The Challenges of Casual Financial Advice
In the past week, I have had three friends ask me how they should invest about $500. On the surface, this seems like a pretty easy question for someone with good knowledge of markets... It's not
Encouraging people to invest with as little as $500 is important to my mission with Rendezvous Investing. But investing with only $500 presents unique challenges: diversification is hard to achieve, which presents a challenge to the informal advisor. Because you only have $500 should that mean I should give you choices with greater risk/reward or play it safe and just recommend an index fund? You also have to consider you want to encourage people to continue to invest and index funds are not that exciting in a world where Millennials are chasing 100X returns in cryptocurrencies.
So what we are looking to maximize are not only risk vs return, but also interest, which may lead to a greater career of successful investing
It is pretty easy for me to give out a few recommendations for stocks I like. But considering I am advising on something that your friends could potentially lose money on is a big responsibility.
Financial advisor and Blogger Ben Carlson recently wrote on the topic of giving financial advice to friends/family, and echoes my claim of the difficulties of offering casual financial advice.
"Anyone can make buy or sell recommendations, give you an optimized portfolio allocation, offer a quantitative investment strategy, or make market predictions. That’s the easy stuff. Anyone can give one-off advice about what to buy or sell because it doesn’t require any follow-through.The hard stuff requires thoughtful consideration, research, and a deep understanding of the person in question."
You to give good advice you need to consider many questions such as:
Have you ever invested before?
Do you understand the role of interest rates and its effect on the market?
Do you know about the risk/reward relationship between stocks, bonds, cash, and other investments?
What’s your time horizon?
When will you need to spend the money in the future?
What’s your current financial situation?
What’s your appetite for risk/volatility on this investment?
How much are you willing to lose on this investment?
What are your expectations for return on investment?
How will you judge the performance? --Do you know how to judge performance?
At what point will you be tempted to sell?
Perhaps the more you know about investing, the harder it becomes to give casual advice. But individual investors need guidance and mentoring to work the physiological challenges that are the reason behind why individual investors tend to lose to the market and make poor buy/sell decisions.
One of my friends who I have been mentoring looked back at some of his buy/sells and in hindsight realized he should have been more patient and thought out his decisions. "Look at this... I bought at 97 sold at 95.5 and now it's 130... or here I bought at 32 and sold at 32.5 and now its 50!"
Every investor makes dumb investments. It's asking a lot of your investments if you think 50% of the picks you make will outperform the market. But the best way to learn is to live it.
My role as a mentor is to save you from the disillusionment that may result from one-off gains or losses and the confirmation bias, recently bias, and the illusion of understanding that may come from short-term investments.
I will answer that question of how to invest $500 to the best of my ability here.