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Heat and Pressure Create Flawed Diamonds

The Godfather Movie in Text
I’m gonna make him an offer he can’t refuse.

“Let us not be too particular; it is better to have old secondhand diamonds than none at all”
–Mark Twain

When I was in graduate school, I used a combination of local auctions and eBay to make some extra beer money each month. The University of Virginia used to conduct surplus property auctions every month in an old warehouse right down the street from my apartment. A week or so before the auction, they’d publish the list of all of the items that were going up on the auction block for the upcoming sale.

So, diligently, I’d research all of the items that were available for auction and look them up on eBay to see how much each sold for. If I could find the item and make a reasonable amount of money on it, then I’d mark the item to bid on it during the auction. I had three rules for the auctions:

  1. The item had to have sold somewhat recently on eBay.
  2. I had to be able to put it in the trunk of the car and carry it home.
  3. I couldn’t pay more than 25% of the recent selling prices on eBay.

Armed with those rules and my list, I’d head off to the auctions. I would usually spend about a hundred dollars a month and bring home all sorts of…well…junk for resale on eBay. Everything would go into the extra bedroom and then on eBay for resale. I’d probably make a few hundred a month, which paid for beer and the occasional night out.

Of course, having to deal with a wife who was unhappy with me storing a rodent breather in the guest bedroom is not quite quantifiable. To this day, I’m not really sure what a rodent breather is, but I do know that there is a proud owner at Rhodes College in Memphis, Tennessee who is breathing rodents to his heart’s content. Cost: $1. Sold: $200. Funny stories about rodent breathers: priceless.

Fast forward a few years later. My wife and I were on a ski trip with her father and stepmother in Breckenridge, Colorado. We’d stopped for lunch at the lodge where we were skiing, and I saw a sign for an estate auction.

Flashbacks of previous eBay successes danced in my eyes.

“I don’t know about this,” my wife cautioned.

“Caution be damned,” I thought. She wasn’t the one who had schlepped heavy, dusty computer parts back and forth for a few extra dollars. I was the expert!

So, like a moth to flame, I was drawn to this auction, and I dragged the family with me.

Apparently, the Feds had confiscated the estate of some notorious drug dealer / mobster / Mafioso / litterer. Since I didn’t know the identity, let’s call him “Michael Corleone.” Mr. Corleone lived the good life and apparently liked to buy his wife / mistress / straphanger bling. Lots of bling. There were diamonds, rubies, and jewelry EVERYWHERE. All of them had some sort of fancy looking appraisal sheets citing the quality of the stones and their estimated retail value. There were only a handful of people attending the auction, so I couldn’t help but to think that I had this nailed. Buy at an auction with limited attendance, and sell on eBay where the whole world was buying.

Furthermore, I’d dated a girl I met using cheesy pickup lines because she was a sales clerk at a Zales. I had the jewelry thing licked.

The auctioneer was a British guy. For whatever reason, I find British accents to sound authoritative. So, when he rattled on about the high quality merchandise that Mr. Corleone had purchased, I was hanging on every word. I wanted him to hurry up and get to the actual auctioning so that I could start bidding a dollar on everything.

Finally, the bidding started. There were a few items in the beginning which I wasn’t interested in. They were probably Picassos or original Gutenberg prints, but I was focused on the jewelry. It was in my price range, assuming that the auction went according to the well laid out plot I’d developed in my mind, and I was certain that there were buyers on eBay.

Did I mention this was before the advent of smart phones with Internet access? No? Thus, I had no actual access to eBay or any other useful information which Google could have thrown my way.

Eventually, the British guy started auctioning off the items I was interested in. Unfortunately, there were other people who had the same idea that I did and had the gall to bid against me! Well, I wasn’t going to let those buffoons stand in the way of me getting that jewelry so that I could auction it on eBay and make scads of money! So, I raised my price.

…and I started justifying why I could go over the prices I’d set as upper limits. My wife did an excellent job in suppressing the groans which were growing ever louder and more persistent in her gut while I’d given the reins over to Monkey Brain and was letting him go wild.

In the end, we spent several thousand dollars on jewelry. I think we wound up with six or seven pieces – necklaces, bracelets, rings, you name it. I couldn’t wait for the vacation to end so that we could go home and I could get them appraised and get going on eBay.

Sweating, we carried all of the jewelry through security at the airport and flew home. I felt like a drug mule must feel, although we weren’t absconding with the jewelry in the same way that a drug mule might sneak through a bag of cocaine. Still, I felt like I had a target on my forehead: “CARRYING MANY DIAMONDS. ROB ME!” Eventually, we made it home, and I made an appointment with the local jeweler.

On the appointed day, I carted my haul over to the local jeweler for an appraisal. The appraiser looked at my paperwork with a less than impressed expression. Apparently, there’s a gold standard (pun intended) for jewelry appraisers, and my appraisal was not done by someone who came from that school. Think of it as Engrish for grammar rather than Strunk and White.

Needless to say, while the diamonds and rubies and whatnot looked shiny, they had several flaws that significantly reduced the value. His appraisal for what I could get for the jewelry came in at about a third of what I paid and probably 15% of what the other appraisals suggested.

We were finally able to dump the jewelry at a dealer in Fort Worth and recoup some of the “investment.” We – well, I, since my wife was dragged along into this – lost enough to pay for multiple ski trips. My dreams of turning four digits of investment into five digits of return evaporated right along with Michael Corleone’s carefree days when he did not break rocks in the hot sun and wear an orange jumpsuit.

What did I do wrong? Let me count the ways:

  • I didn’t do my homework. This auction was in the days before the advent of smartphones when I could have looked up the organization, the auctioneer, Michael Corleone, and anything else I wanted to see about what I was getting myself into.
  • I confused retail with aftermarket. Just like with cars, the retail price is not the price you will get for something when you put it up for sale. Unlike with cars, there is a SIGNIFICANT drop in jewelry between what you can get and what the retail price is.
  • I had too much capital at risk. When I was auctioning items in graduate school, I was only paying a few dollars for each item. I could put them up for auction on eBay with no reserve to generate bidding action and to engage psychology in my favor. If something sold for a penny, then so be it – I’d only lost a few bucks. However, when the cheapest item was still about a thousand dollars, I was far too risk-averse to put it up for auction on eBay for a penny lest I only get a penny. Instead, I was willing to take a known loss rather than risk taking a higher unknown loss. Loss aversion kept Monkey Brain in the game long after I got on a plane.
  • I thought I knew more than I actually did. I knew that there were 4 Cs in buying diamonds, so I knew all I needed to know, right? I fell victim to the Dunning-Kruger Effect, which says that we are unaware of our incompetence and tell ourselves that we’re better at something than we truly are. Poor performers are particularly hard-struck by this effect, as they stink at things and aren’t cognizant enough to recognize it. Furthermore, I was wallowing in confirmation bias. I took the evidence of my limited success in auctions previously to assume that I would be successful at identifying profitable opportunities at this auction.
  • I let the auction become a competition against other bidders. Suddenly, my ego was at stake. I couldn’t let other people win. Instead of being about the value I might be able to capture, the auction suddenly morphed into wanting to show others – whom, I might add, I’d never met and would never see again – that I was a better bidder than they are. It’s this type of interpersonal competition, as Duke’s Daniel Ariely and Stanford’s Itamar Simonson point out that leads people to overpay in auctions. I could stare Exhibit A for this phenomenon in the mirror.

Every time I go to the in-laws’ house, I am reminded of the auction. I see the oriental rugs and the Remington statue that they bought at the auction. Fortunately, they are quite happy with their purchases – they bought things because they liked them and wanted them in the house – otherwise, I’m sure that family outings would be extremely uncomfortable; they might have found some of Michael Corleone’s friends to “teach” me another lesson about auctions and the cost of concrete shoes! The upshot of the experience, besides the rugs, was that I was once and for all cured of the get-rich-quick schemes I concocted in my head. That lesson itself was worth the cost.

Have you ever been caught up in the excitement of an auction only to wonder what in the heck you just bought? Let’s talk about it in the comments below!

By

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business.

You can read more about him in the About Page.

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