The fine art market is a $10 billion-a-year industry in the U.S. alone. Over the past 50 years, art has returned a compound annualized rate of 10.47 percent, according to the Mei/Moses Annual All Art Index, the leading art market index. Meanwhile, during the same period, the Standard & Poor's 500 Index for stocks performed only slightly higher—10.95 percent.

Surprisingly, art prices don't entirely depend on a healthy U.S. economy. Many recent record-setting art sales are due to foreign buyers who were prepared to pay top euro, ruble, rupee, yen, or rial for modern masters.

Given these statistics, art certainly seems like an attractive investment. But, like every investment, there are numerous risks.

You can't treat it like a stock
Art is a fine collectable, and collectables tend to hold or increase in value as they get older or rarer. The risk in art, however, is higher than the chance of appreciation.

That's because a painting's price is highly subjective and dictated by what the art market is willing to pay for it. This hinges on several things such as current trends, whether or not the artist has an agent, and a lot of buzz.

An artwork's value also depends on its:

• Provenance (paper trail of ownership)
• Condition
• Medium
• Subject matter
• Size

Art is for the long term
Unlike other investments, art is not a speculative venture that you can turn around swiftly for a profit. Art is not liquid. While stocks can be sold or bought pretty quickly, selling art can be a long, drawn-out process involving appraisals, dealers, insurance, lawyers, and the IRS.

Mutual funds for art do exist through specialty investment companies that use sophisticated research techniques and analytic tools similar to picking stocks for a portfolio. Through these, investors can buy shares in pools of art, depending on genres, periods or movements, condition, and even scarcity.

These are long-term investing vehicles, however. And they are not for everyone because:

• They often have high account minimums, usually starting around $250,000.
• They may require participants to commit to a minimum 10-year holding period to build equity.

For investors who want a smaller commitment, galleries are good places to start. They can point you to undervalued and up-and-coming artists and adhere to your budget. If you fall in love with something outside your price range, many galleries offer installment plans.

Just like stocks, don't buy at the top of the market. Resist the urge to buy what everyone else is buying, since demand inflates prices. In fact, if an artist in your collection is being talked about all over the media, it's probably time to sell.

You may need special insurance
Depending on your collection's value, you may need an additional rider on your home policy. Some insurers may not replace items of antiquity, which are often considered to be more than 25 years old, if you haven't purchased special coverage. Others may require that you keep art in a vault, not on display at home. As these criteria vary from insurer to insurer, be sure to check specifics with your agent.

Estate planning is complicated
Things get tricky when it comes time to pass along your collection.

• What do you do if both your children love the same painting?
• What if your children hate it and don't want to pay capital gains taxes on it?

And you can't just leave it on the wall for your heir to take home when nobody's looking. A secret transfer of ownership like this not only disrupts the provenance of the painting's ownership (and drives down the value)—it's also tax fraud.

That's why many collectors donate fractional or outright ownership of their artwork to institutions. You might need to hire a professional art consultant to identify museums whose collections would be a perfect home for your holdings and get you a solid appraisal of your collection that the IRS would be likely to accept.

And it's the IRS that will likely determine the value of your collection, not the art world. In the past, people used to overstate an artwork's value if they were donating it to a museum and undervalue it on their estate taxes. Now, the IRS wants to see a detailed estimate that is realistic and based in fact—and usually provided by a professional appraiser. Look for one who complies with the Uniform Standards of Professional Appraisal Practice (USPAP); his or her fee should not depend on your collection's value.

Buy art because you like it, not because you think it's going to make you rich
While art can be a viable investment alternative in certain cases, you probably won't be able to sell it at Sotheby's to fund your retirement. Your collection should be a reflection of your tastes and a part of your everyday life. Ignore trends and trust your best instincts. Make sure it's something you love, because you may be looking at it for a very long time!