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I have a friend who is very risk-averse, by self admission. By my standards he is too much risk averse for his own good.

He says that his personal experience over the last 15-20 years taught him that investing in "risky" markets such as the stock market is "not worth it", and he prefers to keep his money "safe" outside of the stock market. Also, I believe he mentally associates investing with active management, and he thinks that the potential benefits from investing in anything but the most solid investments doesn't yield a lot, compared to the time and money it takes to "properly manage your investments".

Another point is that he compares the money he earns by investing the money he earns from his day job, and he "prefers to concentrate on building something meaningful via his work", as opposed to just earning interest on high yield investments.

I believe that these categorical statements are false. Anyone who has a decent free income and some savings, should not invest only in super solid investments like Time Deposits. Instead, people should choose an investment strategy that allocates a certain portion of their savings to super solid investments, some portion to bonds, and some to stocks, with none of these components being a total flat zero percent. The distribution of the portfolio should vary with age and financial situation, of course.

Now, for my question - what short "tl;dr" link I can send him that might convince him that he is wrong, or at least make him reconsider? I have tried explaining my views a few times, but I wasn't able to convince him so far.

  • 2
    I think I might be your friend. :D I have felt rather similarly to him, and have been trying to shake it, but despite reading about these issues, I can't help but feel, as perhaps he does, that a lot of this is echo chamber/wishful thinking. But I am open to being convinced otherwise. – Chelonian Feb 3 '12 at 4:19
  • @Chelonian - Well, read the links and books referenced in the accepted answer, and get back to us to report. – ripper234 Feb 3 '12 at 6:54
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    I will read some links, but it might be a while (possibly never) before I get to reading the books, only because there are other books I wish to read first. It also may be the case that the details that undergird the books' arguments are beyond my mathematical, legal, or business ability to evaluate effectively. – Chelonian Feb 3 '12 at 19:31
  • Is there a reason you are trying to run your friend's financial life? – JohnFx Jun 6 '15 at 0:55
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(Leaving aside the question of why should you try and convince him...)

I don't know about a very convincing "tl;dr" online resource, but two books in particular convinced me that active management is generally foolish, but staying out of the markets is also foolish. They are:

Berstein's book really drives home the fact that adding some amount of a risky asset class to a portfolio can actually reduce overall portfolio risk. Some folks won a Nobel Prize for coming up with this modern portfolio theory stuff.

If your friend is truly risk-averse, he can't afford not to diversify. The single asset class he's focusing on certainly has risks, most likely inflation / purchasing power risk ... and that risk that could be reduced by including some percentage of other assets to compensate, even small amounts.

Perhaps the issue is one of psychology? Many people can't stomach the ups-and-downs of the stock market. Bernstein's also-excellent follow-up book, The Four Pillars of Investing: Lessons for Building a Winning Portfolio, specifically addresses psychology as one of the pillars.

  • I got only partway through the modern portfolio theory link when what had been moderate suspicions about MPT turned into appreciable suspicions. – Chelonian Feb 3 '12 at 4:17
  • @Chelonian - details, please. – ripper234 Feb 3 '12 at 6:55
  • @ripper234 Well, read the link, particularly the section, "Criticism". That MPT assumes that 1) people are rational, 2) that markets are efficient, 3) That everyone has the same information, 4) there are no taxes or trading costs (!), 5) investors have an accurate conception of possible returns, etc. None of these strike me as true. I have much more confidence in behavioral economics, which at least grows out of empirical psychology. – Chelonian Feb 3 '12 at 19:28
  • @Chelonian - I believe that my conclusion (everyone with a decent income/saving should invest _some_ part of in bonds, and another part of it in stocks) is true, even if people are not rational, markets are not perfectly efficient, everyone does not have the same information, there are trading costs, and investors don't have accurate an conception of possible returns. Just don't pick specific stocks but go for something like S&P 500. – ripper234 Feb 4 '12 at 20:05
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    @ripper234 Thanks for that. Yes, I guess I put less confidence in past performance as an indicator of future performance. I may ask a question on this site about this "debate". – Chelonian Feb 6 '12 at 20:10
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Let the man be.

If you've tried again and again to convince him, and haven't, maybe he doesn't want to be convinced.

It's his money, and he has every right to manage it as he sees fit. You can advise him, but its his call whether he accepts your advice or not, and for what reasons.

And suppose you push and push and it gets through?

Now either he has more money than he would otherwise, and he's happy he has such a smart friend. Or he loses 30% of his money, and you're trying to tell him that he's going to earn it back in due time, but you can't, because he's not talking to you. Ever.

What do you think is the mean benefit to your friendship?

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    +1 for addressing the concern I explicitly avoided :-) – Chris W. Rea Feb 2 '12 at 22:20
  • I'll send him this question, and never speak of it again. I'm really not trying to push him, just want him to make a conscious choice ... and I feel that he's going by instinct more than choosing. Of course, his gut could be right, I really don't know, but I think it's only fair to send him more info ... he doesn't have to read it. – ripper234 Feb 2 '12 at 22:31
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I feel these beliefs can not be changed so easily. Once someone loses their money, how can you convince him? And on what ground can you convince him? Can you give a guarantee that investments will perform at a certain level?

There are many people who are happy with low returns but highly safe instruments. They are not concerned with what you earn in the stock market or the realty market. They are happy not losing their money.

I known many people who earned decently during the up-rise of the stock market but all profits were squared up in the downturn and it turned to negative.

Such people have their own thinking and such thinking is not out of place. After experience with much turmoil, I feel that they are also right to a great extent.

Hence I feel if the person is not getting convinced, you should accept it with greatness.

2

Introduce him to the concept of Inflation Risk, and demonstrate that being too conservative with your investments might be a very risky strategy as well.

  • He knows about Inflation Risk. – ripper234 Feb 3 '12 at 0:50
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Remind him that, over the long-term, investing in safe-only assets may actually be more risky than investing in stocks. Over the long-term, stocks have always outperformed almost every other asset class, and they are a rather inflation-proof investment. Dollars are not "safe"; due to inflation, currency exchange, etc., they have some volatility just like everything else.

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