So you put away some nice returns this year - not too shabby. While you can't be blamed for bragging about good performance, it's not uncommon for friends to want a part of the action. What would you do if a friend asked you to make investments on his or her behalf? In this article we'll show you the highs and lows of investing for others.
Taking Advantage of Your Financial Knowledge
It's no surprise that your pals might want you to manage a couple of bucks for them. If you're pulling down decent returns and talking about your investing strategies, you've now become the go-to guy (or girl). These days, money talks and people who understand the financial world are getting a lot of respect as young people realize there's more to investing than they once thought. (The top-down investment strategy depends on economy and market strength. Find out what you should know in Technical Top-Down Investing.)
If you have financial knowledge, people who know you might view you as a very valuable commodity - a free money manager. All too often, the person asking you to invest his or her money is the person who knows a little something about investing - just enough to get into trouble. If you're nailing double-digit returns this year, why couldn't you repeat the performance year after year, right?
The Problems with Investing for Others
You may think that investing for someone else is just a way of helping out a friend, but the thing is, when you start investing for other people, particularly your friends, you enter a world of complications that you might not have foreseen when you started out.
That friend of yours, the one who thinks that your 35% returns this year are going to happen next year as well, might be in for a nasty surprise when your picks make next to nothing. When you invest for friends, you have to deal with unrealistic expectations that can really put a damper on a relationship. If your friends wants you to invest for them, they likely don't understand all of the risks involved with investing, including not quite meeting the investment goals that they may have been projecting.
Losing a Friend's Money
Not meeting a friend's investing expectations could jeopardize your friendship, but falling short of your friend's projected returns could be a best-case scenario. When things go wrong, making some money is a lot better than losing money, which isn't an abstract concept for anyone who invests actively. When you bring money into a relationship, things can get uncomfortable pretty fast, especially when that money is hemorrhaging out of an investment account. Do you tell the friend to suck it up? Do you repay the person out of your pocket? Do you try to make up the difference with new picks? Really, there probably isn't a good way to deal with losing a friend's money and you should consider this risk before you agree to invest for anyone.
Managing a friend's money is a sticky business and if you go through with it you may be breaking the law. Investment professionals must be registered with the Securities and Exchange Commission or have a federal license. They are heavily regulated by the government and by trade organizations like the National Association of Securities Dealers, for the protection of consumers. If you invest for a friend for compensation, you could be breaking laws that are in place to protect investors from people who aren't qualified to have discretionary control over others' accounts. (For more insight, see Policing The Securities Market: An Overview Of The SEC.)
Short End of the Stick
Despite the drawbacks, investing for friends isn't always doomed to failure. With skill, smarts and a whole lot of luck, you might rake in the cash. If that's the case, you still have to consider whether or not your friend is taking advantage of you. Helping out a friend is nice, but when that help consists of making significant amounts of money for that person and getting little or nothing in return, you might be suffering from an off-balance relationship. (For further reading, check out Choosing An Advisor: Wall Street Vs Main Street.)
What You Can Do for Friends
Now that I've taken the wind out of your sails, and your friend's as well, there are things that you can do to help your friends' investments without burdening yourself with the substantial responsibility of investing someone else's money. One of the best ways to lend a hand is to help teach your friend about investing.
Help Them Learn
There are a lot of pitfalls out there for new investors. If you're lucky, you've been able to avoid quite a few of them or you learned how you should have gone about avoiding them. The benefit of your experience can be one heck of an asset to pass on to a friend and it won't cost either one of you personally or financially. Therefore, if you want to help your friends, work with them; show them how to analyze a financial statement, how to execute a trade online, how to look up business news, or how to find online resources. (If you are interested in learning more on this subject, check out 20 Investments You Should Know.)
Going farther still, there is a popular way to invest hands-on with friends without taking on the responsibility that an investment advisor would feel for a client - the investment club. The investment club consists of a group of people who vote to decide whether or not to buy or sell their group-owned investments. Investment clubs are great, because they allow a more personal approach with actual investments than just helping someone with investing concepts. These clubs will also give you a vested interest in performance of your friend's portfolio.
If you're interested in starting an investment club, there are plenty of resources available, ranging from your broker to the internet. It's important to recognize that an investment club isn't just a couple of people who want to invest together - it's a formal (and legally defined) organization with members who have an equitable claim to their assets. This means you should look into the rules and laws that govern investment clubs where you live before joining or starting one yourself. (To learn more about investment clubs, see Investment Clubs Offer Experience And Insight and Get Active, Join a Club!)
The Bottom Line
Investing for a friend usually isn't worth the amount of trouble it can cause. Money just isn't something you want to bring into a good friendship. In the end, by helping your friends invest on their own, you'll be doing them, and yourself, a much bigger favor. (For more information on investing, see Investing With A Purpose and The Seasons Of An Investor's Life.)