What considerations are there for making investments on behalf of a friend?

Question

I've thought of two approaches so far:

1. Pool their money into my own brokerage account and simply split the gains/losses proportional to the amount of money that we've each contributed to the account. I'm wary of this approach due to the tax implications and perhaps other legal issues so I'd appreciate community insight here.
2. Have them set up their own brokerage account and have them give me the login credentials and I manage the investments for them. This is obviously the best approach from a tracking and tax perspective, but harder for me to manage; to be honest I'm already spending more time than I want to managing my own investments, so option 1 really appeals to me if the drawbacks aren't prohibitive.

Answer 1

Pool their money into my own brokerage account and simply split the gains/losses proportional to the amount of money that we've each contributed to the account. I'm wary of this approach due to the tax implications and perhaps other legal issues so I'd appreciate community insight here.

You're right to be wary. You might run into gift tax issues, as well as income tax liability and appropriation of earnings. Not a good idea at all. Don't do this.

Have them set up their own brokerage account and have them give me the login credentials and I manage the investments for them. This is obviously the best approach from a tracking and tax perspective, but harder for me to manage; to be honest I'm already spending more time than I want to managing my own investments, so option 1 really appeals to me if the drawbacks aren't prohibitive.

That would also require you to be a licensed financial adviser, at least to the best of my understanding. Otherwise there's a lot of issues with potential liability (if you make investments that lose money - you might be required to repay the losses).

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You should do this only with a proper legal and tax advice - from an attorney and/or CPA/EA licensed in your state. There are proper ways to do this (limited partnership or LLC, for example), but you have to cover your ass-ets with proper operating agreements in place that have to be reviewed by legal counsel of each of the members/partners,

Answer 2

how many transactions per year do you intend? Mixing the funds is an issue for the reasons stated. But. I have a similar situation managing money for others, and the solution was a power of attorney. When I sign into my brokerage account, I see these other accounts and can trade them, but the owners get their own tax reporting.

Answer 3

There's a sizable community of people and fiscal advisers who advocate not managing the money at all.

Set your passive investor friend with automatic bank draft into a simple three/four fund portfolio of low cost index funds and never never ever trade. See https://www.bogleheads.org/RecommendedReading.php

You might be able to beat the stock market for a few years, but probably not over the long term. Most mutual fund professionals don't. Playing with your own money is one thing: playing with other people's money is a whole other ball game.

Answer 4

If you want to do #1, then you should form an "investment club." This is an entity that is recognized by the SEC and the IRS. From the SEC:

An investment club is a group of people who pool their money to make investments. Usually, investment clubs are organized as partnerships and, after the members study different investments, the group decides to buy or sell based on a majority vote of the members. Club meetings may be educational and each member may actively participate in investment decisions.

https://www.sec.gov/investor/pubs/invclub.htm

You should do your own legal research on how to organize, but I believe that a common way is to form a formal partnership, which then provides the legal structure for distributing gains, tax liability, income, and other costs to the members. IRS publication 550 has a section on Investment Clubs from a tax perspective, but I'd definitely recommend get professional help on this in addition to whatever you can read yourself.

As for #2, I believe that's illegal unless you're licensed.