Why giving investment advice to friends can be injurious to your relationship’s health

One of the perils of writing on different aspects of money is people asking for investment advice. In most such cases they do not want you to get into any detail and are typically looking for simplistic pointers that they can understand and that, at least in their minds, can help them make a quick buck.

Something similar played out with me recently. At the end of February, a friend approached me with a question: “The stock market has fallen,” he said. “Do you think it’s a good time to move some money from bank deposits into equity mutual funds?”

I could have simply said yes or no and moved on but given our long association I decided to get into details and look at his overall money situation. Around a fourth of this overall investment is in bank deposits. The rest is in real estate—in a flat that he and his family lived in—and in gold and equity mutual funds. He had been regularly investing small amounts in equity mutual funds through the systematic investment plan(SIP) route for more than 12 years now.

Further, he is still repaying the home loan he had taken to buy the flat he and his family live in. His spouse and his parents are dependent on him. His children are in their teens and just about ready to go to college.

I thought, in such a situation having one-fourth of the overall net worth in deposits was a decent level and should not be reduced, especially given that five people were dependent on his income and the fact that his house wasn’t an investment given that the family lived in it.

I communicated my logic to him and I thought he got what I was trying to say, until I got a call from him after the stock market closed today. This is how the conversation went.

“Boss, I think I should have moved money from bank deposits into equity mutual funds,” my friend said.

“Why?” I asked.

Knowing me well he had come armed with numbers: “The NSE 500 index has gone up 8.3% between end February and now (March 24).” NSE 500 is a stock market index which is a good representation of the overall Indian stock market.

“So?” I asked.

“I would have gained,” my friend replied.

“Yes, you would have,” I said.

“Listening to you has cost me money.”

Now, I could have left it at that and moved on, but then keeping my mouth shut isn’t something I specialise in: “Tell me something, do you have term insurance?”

“Yes,” he replied, slightly surprised at where this conversation was suddenly going.

“Why did you buy it? And why do you continue paying its premium regularly?”

“Well, my family is dependent on me and if something were to happen to me and I die, the term insurance payout will ensure that they can continue to live relatively comfortably.”

“Right. Now, what will happen if you don’t die during the years in which the term insurance policy is valid?” I asked.

“As in?”

“I mean you are paying a premium every year to keep the policy active.”

“Yes,” my friend replied.

“Wouldn’t that premium be wasted? Wouldn’t it just have been better to invest that money into equity mutual funds?”

“Wasted? Why? I am paying the premium for insurance. I am paying it because I don’t know what the future holds. I am trying to take into account the probability of something unforeseen happening to me and ensuring that it doesn’t weigh down on my family. It’s not a waste at all.”

“Good. So, if you realise this, then why don’t you realise the importance of diversification?”

“Diversification?” my friend asked.

“Not putting all your eggs in one basket. Spreading out your investments across different asset classes.”

“But I have done that. I told you. 25% of my money is in bank deposits. 25% is in equity mutual funds. And the remaining is in real estate. Over and above this, my wife owns gold.”

“Yes. But do you realise that you are still repaying your home loan and that you live in the flat that you own or rather the bank still owns. So, in that sense, it’s really not monetizable. Plus, you work in IT where artificial intelligence is destroying jobs. Taking all that into account I just thought you shouldn’t move more money into equity mutual funds.”

“But the fact of the matter is that the stock market has gone up by more than 8% in March.”

“Yes, but no one knew that at the end of February. Diversification is about preparing for various potential outcomes because preserving capital is more critical than maximizing returns, at least for someone who has your kind of profile. The absence of negative events doesn’t diminish the value of diversification; rather, if those risks had materialized, diversified investors would have been better positioned. Effective investing always considers this possibility.”

“Hmmm.”

“It’s like buying term insurance. If you survive the period during which the term insurance is active does that make that decision a stupid one? No, as you just explained. The fact that you are preparing for an unforeseen event comes with a cost attached to it. The same is true for diversification as well. It comes with a cost attached”

“Now that you put it that way, it makes sense I guess,” my friend said.

“You should remember something that Zahaan Bharmal writes in The Art of Physics—Eight Elegant Ideas To Make Sense of Almost Everything: “Blithe predictions, or for that matter even extremely well informed decisions, cannot be made in a complex system where the impossibility of accurate prediction is inbuilt. Probability can be assessed, but should not be taken as absolute. There is simply no way to know exactly what markets will do next, or what the reaction will be to whatever they do.””

“Hmmm.”

“A stock market is a complex system. No one can know in advance what is going to come even if they make such forecasts about the future with utmost confidence,” I explained and then ended the call.

The conversation made me realise all over again why giving such investment advice is injurious to one’s relationship health. The kind of advice most people are looking for needs to be clear, crisp and confident: something that makes them feel good about themselves and tells them that it is possible to get rich quickly and easily. But then that rarely happens.

As Jason Zweig, a columnist for the Wall Street Journal, wrote in November 2014: “The advice that sounds the best in the short run is always the most dangerous in the long run. Everyone wants the secret, the key, the roadmap to the primrose path that leads to El Dorado: the magical low-risk, high-return investment that can double your money in no time.” But that rarely happens and is something worth thinking about.