How to Help Friends Make Smart Financial Decisions

Please note the publish date of this blog. Financial information, market conditions, and other data mentioned in this post may no longer be accurate or relevant.

When your friend is about to do something that might threaten his financial health, is there anything you can do to help him?

In 2009, my close friend Ben called me. He had just inherited $1 million and wanted to talk about becoming an Abacus client.

I told him about the Rainbow Portfolio™, with its allocation to 14 distinct investment categories and its track record of robust returns and low volatility. “Your $1 million, if all goes well, will likely grow to over $2 million in 10 years. And you’ll be providing capital to the best business ideas all around the world.”

Ben got it, but he believed another story was more compelling.

Ben’s friend Dave asked him to invest that same $1 million into a startup technology company. Dave was persuasive: “An investment into this tech company could easily turn the $1 million into $50 million.” “Wow,” Ben said. “Even if Dave is exaggerating, it’s still a great deal. Let’s say my $1 million only grows to $5 million; that’s still a lot of money. Yeah, I’m in.”

Five years later, Ben thinks it would be a miracle if he sees even one-quarter of his $1 million back. And I have to admit that I was wrong about the $2 million in 10 years—it would have grown to nearly $2 million in only five years.¹ But I don’t feel smug. I feel that I failed my friend; I didn’t persuade him to invest the majority of his inheritance in a diversified and much safer strategy.

Helping the Financially Reckless

So, what can you do to stop friends from making reckless financial decisions?

  1. Ask your friend if there’s a consistent historical track record for making money with the strategy he’s about to initiate. The reality is that very few people have made money by investing in startup companies, let alone betting on just one of them.
  2. Make a proposal: “What about starting with a tenth of what you intend to actually invest, and invest an additional tenth every 6–12 months?” This is akin to tasting a soup you’re making every 15 minutes to see if it requires additional seasoning. The worst scenario here is that the investment does so well that the price goes up over time. But, given the very low probability of success with a startup, that’s a good thing, and one should be happy to invest at the higher level when the more mature company is a less risky investment.
  3. Ask your friend, “Will you still be able to handle all of your financial obligations if the investment goes to zero?” This is a hard one to imagine when one is convinced that they have found the next Apple. But ask the question anyway. At Abacus, we calculate the amount that a client can afford to lose in speculative investments using these indicators:  Will they lose their house? Their financial security? Their peace of mind?
  4. Pause. Advise your friend to sleep on it. Usually the less impulsive we are, the better decisions we make.
  5. Introduce your friend to a fee-only advisor who can offer feedback based on years of experience, without having to worry about a conflict of interest.  We all get deluded from time to time; why not offer your friend a professional and unbiased perspective?

So, what happened to Ben? He still doesn’t know if he’s lost all or just some of his money, but he’s happy. Surviving a life-threatening illness put the loss of his nest egg in perspective. Yes, he wants that money back, but his gratitude for his bonus years of health trump the pain of the lost money. On the other hand, he gave me permission to share his story to keep others from replicating his financial life. He’s 68 and it’s time to give back.

1) This was calculated using the assumption that Ben would have invested in the Abacus Rainbow Portfolio using a 60/40 model. The hypothetical past performance of this model is as follows: (2009: 24.7%, 2010: 13.70%, 2011: -3.00%, 2012: 13.40%, 2013: 12.00%).

The figures shown do not represent past performance of any actual portfolios, including those of Abacus clients. Clients following the same model may have had different actual holdings and different performance. These model results do not reflect any impact that material economic or market factors might have had on the adviser’s decision making if the adviser were actually managing clients’ money.

These performance figures are shown net of mutual fund expense ratios. The figures are net of an assumed 1.2% per year reduction to cover trading costs, custodial costs and Abacus management fees. The effect of taxes is not reflected in these results, and inclusion of tax costs would reduce the illustrated returns.

The figures shown are not intended to represent potential future performance of actual or hypothetical clients, portfolios, models or asset classes. Future results may vary substantially from past results, due to a wide variety of uncontrollable and unpredictable factors. These factors may include market changes, military or political events, economic or societal changes, and many others. The performance statistics assume annual rebalancing at the end of each year, whereas actual client accounts may be rebalanced at irregular times based upon a number of factors. Actual client portfolios may never exactly match these models nor any models used in the future to guide their construction.

The historical model performance illustrated derives from a number of assumptions. Asset classes were included in each model according to the percentages shown above. Annual rebalancing is assumed, along with immediate reinvestment of all income and capital gains. Asset class returns were measured using mutual fund returns where available (i.e., about 10–15 years for most stock funds), and index returns where mutual fund returns were not available (i.e., earlier years). The performance results reflect the specific mutual funds and indices we selected. Other indices or funds may be available to measure returns in one or more asset classes. Index returns do not include actual costs of investment.


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