An Investment club basically is a self-managed group of people who have taken the initiative to pool their resources in order to invest together. They are mostly organized as partnerships and after studying carefully different kinds of investments, the group then decides to make the investment usually in the form of buying or selling based on popular opinion. From time to time investment club members hold a meeting that may be educational and each of the members is allowed to actively participate in the decision-making process. One of the questions that people ask in regard to investment clubs is how to start one and in this article, we will delve deeper into what they are about how to start an investment club.
Understanding the underlying concepts of an investment club
In simple terms, an investment club is usually a group formed by amateur investors who learn about the investment world by pooling their resources together with an investing group. Basically, if you are scared about investing in the stock market, you could partner up with a friend to form an investment club and invest that, way, the risk will be spread between the both of you. That is the driving wheel of the investment clubs. In the United States, there are two recognizable definitions of investment clubs. The Security and Exchange Commission defines it as;
“Generally a group of people who pool their money to invest together. Club members generally study different investments and then make investment decisions together — for example, the group might buy or sell based on a member vote. Club meetings may be educational, and each member may actively help make investment decisions.”
While the IRS defines it as;
“An investment club is formed when a group of friends, neighbors, business associates, or others pool their money to invest in stock or other securities. The club may or may not have a written agreement, a charter, or bylaws.”
The SEC does not regulate the activities of the investment clubs, but some of the activities of an investment club may fall under the scrutiny and purview of the SEC. SEC further gives a guideline ruling the structure and the rules for these clubs. For example, if the club invests in securities, it has to register with the SEC under the Investment Company Act of 1940.
According to the IRS, an investment club operates informally, with some dues paid regularly. Some other clubs may employ a committee that makes recommendations on which assets to invest in. some of the clubs subject any actions to a vote by the membership.
How investment clubs work
If you are interested in learning how to start an investment club, there are a lot of things that you need to consider. First, the most important decision is whether you want to be a part of an existing investment club or want to form your own. Secondly, after deciding, say you choose to form your own; the next decision is how many people you want to enroll in your club.
Graham Spooner, an investment research analyst at The Share Center says that investment clubs should have at least eight to ten members, but no more than 20.
“Too few and you may have trouble accumulating funds to invest,” warns Spooner.
One thing you need to understand about the investment club formation is that they do not conform to a specific standard or governance but, there are some of the common characteristics about their operation. Usually, investment clubs will form a legal entity for example partnership or a limited liability company. In this manner, the members of the investment club will be considered the joint owners of the entity, and their financial contributions will follow the standard accounting rules.
In most cases, and with most clubs that are already in existence, one thing they commonly have is a brokerage account. Some of the brokerage firms have certain rules and incentives for investment clubs. Thus, when learning how to start an investment club, it is good to be extremely selective of the brokerage firm you choose.
In order to join an investment club, a new member will contribute a lump sum and then pay monthly payments such as $100 or whatever amount the club has set. For instance, last week we looked at the Grassroots Investment Group LLC, one of the most successful black investment clubs. New members wanting to join the club have to make an initial contribution of $10,000 to the club. Then an additional amount of $10,000 is paid over a 15-month period, plus monthly dues of $175 each.
In most cases, members will meet periodically; say once a month to discuss investment opportunities.
Investment strategies for an investment club
“Agreeing on an investment strategy is important, though it is vital to understand that this may change over time through reasons of trial and error, shifting decision focus, and market changes,” says Spooner.
“To begin with, clubs should generally focus on individual companies rather than funds.
Strategies are important as they ensure that the company or the club is on the right track. In addition to strategy, it is important that the club also consider formulating its objectives right off the bat. For instance, they should consider either value investing or growth investing. Furthermore, members can also decide to set up screens that the securities need to meet before they can qualify for purchase.
There are some instances where the investment club may be compared to a mutual fund. Mutual funds are investment security whereby investors pool their money together into one professionally managed investment. Mutual funds can invest in stocks, bonds, cash, or even a combination of these assets. In the same manner, investment clubs are at liberty to invest, but the only difference between the two comes in how they are managed with mutual funds being managed by a fund manager whereas an investment club is managed by the group.
The risk factor
For an investment club to be successful, it has to collectively agree on its attitude towards risks. The members will have to agree on what they want to get out of their investment, like we previously mentioned, will it be a growth or value investment. To control risk, transparency is important and the key to helping the investment club avoids taking too much risk. As such the information about the portfolio and its performance should be freely available to each of the members.
Basically, each investment club is as good as its members. If in your group you do not have experienced investors, chances are, the club will not do as well. The outcomes of the group are also likely to hinge on how active every member is and the level of participation. The benefits that investment clubs bring to the table are very many, but good preparation and communication will be paramount to the success of the club.
“If all goes well in your club, membership can be a nice little earner,” says Spooner.
Are investment clubs any good?
Yes, an investment club has so many benefits attached to it. They are the easiest and most economical entities to form, operate and maintain. By simply pooling your resources together, it means that individuals are able to perform larger transactions at a lower cost. In addition to that, they present a unique opportunity for members to learn various aspects of the investment world. They are also a valuable resource for members to make valuable contacts and meet people who share the same ideologies. The return potential in some clubs is terrific, and while we cannot dispute the possibility of a loss, these losses form valuable lessons to the members.
