Beginner's Guide to Investing Lego Style

"Greed, for lack of a better word, is good."

These are the immortal words of Gordon Gecko, a fictional maven from the movie "Wall Street" who made millions "parting out" struggling companies with asset-rich balance sheets. As I peruse Brickpicker on a daily basis, these words always echo in my head. For most members, BP is part of their Lego hobby: the Pricing Index, Discussion Forum, and blog articles provide outlets for members to share, enrich and supplement their Lego hobby. Yet Brickpicker is, at its core, a powerful tool that’s been crafted and honed to fulfill one primary mission: to give members a better opportunity to make money.

While the word “greed” may be a little unsettling, the spirit of Gordon Gecko’s infamous mantra should be embraced. Whether members use their Lego investment income to supplement their Lego habit, their mortgage payments, or 401Ks, more money is better! Yet, day after day, I read posts on the Discussion Forum that espouse uninformed purchasing decisions, and cringe when other BP members echo in agreement. The goal of this blog entry is to educate readers on the fundamentals of portfolio management and investing to help BP members build a better portfolio.

Portfolios – what are they, and why do we use them?

In the high stakes world of finance, a portfolio is a collection of investments that are strategically selected to maximize a return at an estimated level of risk, or to minimize risk at a given level of return. Asset classes, or types of investments that professional portfolio managers buy, include stocks, bonds, real estate, commodities, and cash, among others. Interestingly, art and collectibles can also be part of a well-rounded investment portfolio, and I would be willing to wager a number of Lego investors already have a portion of their net worth wrapped up in this asset class! The market provides thousands of asset classes and investments to financiers, and shrewd portfolio managers target specific investments from all of these asset classes to build a portfolio.

Within the Lego investing realm, the closest parallel to asset classes are themes since their sets share certain characteristics. Similar to a portfolio manager, the savvy Lego investor should target investments from different themes to build their portfolios. Why pick from a variety of themes? Like the old “eggs in one basket” analogy, there is value in diversifying the portfolio: when one theme or set size doesn’t appreciate as expected, there are other earners to pick up the slack.

Investment Profiles - Risk and Expect Return

Portfolio diversity is achieved by strategically selecting a variety of sets across themes and sizes, not just purchasing different theme sets at a discount. When targeting sets to purchase, the Lego investor must consider the risk inherent in the set, and the expected return on the investment. To adequately decide whether a set is right for investment, its risk and expected return should be always be estimated and compared to other options (sets) available to the portfolio.

In finance, risk roughly correlates to the range of expected prices the set could realize after retirement – the wider the expected range of returns, the riskier the investment. Unfortunately, there’s no statistic or financial model that that quantifies risk of Lego sets, so other more subjective methods must be used. To assess risk, we can review the range of prices that similar retired sets sold for in the past. For example, let’s assume we are trying to assess the risk of investing in 7498 Police Station. Since it’s still on the market, the savvy investor will review the previous performance of similarly sized “base-type” sets from the City theme to build a risk profile for this set. Here are some raw numbers from comparable sets:

What do these sets tell us about the risk profile of 7498? Incredibly, they have been very consistent performers, with returns from these comps (comparable sets) fluctuating between 83% and 97%, a nice tight window. Let’s contrast that with a risk profile for 79003 An Unexpected Gathering:
 

The range of ROI for these comps provides a high risk profile for this set as comparable ROIs yield anywhere from a 14% loss to a 138% gain. The idea isn’t to estimate the value here, so I would assign 79003 a label of “high risk” while I would assign 7498 Police Station a “low risk” label.

After assessing the risk of these two sets, we must create an expected return profile. Expected return is the amount of money the investor thinks the investment set will sell for on the secondary market. The two primary factors that affect secondary market demand are primary market set popularity and primary market availability, but because TLG keeps sales by theme and production numbers private, we must once again make subjective estimates for each to determine comps. Brickpicker provides eBay sales of the top 50 sets by month to give users an idea of what’s selling, and Lego S@H and Brickset can be used to determine the “Exclusive” and “Hard to Find” sets that are on limited production runs or are otherwise not readily available to all distribution channels. Investors must also consider the length of time a set has been on the primary market as a crude measure of production as well. These characteristics form a profile for the set that are then compared to other comps. Piece count and theme similarity should also be considered when finding comps for the investment set in question.

Lego investors should also factor purchase price into their expected return metrics. If I buy 7498 Police Station for $75 instead of the $100 MSRP, I add an additional $25 to the expected return, making the set an even more attractive addition to the portfolio.

To determine the expected return profiles for 7498 and 70003, let’s look again at the tables from our risk example. For 7498, I would drop 7240 from the comparison since it had significantly fewer pieces and a lower MSRP, so I would expect returns from 7498 to be around 90%. For 70003 An Unexpected Gathering, I would lean more toward performance of The Burrow and Mill Village Raid since the POTC and PoP sets were less popular themes and movies than HP and LOTR/Hobbit, and Mill Village Raid is a castle theme that’s quite similar in design to the LOTR/Hobbit themes. I would also peg the expected return of 70003 at 90%.

While the low risk/90% return for 7498 appears to have a more appealing profile than the high risk/90% return for 70003, I want to be clear that the profiles this process yields are not absolute. Two intelligent investors assessing the same set can arrive at very different investment profiles. For fledgling investors, developing a habit of routinely assessing potential sets based upon risk and return profiles is more important than being in agreement with the analysis of other Brickpicker members. As new investors experience sales cycles from start to finish, they will begin to learn how and what sets sell, and through time and experience, can refine their profile assessment strategy accordingly.

Personal Investing Profiles

With our investment profiles established, we can begin to construct our portfolio. But before diving in, an investor must answer three key questions to define their personal investing profile:

• What is your monthly budget?
• What is your investment time window?
• Does it bother you to lose money on sets for the chance at higher returns?

The answers to these critical questions must shape the types of sets selected for your portfolio. For example, if my monthly budget is $100, I have a three year time window before seeing profit, and I am risk averse (or don’t like seeing losses on my sets), I would select sets that fit these criteria:

• Small to medium sized sets (at least to start)
• Lowest risk profile at the expense of a little return
• Expected EOL within 1-2 years of the purchase date

At $100 per month with a 3 year time window, the total budget is $3,600 to spend before returns on my first purchases will begin. Between the two Set Investment Profiles we’ve developed for 7498 and 70003, it appears 7498 fits well into my portfolio, especially if I can get this set at a good discount. On the other hand, the investment profile for 70003 probably will not work since the risk profile is on the high side.

Each investor must track their portfolio diligently, and as many members already know, Brickpicker’s Brickfolio feature is an especially useful tool for this purpose. I would suggest including each set’s investment profile (risk/return) in the “Notes” section of each set’s “Edit Collection Details” page so that you always know the parameters you used when deciding to purchase.

Once a Lego investor sells a set in the portfolio and realizes income, there are a few key steps to take before closing out the sale:

• Calculate ROI, or return on investment, for the set
• Calculate CAGR, or compounded annual growth, for the set
• Update the portfolio’s overall return
• Assess the set’s performance critically

ROI is a simple percentage – subtract the purchase price from the sale price, and divide it by the purchase price. This simple metric provides you with a return on your investment. CAGR is a little trickier, but a thorough analysis can be found at the following Brickpicker page:

http://www.brickpicker.com/index.php/blog/view/cagr_compound_annual_growth_rate_and_lego

The difference between CAGR and ROI is that CAGR incorporates a time element, so you can quickly understand the average annual return from your set. A higher CAGR will tell you the set returned profit quicker than a set with lower CAGR. The Brickfolio doesn’t offer tracking of sales gains yet, so a separate spreadsheet or ledger should be kept for tracking and tax purposes at a minimum. Finally, performing an “autopsy” on a set after it’s sold will help educate the investor on how to better assess risk and expected returns for future investment sets. While we hope all of our sales net profits, often there is more to be learned from failure than from success.

With the daily concerns raised by members about new entrants into the Lego investing community, it’s more critical than ever to understand who you are as an investor, and how you like to invest. Investing your money in Lego systematically will allow you to make better investment decisions and give you a leg up on less savvy investors. In the immortal words of another self-absorbed movie character, Jerry McGuire's Rod Tidwell beckons us all to, “Show me the money!”

"ED"itor's Notes: This is an excellent article that relates common stock investing to LEGO investing. Years ago, my first boss, Edd Kluth (a multimillionaire), taught a young punk like myself how to invest in stocks and mutual funds. He invited his financial planner to one of our weekly corporate meetings and the basics of dollar cost averaging were explained to a 20 year old kid. Mind you, this was a big deal. This was before today's internet and TV business and stock shows that help guide people through basic Investing 101 and show the hot stocks of the day. Mutual funds were taboo topics back some 25 years ago, but investing in mutual fund and learning the basics of dollar cost averaging made me some nice profits over the years.

Fast forward 25 years...While I still invest in stocks and mutual funds, a good portion of my investment dollars goes towards LEGO sets. As Quacs so eloquently stated, there are many ways to invest in LEGO sets. Short term. Long term. Low risk. High Risk. Different asset classes or themes. And so on...Whatever works for you. I have always been a long term investor, slowly accumulating sets over the years, buying low and making paper profits. While I haven't sold my sets as of yet, the slow and steady approach has made me thousands of dollars over the last 5 years. I am not telling you to use my method. Storage is at a premium and expensive and my money is tied up, but that is the price I pay to sleep at night. Good luck on your LEGO investment journey...