Helping a Friend: Investing for the Risk-Averse

[Lex Luthor]

Hey everyone -

I have a slightly under 30 friend who is very frugal. But very risk-averse. So, risk-averse in fact that his entire life savings (~$60k) is sitting in a checking account or CD earning ~1-2%.

He has not ventured into the stock market at all. Mostly I think the issue is lack of information about investing. And he has reached out to me for assistance in this area, primarily with a goal towards investing for retirement, and I want to help. And I am reaching out to you all for your advice in how you might help him.

I believe I'll start with having him define what he would be comfortable with as an EF. Since he is so risk-averse, I'm thinking it would probably be 12 months of expenses, which would probably be no more than $24k. Leaving $36k for investing from current savings, plus the $900 per month he saves on top of that.

He also has some 401k funds to roll over from a job change about 6 months ago. He doesn't know what that amount is, doesn't know what it was invested in, and doesn't know what company it was invested with. He simply did the amount needed to get the company match (so, he's not completely clueless). He has also signed up for the company match at his current employer, but again has no idea who it is invested with, or how it is invested.

He has also indicated to me that he may or may not be ready to buy a house in 5 years.

He also wants to be very hands-off. He pretty much doesn't want to think about what he's investing in....just wants to set it up and not be concerned about it. He's really the ideal target for those Target Date Retirement Funds.

So this is what I'm thinking to get him started:

-Define EF to be held in the bank - ~$24k (or ~12 mos. living expenses)

-Open IRA and rollover old employer 401k funds

-Open Roth IRA and add $5k to it for 2011 tax-year. With the thinking being that he can withdraw up to $10k for a first-time home purchase penalty/tax-free (including earnings, I believe) after 5 yrs have passed. Unfortunately, he asked me after the 2010 contribution deadline passed, so no go on that.

-401k - I am thinking of advising him to max this out for 2011. He can do this by saving more than the $900 per month he normally saves and draw against his savings this year, thus effectively transfering money in his checking to his 401k. Assuming he has contributed say $1k or so up to this point in time to his 401k. And he saves $900 per month from May to Dec for 2011 for a total of $7200. He would be able to effectively transfer an additional $7300 from checking to 401k. I don't know what his employer limits are yet, so I don't know if this will work. And I don't know if the employer offers a Roth 401k - so that's another possibility.

-So taking away ~$7k for the 401k and $5k for the Roth IRA, that leaves ~$24k of funds outside of retirement specific accounts. He could open a regular brokerage account, but like I said he really wants to be hands-off. Or he could continue to add to an IRA/Roth IRA account next year and/or draw against savings next year to add to the 401k.

I haven't even gotten to the "how should he invest these funds" question, but I'm really thinking a Retirement Date fund is perfect for him for now. Maybe once he gets his feet wet, he'll want to learn about other funds.

Would you simply direct him to a fee-only financial planner?

What are your thoughts? Would you recommend any specific books/articles you have come across and found to be helpful for new risk-averse investors?

Thank you!

[phil5185]

But very risk-averse.

Maybe - or just a fear of the unknown? Is he risk-averse in the other things in life? Vacation trips? Gambling? Try new foods? ( I can remember being pretty shaky at age 22 when I went to a brokerage and wrote out a check for some Boeing shares - 50 years later that fear mostly gone).

Married? Kids? Income level?

I agree with your call - Target Funds at a no-load company for the rollover IRA, for the new Roth, and for the taxable account (part of the $60k savings). The new 401k will depend on what's available in the Plan, but most have a SP500 Index Fund.

[Deleted]

I think this guy is why they created target date funds. Although, he should probably be looking at a 2030 fund or thereabouts rather than his actual projected retirement so it is a bit lower risk.

Otherwise, what Phil said.

[Lex Luthor]

Maybe - or just a fear of the unknown? Is he risk-averse in the other things in life? Vacation trips? Gambling? Try new foods? ( I can remember being pretty shaky at age 22 when I went to a brokerage and wrote out a check for some Boeing shares - 50 years later that fear mostly gone).

Married? Kids? Income level?

I think it is definitely fear of the unknown, due to a general lack of information about retirement investing. But he is definitely also risk-averse in other areas of his life too.

He is not married, but has had a steady, now live-in, serious girlfriend for three years. No Kids. He makes about $40k per year.

[Deleted]

Apr 24, 2011 17:47:00 GMT -5 Lex Luthor said:

He is not married, but has had a steady, now live-in, serious girlfriend for three years.

Do you think "ring money" may be adding to his stress? He may be somewhere between not quite ready to actually make the forever commitment and not wanting to lock up the funds for retirement that may be diverted to a wedding or whatever.

If he is risk averse, an emergency fund is for emergencies only, he may need an EF account that is distinct from "short term savings" for vacations and/or major jewelry purchases.

[azphx1972]

Interesting. Risk averse yet it sounds like he's not taking into consideration the risk of his money becoming devalued due to inflation.

[Deleted]

He's risk adverse because he doesn't understand investing. So while I like the idea of the Target Funds for his retirement funds what he really needs to do is to educate himself. I'd get him a used copy of A Random Walk Down Wall Street for starters.

And I wouldn't do a year's worth of EF. He doesn't have much in the way of committments right now and has a lot of different options if he loses a job. I'd split that into 3-6 months EF and fund a "short to mid-term goal" e.g. "ring" or "down payment" outside of the qualified funds.

[Lex Luthor]

Do you think "ring money" may be adding to his stress? He may be somewhere between not quite ready to actually make the forever commitment and not wanting to lock up the funds for retirement that may be diverted to a wedding or whatever.

If he is risk averse, an emergency fund is for emergencies only, he may need an EF account that is distinct from "short term savings" for vacations and/or major jewelry purchases.

That's a great point. I'll make sure to add this to the discussion.

Interesting. Risk averse yet it sounds like he's not taking into consideration the risk of his money becoming devalued due to inflation.

This is exactly why he's asking for my help. He realizes that every year he is actually losing money because inflation is higher than his current return.

He's risk adverse because he doesn't understand investing. So while I like the idea of the Target Funds for his retirement funds what he really needs to do is to educate himself. I'd get him a used copy of A Random Walk Down Wall Street for starters.

And I wouldn't do a year's worth of EF. He doesn't have much in the way of committments right now and has a lot of different options if he loses a job. I'd split that into 3-6 months EF and fund a "short to mid-term goal" e.g. "ring" or "down payment" outside of the qualified funds.

I agree that he needs to do some more self-educating in this area. Thank you for the book recommendation.

And I'm a big believer in doing what's right for each individual, so while I agree that a 3-6 months EF is more appropriate given his circumstances, it may not work for him right now based on his risk/information-aversion. I'm just guessing that he'll want 12 months, but maybe I can convince him he only needs 6 months. And thank you for also pointing out that there should be additional funds for shorter-term EFs and a ring if need be.

[azphx1972]

I would recommend a basic personal finance book like "The Wealthy Barber" which doesn't get too heavy on the intricacies of investing, but drives home the importance of using things like the power of compounding to succeed financially, explained in layman's terms.

[brdsl]

I hate to say it, but he is risk adverse. He might put some in the market, then pull it out if it drops significantly. He knows the basics, but wants someone to tell him where to get max gains for the safest possible bet.

Good luck converting this person.

I myself was this way, until about 25 or 26.

If he is open to actually doing this, instead of talking and thinking about it. Open a ROTH IRA, put 5k of his savings in a Target Retirement Fund....and see how he reacts.

You will be able to tell if he is serious, or if he isn't. btw. He can remove the money, penalty free if he so chooses. I wouldn't tell him that, if he is really interested.....he will look it up and find out on his own.

If he removes it, then you know he won't follow any of the other advice.

btw. Don't worry about the ring....it won't come until he is pushed into it by her.