Should You Manage Your Friends Money?

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When you’re a financial advisor with a track record of success, it’s natural for friends and family to see you as someone who can manage their money. After all, you have the expertise and knowledge they need, and they trust you implicitly—an essential quality people look for in a financial advisor. However, there’s a reason for tired cliches like not combining money and friendship unless you’re prepared to lose both. Before you agree to take on loved ones as clients, it’s crucial to consider the pitfalls of mixing personal relationships and professional responsibilities. You also need to ensure you’re doing it for the right reasons, not just to be a free money manager.

“If you set expectations upfront, you will be more confident in your decision over whether to work with them or not,” said Valerie R. Leonard, CEO of EverThrive Financial Group in Birmingham, Alabama, and one of Investopedia’s 100 Top Financial Advisors.” She said it’s easier to decide not to work with someone you don’t know, or to say no to other clients if a difficult situation arises. However, “with friends and family, this conversation can be more complicated and can carry extra baggage.”

In this article, we’ll explore the critical factors when deciding whether to work with friends and family as a financial advisor. We’ll discuss how to set appropriate boundaries and maintain your professional integrity should you choose to advise your loved ones-turned-clients.

Key Takeaways

• It may be tempting to start managing money for friends and family, but beware of the negative consequences.
• If you lose your friend’s money, it can result in more than a ruined friendship.
• A better strategy might be referring friends to other professionals in your network.
• You can also agree to help them learn about finance and investing without directly investing for them.

The Risks of Investing for Friends

Managing money for friends and family can strain relationships, especially if investments don’t perform as expected or conflicts arise over financial decisions. It’s essential to establish clear boundaries, communicate clearly about risks and expectations, and treat these clients with the same professionalism you would any other. Let’s go through some of the specific issues that can arise.

Unrealistic Expectations

Your friend who thinks the 35% returns this year will happen next year and the next after that is in for a nasty surprise should the market shift. Should you invest for friends, you may have to deal with unrealistic expectations that can harm the relationship.

“When deciding to work with friends and family, it is critical to have a frank conversation upfront. Be sure to remind your friends and family that you don’t control financial markets or investment outcomes, but you will do your very best to employ prudent strategies that may help them reach their goals,” Leonard said. “It’s important to let them know that taking on their business can carry implications for your personal relationship, and you expect open and honest communication, no matter how difficult the topic.”

Losing Money

If your friends want you to invest for them, they might not understand all the risks involved, including not meeting investment goals. Managing and explaining losses can be tricky when there’s a friendship involved.

Do you tell your friend, essentially, to suck it up? Do you try to make up the difference with new picks, or worse, offer to make them whole? There isn’t a perfect way to deal with losing a friend’s money, and you should consider this risk before you agree to invest for anyone.

Losing a client’s money is always difficult for a financial advisor, but it can be especially challenging when that client is also a friend or family member. The personal relationship adds complexity and emotional weight to the situation.

When losses occur, it’s essential to approach the situation with empathy and professionalism. Resist the temptation to downplay the losses or promise quick fixes. Instead, be transparent about what happened and why. Explain the market conditions or other factors contributing to the losses and outline the steps to mitigate further damage.

It’s not advisable to try to make up the difference with new investment picks, as this could appear to reduce your work to gambling with your friend’s money. Stick to your established investment strategy and risk management protocols.

The best approach is to set realistic expectations from the beginning, communicate clearly about risks, and maintain professional boundaries. If you’re not confident you can do this, it may be best not to work with friends and family.

Legal Matters

As an investment professional, you are subject to various laws and regulations designed to protect investors and ensure fair and transparent market practices.

The main thing to consider is registering with the appropriate authorities. In the U.S., investment professionals must register with the Securities and Exchange Commission (SEC) or the state in which they operate. This registration process involves meeting specific qualifications, passing exams, and adhering to strict ethical and professional standards.

If you invest for a friend and receive compensation for your services, you could be violating these registration requirements. Unregistered individuals are not permitted to have discretionary control over others’ accounts, as this could expose investors to undue risk and potential fraudulent activities.

In addition, managing money for friends and family could create conflicts of interest that may compromise—or appear to compromise—your objectivity and professionalism. For example, you may feel pressured to make investment decisions that prioritize your personal relationship over your client’s best interests, or you may be tempted to give preferential treatment to friends or family members. Even if this is not the case, you must avoid such appearances.

Leonard said that disclosing potential conflicts of interest in advance is the best policy. “Doing so can help friends understand your position, the nature of the conflict, how the products and services you offer may require additional consideration… It’s also important for advisors to remind friends that their professional responsibilities will come before personal interests,” she said.

To avoid these legal and ethical pitfalls, you can do the following:

• Ensure you are properly registered with the SEC or state authorities before offering investment services to anyone, including friends and family.
• Establish clear boundaries and expectations with friends and family who approach you for investment advice or management.
• Disclose any potential conflicts of interest and explain how you will mitigate them to ensure fair and unbiased treatment of all clients.
• Maintain detailed records of all interactions, decisions, and transactions related to managing money for friends and family.
• Consider referring friends and family to other qualified investment professionals if a situation arises when working directly with them could compromise your legal or ethical obligations.

Pitfalls of Pro Bono Investment Help

If you’re not a financial advisor, you could decide to invest your friends’ money for free to avoid registration and licensing. At that point, it’s essential to be aware of the potential for unbalanced relationships and the risk of being taken advantage of. While helping a friend with their investments can be a kind gesture, ensuring that both parties feel the arrangement is fair and mutually beneficial is crucial.

If you find yourself dedicating significant time and effort to managing a friend’s money without receiving any compensation or reciprocal support, it may be a sign that your friend is exploiting your kindness and expertise. This can lead to feelings of resentment and strain on your friendship.

It’s also important to recognize the value of your knowledge and skills. While you may be willing to offer some help for free, it’s reasonable to expect your friend to respect your time and effort. If you feel that your contributions are not appreciated or reciprocated, you may need to have an open conversation with your friend about your concerns.

Alternatives to Investing for Friends and Family

There are things that you can do to help your friends with investing without taking on the substantial responsibility of investing someone else’s money. One of the best ways to lend a hand is to teach friends and family about investing.

Help Them Learn

The biblical parable of giving a person a fish versus teaching that person to fish is, among other things, a lesson on investing and multiplying returns. Teaching friends and family about investing might produce more gains than simply doing the work for them. If you’re an experienced investor, you’ve likely encountered and overcome many common problems new investors face. You’ve acquired some practical strategies and risk management techniques and know the importance of due diligence. Sharing this knowledge with your friends and family can be invaluable for them.

Here are some things you can teach them to get started:

• Analyzing financial statements: Show them how to read and interpret balance sheets, income statements, and cash flow statements to assess a company’s financial health and potential for growth.
• Executing trades online: Guide them through opening a brokerage account, placing trades, and managing their portfolio using online platforms.
• Finding reliable resources: Introduce them to reputable platforms, books, podcasts, and other resources that can help them stay informed about market trends, investment strategies, and financial planning.
• Developing a long-term mindset: Encourage them to focus on their long-term financial goals and avoid making impulsive decisions based on short-term market fluctuations.

By becoming a mentor and educator, you can provide your friends and family with the tools and knowledge they need to make sound investment decisions independently. This approach allows you to support their financial well-being without the potential conflicts of interest or legal complications that can arise from directly managing their money.

Investment Clubs

A popular way to invest hands-on with friends without taking on the responsibility of an investment advisor—an investment club. These consist of a group of people who vote to decide whether to buy or sell their group-owned investments.

Investment clubs allow a more personal approach to actual investments versus just helping someone with investing concepts. These clubs also give you a vested interest in the performance of your friend’s portfolio.

If you’re interested in starting one, many resources are available, ranging from your broker to various online platforms. It’s essential 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 the assets. This means you should look into the rules and laws that govern investment clubs where you live before joining or starting one yourself.

How Do I Politely Decline When Friends or Family Ask Me To Invest Their Money?

Be honest about your reasons for declining. Explain that you value your relationship and don’t want to risk straining it by mixing business with personal matters. Offer alternative ways you can support them, such as sharing educational resources or referring them to a trusted colleague.

What Should I Do If Friends or Family Insistent on Having Me Manage Their Investments?

Reiterate your position firmly but kindly. Explain the legal and ethical considerations that prevent you from taking on this responsibility. If necessary, suggest a formal meeting to discuss their financial goals and provide professional recommendations without directly managing their money.

How Can I Stay Objective When Advising Friends and Family on Their Investments?

Treat your friends and family members as you would any other client. Follow your established processes, maintain detailed records, and base your recommendations on thorough research and analysis. Regularly remind them that your professional advice is separate from your relationship. If losses occur, ensure that you’ve previously communicated the risks involved and have a written record of your advice—this helps relieve any guilt you might feel. Be understanding and transparent about the reasons for the losses, and guide them on potential next steps.

The Bottom Line

Working with friends and family as a financial advisor can be challenging. While the opportunity to help loved ones achieve their financial goals may be appealing, it’s crucial to consider the potential risks before taking on this responsibility. Mixing personal relationships with professional services can strain friendships, create conflicts of interest, and lead to legal and ethical difficulties.

To navigate these challenges successfully, set clear boundaries, communicate transparently about risks and expectations, and maintain high professionalism when working with friends and family. This includes ensuring proper registration with regulators, disclosing potential conflicts of interest, and treating all clients fairly. If the risks outweigh the benefits, it’s best to focus instead on providing education and support to help them become confident, independent investors.

Read the original article on Investopedia.