What is an investment club?
According to the U.S. Securities and Exchange Commission, “An investment club is 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.”
One type of investment club is a self-directed investment club, where members strategize with the group about which investments they want to purchase but invest independently. Some prefer the self-directed route because they think it's safer.
“You don’t need to trust that other members are managing the cash responsibly, reducing your fraud risk… money can turn otherwise upstanding people to behave in their own self-interest,” says John Li, co-founder and CTO of the lending company Fig Loans. “Plus, if you disagree with any investment direction the majority of the club wants to take, you’re free to invest elsewhere, maintaining complete control over where your money goes.”
More: How to avoid the most common investment scams today
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Learn MorePros & cons of investment clubs
Michael Ryan, a financial coach and founder of www.MichaelRyanMoney.com, listed some of the advantages and disadvantages of investment clubs:
Pros
- Offers a way for people to learn about investing, especially if club members can share their knowledge
- People can pool their money and resources, which allows club members to make larger investments than they could make on their own
- Is a way for people to diversify their investments, which can help to reduce risk and improve returns
- Can be a great social activity, providing a way for people to meet new friends and network
Cons
- Can be time-consuming
- Can be difficult to find like-minded individuals willing to commit to the club
- There is always a risk that the club will not be successful
How to start an investment club
Whatever type of investment club you would like to start, there are some best practices you should know beforehand:
1. Create your clique
“There are risks involved with investment clubs,” says Claire Hunsaker, CEO of AskFlossie, a personal finance site for women. “You are putting your trust in a lot of other people and hope that you are going to see your money come back. You want to make sure they are people you are strongly aligned with in terms of your goals.”
When you decide who to add to the group, be clear about your deal breakers, Hunsaker says. For instance, if Hunsaker does not want to not invest in the military, but a potential club member is interested in that area, that person wouldn’t be a good fit for her investment club.
Be clear with your expectations. An investment club is still a “club,” so you might socialize with these people outside of your shared interest. Enjoying the company of the people you may see monthly for the next decade or longer is essential.
On that note, the experts also say it’s important to find people who want to have their money in investments for the same amount of time. Chisolm advises recruiting people who can commit to leaving their money in the market for at least five years.
To find potential members, he recommends reaching out to people in your social sphere to bring in 10 to 15 like-minded people. “The more people you have investing, the less you have to put in monthly,” Chisolm explains.
Group members should be prepared only to invest money that they can stand to lose because the market fluctuates. Some clubs invest amounts as small as $50 to $100 per month.
”Getting it perfect is less important than getting started and doing it consistently,” Hunsaker says.
More: How to invest my money wisely
2. Set money goals and organize
“The big value of investment clubs is that they are social,” says Hunsaker, a chartered financial consultant. “They can help people who haven’t invested before feel empowered to get started and help provide a little support. For some people, investing is intimidating, and clubs help them get started in small amounts.”
Before investing one dollar together, Chisolm recommends meeting with the potential club for 6 to 12 months. During that time, the potential club members get to know each other and learn how to work together. Use that time to set goals. Potential members should ask questions like “How are we going to do this? What are we going to invest in? How are we going to invest?'” says Chisolm. He also says this is the time to develop your strategy as a group and decide if you will be conservative or aggressive.
In addition, you should set up an organizational structure during that time. Elect club officers such as president, vice-president, secretary, treasurer, and assistant treasurer. Make sure you have checks and balances and always have two people looking after the money.
The group should also determine how to elect officers and the length of time they will serve. And you'll want to set up rules for buying and selling and how to handle it when someone wants to cash out. The group should also discuss together how to bring in or remove members and who will do necessary tasks such as:
- Run the educational part of the club
- File taxes
- Execute the trades
- Record-keeping and sharing the info with members
More: Choose your investment strategy
3. Ensure you’re legally sound
The club will have to come up with a name, register the business as an LLC or partnership, and get an employee identification number from the Internal Revenue Service, Chisolm says. “It’s a legitimate business.”
Carter Seuthe, CEO of Credit Summit, says you should consult an attorney to protect everyone's investments when starting an investment club. “I've heard more than a couple horror stories about people who didn't take these steps and got burned,” Seuthe says.
Make sure the club is a legal trading entity so that the club doesn’t risk losing everyone's investments or getting charged with securities fraud. Once the investment club is legally sound, set up an account at a brokerage.
More: 8 best online stock brokers
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Discover the secretThe bottom line: should you start an investment club?
An investment club is an excellent way for people to get started in the world of investing. There are many benefits to creating an investment club, including the chance to learn about different investments, the option to pool resources, and the ability to diversify your portfolio.
Learning about the types of investments, how they work, and the risks and rewards will enable you to make better investment decisions in the future.
Be aware that there are some financial risks associated with starting an investment club. Still, the benefits typically outweigh these risks. And if you follow the tips above, you can minimize the potential pitfalls.
Overall, an investing club can be a great step for anyone who wants to take their investments more seriously but isn't sure where to start.
Further reading:
- How paper trading made me fall in love with finance
- Investment risk 101
- How to invest my money wisely
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