Investment Clubs

Potential Pitfalls

Investment Clubs

Investment clubs, like many other things, offer much promise -- if you successfully avoid a few obstacles. Lest any Fool be caught off guard by these obstacles, we offer some words of warning below.

The Pitfall of the Pernicious Co-Member
Know that people you meet online or offline may not always be what they seem. This is far from merely a hazard of cyberspace -- it's even been known to happen among friends. There's always a chance that you'll end up with a dastardly, unscrupulous person in your investment club. This is why, if your club is one that pools money and invests jointly, it's important to set up the club formally. Don't neglect to draft legal agreements and bylaws. Take some precautions. Perhaps set up your systems so that two people have to sign off on any financial transactions. This is important even if your club consists of family members.

The Danger of Under-Delegation
This danger might seem less terrifying than the last one, but experienced investment club members have asked us to stress it. As one Fool noted: "Delegate, delegate, delegate... or you will be stuck with most of the work." Take note of your group's dynamics and make sure that the work is being shared by all. Anyone who isn't contributing his or her fair share may be enjoying the free ride and/or may be losing interest because they're not very involved. Anyone who's taking on too much may come to resent other club members and may burn out. Some might be reluctant to volunteer because they're not confident of their stock-researching capabilities. Help these folks learn. It's in everyone's best interest to get all members up to speed so that all can contribute.

The Entanglement of Ennui
Over time, club members might start to lose interest. This can be especially true if the market has been rising relentlessly (causing people to doubt the need for a club when it seems that any monkey can succeed in investing) or falling relentlessly (causing people to think that success in investing is impossible to achieve). It can be due to a club sticking to the same routine for several years, without injecting anything new. Keep your club alive. Take the pulse of your members (figuratively). Are they still excited to be in the club? Do you all need a field trip or guest speaker to liven things up? If you ever feel your club is in trouble, tap the experience and counsel of others in our Investment Clubs discussion board.

The Jeopardy of Jelly Donuts
Club members can tire of the same snacks each month. Try new treats. Perhaps refreshment duties should be rotated among all members. Don't let your fellow members fall into a "not-jelly-donuts-again" stupor.

The Snare of Subterfuge
A club that isn't paying attention might find itself derailed by a member who has veered off toward unsound investing principles. Be vigilant. If a member is all excited about some article that sings the glories of technical investing, or a friend's enthusiasm over a particular penny stock, be careful. Stick to the fundamentals, such as a company's earnings, growth, competition, and future. Otherwise, you might wake up one morning and find that your club's portfolio has half its funds invested in South American gold mining ventures!

The Booby Trap of Time
Investment clubs take time. Make sure that you and your fellow members have the time to devote to it and are willing to devote that time. If you figure about one to three hours for a monthly meeting and two to four hours of research or work preparing for the meeting, that comes to three to seven hours that you'll have to commit each month. This is probably manageable for most people, but make sure that everyone has clear expectations. Broken up, it could be two or fewer hours per week.

If this still sounds like a lot of time, consider the alternative. If you want to invest successfully, you're still going to have to spend some time researching stocks and following companies you've invested in. For many people, participating in an investment club isn't adding significantly to the amount of work they'd do anyway. And remember that you also reap the benefit of the hours of work of many other club members.

The Menace of Math
This may seem obvious and silly, but make sure that you're performing your math correctly. An incredible example of what we mean by this is provided by none other than the Beardstown Ladies. Apparently, their impressive 20-something-percent average annual return was kind of... wrong. It seems that when calculating their return, they counted as appreciation all the dues they had contributed. Using such a system, even if their investments returned zero percent, they would still have sizable gains from the dues that were continually added to the pile. This shouldn't happen to you, though, if you're paying careful attention to your club accounting system. The National Association of Investors Corp. (NAIC) offers instructions and software on how to keep track of your contributions and gains -- and bivio offers online club accounting.

If you're worried about the math involved in investing itself, don't. Yes, there's math involved in investing. But it's pretty much just good old addition, subtraction, multiplication, division, and percentages. Calculus, trigonometry, and logarithms are not required.

The Hazard of Humorlessness
Keep things fun, fellow Fools! Remember the words of that great investor of yore, Mary Poppins (if she invested, can you imagine her being anything but great at it?): "A spoonful of sugar helps the medicine go down." Learning about investing isn't as bad as swallowing some bitter tonic, but it's sure easier to do when you're having a good time. Never think that a sense of humor detracts from sound investing. If you ever find yourself forgetting this rule, check out some of Warren Buffett's enlightening and amusing annual letters to his shareholders -- available at http://www.berkshirehathaway.com/letters/letters.html.