An investment club is a groupof individuals who pool theirmoney to invest as a group. Theymeet regularly to learn the basicsof stock investing and researchpossible investments. Historically,investment clubs outperform thebroad market indices (Dow JonesIndustrial Average, Standard &Poor’s 500 Stock Index, etc.) about60 percent of the time, whereasprofessionally managed mutualfunds outperform these indicesonly 35 percent of the time. This isbecause investment clubs, as wellas individual investors, can holdon to a long-term investment per-spective while professional fundmanagers are often held account-able for performance on a quarter-ly basis. By pooling their time, tal-ent and money, investment clubmembers increase their stock mar-ket know-how and learn valuablelessons that can be transferred totheir individual financial manage-ment decisions.

Forming an Investment Club

Group dynamics is a veryimportant consideration whenorganizing an investment club.When prospecting for members,

remember that each member willbe both a social and business part-ner. Therefore, it is preferable tofind people who have differentperspectives but who all agree ona basic approach to investing.Most investment clubs have twostated goals: first, to learn aboutinvesting in stocks; and second, tomake a return on their invest-ments. This should be the order oftheir priority and all prospectivemembers should agree on this. Alldecisions made by the club,whether they result in profit orloss, will lead to educational expe-riences.

Experience suggests that there isno ideal number of participants fora successful investment club.However, a club with 15 to 30members has both a manageablesize (to facilitate constructive dis-cussions regarding stock evalua-tions) and enough members togenerate sufficient funds (throughregular dues) to make stock pur-chases. The group will need tofind a convenient meeting place,one with computer and Internetaccess. The most likely meetingplaces are members’ homes,libraries, community meeting facil-ities, or places of business whereone (or several) members workand have permission to host activi-ties.

Establishing a ClubPartnership Agreement

An investment club is typicallyorganized as a general partnership.The partnership agreement shouldoutline the operating practices andserve as the bylaws, addressing allissues that will confront membersfrom formation through a specifiedending date. The first item shouldbe a declaration of a club name.This effectively becomes the part-nership name (or in IRS terminolo-gy the “doing business as” name).Second, the partnership agreementshould outline the organizationalstructure, including names andresponsibilities of officers; dues orcontribution requirements; andclub meeting times, dates andlocations.

Bylaws also should addressmore controversial topics such asprocedures for admitting newmembers, procedures for with-drawing from the partnership,meeting attendance requirements,the schedule of fines for delin-quent dues, and a list of prohibitedactivities. An important decision tomake is which partner(s) will beon the signature card at the bankand have access to the tradingaccount and passwords at the bro-kerage. Usually the treasurer andone other member are given these

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STARTING ANINVESTMENT CLUB

Jason Johnson, Bill Thompson and Wade Polk*

* Assistant Professor and ExtensionEconomist–Management, AssistantProfessor and Extension Economist, andExtension Program Specialist–RiskManagement, The Texas A&M UniversitySystem.

responsibilities. After careful delib-eration and discussion, all of theseissues should be written into thegeneral partnership agreement,which should then be signed anddated by each general partner.

One particularly useful resourcefor investment clubs is theNational Association of InvestorsCorporation (NAIC), a non-profit,tax-exempt organization whosemembership consists of investmentclubs and individual investors.NAIC was founded in 1951 with amission to provide sound invest-ment information, education andsupport that helps create success-ful, lifetime investors. Manyresources can be found at theNAIC Web site: www.better-investing.org.

NAIC’s official guide, “Startingand Running a ProfitableInvestment Club,” provides all theinformation needed to establishand operate an investment club.This guide addresses a broad rangeof topics, from selecting membersand keeping interest high to tipson conducting monthly meetings,working with a broker, andresearching stocks. Investmentclub members can modify specificrecommendations to fit the uniquepersonality and goals of their club.

Obtaining an EmployerIdentification Number

Clubs must have employer iden-tification numbers (EIN) in orderto establish the necessary bankand brokerage accounts, as well asfor tax reporting purposes.Because the investment club oper-ates as a partnership, it shouldhave its own identification num-ber. Obtain this number from anIRS office or the IRS Web site(www.irs.gov). Download Form SS-4 (Application for EmployerIdentification Number). After com-pleting this one-page form, youcan either fax it to the designatedIRS number or call the toll freeassistance line and give the infor-mation to an assistant. The EIN

number is assigned over the phoneand is available immediately forconducting investment club busi-ness activities.

Establishing a BankAccount and DiscountBrokerage Account

In selecting financial institutionsto handle the club’s banking andbrokerage activities, find conven-ient, low-cost providers. The clubshould establish a checkingaccount in the club’s name toserve as a holding place for duesuntil this money can be transferredto a brokerage account. Clubs canoften arrange for free checkingprivileges. Compare various dis-count brokerages and choose onethat is easy to use and charges lowcommissions.

The rationale for selecting a dis-count brokerage is that the clubrequires only stock trade execu-tion, not investment guidance. Theevaluation process is the responsi-bility of club members. Full servicebrokers typically charge $50 to 60per trade. A discount broker willcharge only a third or a fourth asmuch. The less money spent oncommissions the more the clubhas to invest. Keep in mind thatthe greater the amount of regulardues collected and available forinvestment, the less the commis-sion charges will reduce the club’sreturn.

Preparing for TaxReporting Requirements

Generally, an investment club istreated as a partnership for federaltax purposes unless it chooses oth-erwise. Financial events generatedby the investment club partnership(in the form of capital gains/lossesor dividends) are taxable in theyear they are realized. If an invest-ment club only purchases stocks(and does not sell any of them),then the only taxable event is thereceipt of dividends and/or inter-est. The club will receive a Form1099 from the brokerage showing

the dividend and interest pay-ments. If the investment club isorganized as a general partnership,all financial ramifications passthrough the partnership to individ-ual members on a proportionalbasis. However, this does notabsolve the club from filing theappropriate tax reports.

An investment club must fileForm 1065 (U.S. Return of Partner-ship Income), which shows thetotal of dividends and interestreceived during the year as well asany capital gains or losses thathave resulted from selling stocks.The club also must file a ScheduleK-1 (Partner’s Share of Income,Credits, Deductions, etc.) for eachof the partnership’s members; thisform shows each member’s pro-portional ownership in the club’sportfolio. Each member shouldreceive a copy of the Schedule K-1to include with his or her individ-ual tax return. Thus, a generalpartner of an investment club with20 members would be responsiblefor claiming 5 percent of the club’staxable income on his or her indi-vidual tax return. Until the invest-ment club begins liquidatingstocks, this taxable income is con-fined to interest and dividends.These items must be reportedwhether or not any distributionfrom the partnership was actuallyreceived. However, the tax ramifi-cations are usually negligibleunless the club has accumulated asignificant amount of dividend-producing stocks over a number ofyears.

Beginning the EducationProcess

Most investment clubs arefocused according to tenets pre-scribed by the NAIC. The fourbasic principles include: investingregularly; reinvesting all earnings;evaluating growth stocks; anddiversifying the portfolio. Investingregularly reinforces the concept oftaking a long-term perspective andcreates a genuine purpose for eachmeeting. Reinvesting all earnings

allows the power of compoundedgrowth to work for the club. Byfocusing on growth stocks, mem-bers can see that the value of theirinvestment changes with the salesand earnings growth (profitability)of the companies. Finally, thevalue of diversification is stressedso that portfolios will be cush-ioned against industry or sector-wide downturns. These lessons aremeant to strengthen members’individual investment plans.

Threats to a SuccessfulInvestment Club

One of the biggest pitfalls for aninvestment club is the challenge ofmaintaining unity of purpose. Ifsome partners develop interest intiming short-term aspects of themarket rather than in investingwith a long-term approach, theclub loses its perspective. Anotherproblem comes from not settingminimum attendance requirementsfor members. Active participationfrom all members ensures a suc-cessful educational experience andimproves the quality of investmentdecisions. Sometimes clubs are tooeager to accept a new member.This can create problems if thenew member doesn’t share theclub’s overall approach to invest-ing, or is not clear on what is

expected of club members.Prospective members should beencouraged to visit the club for acouple of months before beinginvited to join. Finally, accountingissues often cause problems, evenif clubs initially use the “everymember has an equal share” sys-tem. The equal share system doesnot accommodate a member with-drawing some of his money in theevent of a personal emergency; itcan also make new member buy-inprohibitively expensive as the clubaccount grows in value over time.NAIC suggests using a percentageownership, or unit value, methodof accounting from the beginning.

What You Can Expect to Learn

Investment club members gainthe confidence to begin or extendtheir individual portfolios, armedwith the knowledge and skills theygain from belonging to the club.The lessons learned from a proper-ly structured and organized invest-ment club are identical to thosethat must be embraced when mak-ing sound individual investmentdecisions. The first thing to learnis investment terminology (e.g.,dollar cost averaging, companysponsored dividend reinvestmentplans, etc.). This could be part of

the regular educational discussion.Second, investment club membersshould learn about the differentsectors of the economy and, moreprecisely, where companies fitwithin these various sectors.Third, investment club membersshould identify some preferredweighting of their collective portfo-lio (across economic sectors) toguide them in evaluating stocksthat are appropriate. Finally, thespecifics of evaluating and select-ing stocks, and regularly reviewingthe portfolio’s performance, shouldabsorb most of the club’s discus-sion time. There are many meth-ods and perspectives to considerwhen evaluating individual stocks.Investment clubs can use severalof them to identify and select indi-vidual stocks so that they becomefamiliar with different perspectivesand feel comfortable about themethods they prefer.

For further information:National Association of Investors

Corporation website www.better-investing.org

O’Hara Thomas E. and Kenneth S.Janke, Sr. Starting and Runninga Profitable Investment Club.Three Rivers Press, New York::1998.