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The One Rule For Joining Investment Clubs

I was asked the following question about investment clubs by a fellow investor and small business owner:

"What's your opinion of joining an investment club?"

This is a great question. Clubs are a great way to learn about investing and trading. More importantly, they can save you time and money when it comes to gaining real trading experience, which is inline with this sites goal.

You can learn in a pressure free environment, hear a variety of opinions, share ideas and strategies, and even pool your money for greater buying power.

The Number One Rule for Investment Clubs

The number one rule for investment clubs is to make sure that you want to follow the group’s investing strategy before joining.

It is one thing to attend meetings and engage in discussions. It is another thing to have money in the market without total control over the decision making process.

Usually, you will reach decisions by committee, which can be frustrating if you do not follow the same investing strategies.

Some have a committee that gathers information on securities and makes recommendations on the most promising candidates. Other clubs rotate these responsibilities among different groups, or even all members.

Either way, most clubs require all members to vote on all trades, as well as any other transactions.

For example, after graduating from college, I joined an investment club with a few friends.

At that time, I was learning the strategies outlined by William O’Neil, founder of IBD. My friends were learning how to invest strictly using fundamental analysis.

Based on their research, they recommended purchasing shares of Enron. Based on Investors Business Daily, I said we should not purchase Enron.

We voted and surprise, surprise, purchased shares of Enron. I probably don't need to tell you how that investment turned out.

What is an Investment Club?

For starters, they are just a group of people sharing knowledge, information, and data related to investing.

That said, these groups take on many different forms. Some just get together to discuss ideas. Others pool their initial investments and split the returns each year.

Self-Directed verses Contributing

Investing groups fall into two categories: Self-Directed and Contributing.

A self-directed club is similar to the examples at the beginning of this post. Its purpose is to combine time, energy, and knowledge. Individuals make trades in their personal accounts, rather than pooling their capital into one club account.

This type of group may or may not have a written agreement, a charter, or bylaws.

A contributing club is a group of people (friends, neighbors, business associates, etc.) that decide to pool their time, energy, knowledge, AND money to invest in stock or other securities.

And once you add money to the equation, the IRS will want a cut, which requires a little more effort than the self-directed version.

Beware of clubs that have one person in control of the club and its money. Look for different people holding the offices of President, Vice President, Secretary and Treasurer. Having one person responsible for all of the above is potentially dangerous (i.e. the club could be a scam).

On the flip side, make sure that a contributing investment club has less than 100 members. The club may need to register as a private investment company!

You will also want to know if there is a minimum monthly investment. You don’t want to join only to find out later that you can’t afford the payments.

DANGER - Taxes Ahead

For self-directed clubs, taxes are assessed based on the activity in your individual trading accounts. The brokerage firm will send you the appropriate 1099 forms.

Contributing clubs are usually setup as general partnerships (you will need to verify this, because a club could also be a limited liability company or corporation). As a partnership, the following actions are required:

  • Obtaining an employer identification number (EIN)
  • Filing a tax form with the IRS (Form 1065) for gains/losses made by the club
  • Investments made in name of a member
    • This member is considered the record owner for the investment club, and must file an "information return" with the IRS

As a partner, you are required to file a Schedule K-1 with your federal and state tax returns. This will exclude you from e-filing!

The K-1 details your share of the club's income, gains, losses, deductions, and credits. These forms are not complicated, but it may be more of a hassle then some people are willing to endure.

Make sure the club designates someone to create their tax documents. The group may have a CPA or some other person who knows how to create the forms. Otherwise, the club should hire someone.

Before joining, ask for the prior year’s tax return. These documents will tell whether the club is profitable. You may also want to take the forms to your personal tax attorney, CPA, or other financial advisor for review.

Where to find an Investment Club?

The easiest way is to find a club is to search meetup.com; a website that allows people to start group meetings for almost anything.

For example, search for Investors Business Daily or CANSLIM (the acronym for Investors Business Daily’s investing methodology) and you’ll probably find a group near you that meets regularly.

Another example are the clubs that play the "Cashflow" board game, which is sold by the author of the Rich Dad series of books, Mr. Robert Kiyosaki.

Want More Information?

The National Association of Investment Clubs (www.betterinvesting.org) is a great resource for information. You can also find out if the club you’re thinking about joining is registered.

The organization has even partnered with brokers to provide special accounts and discounted pricing for members.