and it introduces an element of gambling into money management.
Seeing wild swings in the price of an asset should be worrisome, triggering caution among investors. One thing you’ll want to do is determine the cause of the fluctuations. In the case of diamonds, prices skyrocketed from 1978 to 1980 as a result of runaway inflation permeating the entire economy. They fell after the resulting stock market crash and recession.
Now, you may think the chances of this happening again are slim – and you’re partly right – but we’ve experienced periods of high inflation numerous times in the past. And, if people have shown themselves to be less willing to purchase expensive diamonds in periods of financial distress, that detracts from their value as any sort of hedge against broad economic turmoil.
Finally, you have to consider the fact that diamonds may not always hold special societal significance. The U.S. tradition of using diamonds as a symbol of wedding engagements is less than 100 years old, for instance, and numerous other stones are rarer.
So, what if the bottom falls out of the diamond market as it did with the tulips during the Dutch Golden Age – whose prices ultimately reached 10-times the annual salary of a skilled craftsman and then collapsed, in the first recorded speculative bubble?
That’s something any investor should certainly keep in mind in regard diamonds.
It’s More Like Diamond Speculation
When you consider the following definitions of an investment from some of the greatest investors who’ve ever lived, along with the aforementioned diamond market dynamics, it will be clear why these particular stones don’t fit the bill:
“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
- Benjamin Graham, “The Intelligent Investor”
“Appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise [i.e. investment] for the activity of forecasting the prospective yield of assets over their whole life.”
- John Maynard Keynes, “The General Theory of Employment, Interest, and Money”
“The speculator is looking for hidden weak spots in the market,” and acts as “the advance agent of the investor, seeking always to bring market prices into line with investment values.”
- Milton Friedman
The Arguments For Investing In Diamonds Are Weak
Proponents of investing in diamonds typically point to a few distinct arguments in defense of the practice. Unfortunately, these justifications have fundamental flaws and could lead you to make financial mistakes if you’re not careful. Here’s why:
Dubious Price Appreciation
Recommendations to invest in diamonds are often based on the idea that the stones do provide a satisfactory return over time, not to mention a floor of support offered by their intrinsic value. Such characterizations are often the result of selective timeframes, however, with end points masking interim events or reflecting largely irrelevant external forces.
Most diamond investing advocates will provide an extended historical overview, contrasting diamond prices decades ago to the modern day, or they’ll highlight a snapshot of a few recent years. For example, they’ll say that per carat prices have increased 67% in the past 37 years or 7% in the past 10 years, and that will sound pretty good.
But viewing things in this manner robs an investor of crucial context, such as what happened to prices in the interim and how other assets behaved in the same timeframe. Not only have diamond prices exhibited wild spikes, but any growth they’ve shown has been significantly outpaced by the S&P 500. In fact, it’s not even close.
That’s one supposed reason to invest in diamonds debunked.
The Undisputed Carat-For-Carat Champs
Investors love limited risk. That’s why the notion that there is a floor to the price of diamonds – it will never get too low, in other words – is so appealing. However, diamonds would seem to objectively have greater downside potential than growth prospects. For starters, diamonds aren’t all that rare, relatively speaking. It’s also possible to make them in a lab, which means we could have an issue of increasing supply on our hands. What’s more, demand for diamonds is largely a cultural phenomenon borne from effective advertising, so the stones could possibly fall out of favor.
When you put all of that together, it’s clear that we’ve unseated another reason to invest in diamonds.
Portable Durability For Emergency Siuations
Finally, investors love the combination of toughness and size that diamonds present. They are much easier to transport during emergency situations than gold, for example, and have proven the ability to stand the test of time. This is indeed true. Diamonds contain the most value per mass of any item on Earth. They are also among the hardest substances known to man, so physical durability is not in question. There is a downside to this, however. It’s a lot easier to lose a diamond than a gold brick, after all, and many people might not want to put so many eggs in such a small basket.
So, while we didn’t totally tear down this diamond investment motivation, it’s certainly questionable at best. Diamonds don’t provide an adequate hedge against inflation, and most people would be better off with more practical financial planning, than investing for catastrophe purposes.
Adding Purpose To Inevitability
People often assume that since they’re buying a diamond anyway – as part of an engagement ring – they might as well do so with an investor’s intent and get their money’s worth. That’s a nice thought, but it’s also flawed logic. Simply characterizing something as an investment does not make it so. Fundamentals do and they aren’t good in this instance.
Diamonds Vs. Key Benchmarks
Diamond may be the most valuable material by size on the planet as well as a recognizable symbol of wealth, love and unavailability. And while it’s also among the most expensive natural resources to purchase, it ranks low when it comes to value stability.
Diamonds vs. Gold vs. S&P 500
*Data courtesy of the Rappaport Diamond Index, Kitco, the World Gold Council and Yahoo Finance. Diamond prices reflect monthly averages based on a 1-carat diamond. Gold prices are based on average annual London PM fixed prices. S&P 500 prices reflect average monthly adjusted closing prices. ROIs are cumulative.
The chart above shows that even in the wake of the Great Recession, when the stock market suffered historic losses, diamonds at best served as a short-term hedge and very quickly fell behind the returns of alternative investments.
Image: Ola-ola / Shutterstock