Investment Club Definition, Rules, Tips and Benefits
Forming or joining an investment club could be your single best investment decision. With investment clubs rising in popularity in recent years, the Securities and Exchange Commission, or the SEC, has clarified for investors the basic structure and rules of investment clubs. Here is the SEC's definition for investment club:
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.
Investments clubs, therefore, can be compared to mutual funds, which are investment securities that enable investors to pool their money together into one professionally managed investment. Mutual funds can invest in stocks, bonds, cash or a combination of those assets. However, with investment clubs, the members of the club invest their own money and act as the management team. They are both manager and investor at the same time.
Rules and Regulations
In general, investment clubs are not regulated by the SEC but there are certain circumstances that would require them to register with the SEC, like mutual funds, under the Investment Company Act of 1940.
If all of the members of the investment club are actively participating in the decisions about investments, they would not generally need to register with the SEC. This is because the membership itself is not considered a security, therefore the investment club is not selling securities under the 1940 Act.
However, if there are passive members in the investment group, their membership may be considered an investment in a security. The membership would be considered a contract and since they are not participating in the management of the investment club's chosen securities, the passive members are similar to shareholders of mutual funds. In this case, the investment club would need to register.
Tips for Forming and Joining
Not all investment clubs will have the same structure but here are some general guidelines for forming and joining an investment club:
- Investment clubs will usually form a legal entity, such as a partnership or Limited Liability Company (LLC). This way, the members can be considered joint owners of the entity and their financial contributions can follow standard accounting rules.
- There's no real minimum or legal limit for the investment club membership but one club usually consists of 10 to 20 members.
- The investment club will usually open a brokerage account in the name of the club, as established by the name of the legal entity. Some brokerage firms have certain rules and incentives for investment clubs; so, be sure to be selective and shop wisely for the right fit.
- To join the investment club, a new member will usually contribute a lump sum, then pay a set, established amount, such as $100, per month.
- Members will normally meet periodically, such as once per month, to discuss investment opportunities and which, if any, securities should be bought or sold.
- It can be advantageous for investment clubs to have a stated investment objective or investing style, such as value investing or growth investing. Members can also set up particular screens that securities need to meet before they qualify for purchase. For example, a value strategy might require a low P/E ratio before the investment club purchases it.
Perhaps the greatest benefit of joining an investment club is education. When several investors come together to share ideas and information, there is often a synergistic effect, where the sum of the parts is greater than the whole.
Also, when you join an investment club, you can avoid the fees and commissions of investment advisors or stock brokers.
And of course, there's the potential that the synergy of the investment club can translate into higher returns than you could have achieved on your own.