Investing

'Investment clubs are an ideal way to learn about the stock market,' expert says: But watch out for red flags

"They're a supportive environment to pool resources, share ideas, and divide research work."

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If you're looking to learn more about the ins and outs of investing, join the club. Literally.

Since the pandemic began and public interest in investable markets ramped up, so too have the popularity of investment clubs — groups that meet to discuss, research, and jointly invest in (usually) stocks. The number of such clubs has more than doubled in the past two years, according to the National Association of Investors, an education nonprofit that provides resources for investment clubs.

It's not hard to see why, says NAIC CEO Ken Zendel. "Investment clubs are an ideal way to learn about the stock market. They're a supportive environment to pool resources, share ideas, and divide research work," he says.

"It's like going to the gym with a trainer," he adds. "You and your friends, family, and colleagues can bounce ideas off of one another, check each other. And because you're dealing with everyone's money, you end up putting in more work and more care."

If learning about investing along with your friends and family is something you'd be interested in, read on to find out how the clubs work, as well as some risk factors and potential red flags financial experts say to be aware of before joining.

How investment clubs work

Investment clubs establish their own rules and bylaws, so no two are exactly alike. Most clubs have eight to 12 members, Zendel says, though "some clubs are as small as two or three people, and others have 30 or 40 people."

Clubs typically have a specialized type of investing account set up at a brokerage, and members are encouraged to invest regularly, say, at each monthly meeting. Members commonly each contribute an equal amount, though some clubs may elect to have some members contribute more or less than others, with certain members commanding a larger claim to the portfolio's profits.

Portfolio sizes can vary as well. NAIC recommends that most clubs keep things on the smaller side. "You don't want to have more stocks than you can keep a good eye on," says Zendel. "We recommend each member watches two or three stocks, and brings one new idea to each club meeting."

In a typical meeting, a club might start by reviewing the entire portfolio quickly before members deliver updates on their assigned stocks and pitch the group on new investment ideas.  Then the group decides jointly how to invest any new funds.

How investment clubs can make you a better investor

Whether or not a club will make you savvier about markets comes down to the investing approach of its members, says Charles Rotblut, vice president of the American Association of Individual Investors. "It all depends on the club and who is in it," he says.

"Some are being formed for people to pool their money together and share trading ideas," he says. "Others want to have serious discussions about what they're seeing in the market and are trying to learn from one another."

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If you're starting a club or thinking about joining an existing one, lean toward groups that trend toward the latter category, says Zendel. His organization's affiliated website, Better Investing, recommends that clubs focus on four investing principles: investing regularly, re-investing earnings such as dividend payments, broadly diversifying the portfolio, and identifying high-quality growth stocks.

Picking winning stocks is way easier said than done, even for the pros. But by delving into companies' fundamentals, such as measures of profitability and valuation, you theoretically learn about what makes markets tick. If the group is committed to that research, everyone has a chance to learn, says Rotblut.

"Ideally, there is a mentoring process, where someone knowledgeable is able to explain how they monitor stocks," he says. "You want people with knowledge and experience to share it and more novice people who are willing to get educated and have that process."

Beware of red flags

If you're thinking about joining an existing investment club, do some research first, says Rotblut. "There's no substitute for asking if you can join for a meeting or two as a guest," he says. "It's really important to see how they're operating, what personalities are at play, and how they go about making investment decisions."

If a club is dominated by just a few people or it isn't transparent about its process, those are red flags, he adds.

Even the most attractive clubs find themselves facing the million-dollar question: Will your club achieve good investing results?

It depends how you define good, says Peter Pallion, a certified financial planner with Master Plan Advisory in East Norwich, New York. "On average, people can certainly enter into such a club with the idea of hopefully getting some education and getting entertainment value out of it," he says. "But outsmarting Wall Street? That would be kind of difficult."

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For that reason, financial pros don't recommend committing a significant amount of money to an investing club, especially at first. "I would tiptoe in," says Rotblut. "Start off with small amounts for a couple of years and see how things are going."

Another potential concern: taxes. Because investment club money is typically held in a taxable account, you could face consequences if the group sells an investment for a significant gain.

"You always need to be aware of the potential for tax consequences," says Pallion. "The last thing you want is a surprise bill come tax time."

Even if you get the taxes right, entering into a financial relationship with friends or family has the potential to backfire, he adds. "If there are losses or underperformance, that could test relationships," he says. "When it comes to real money and real losses there is potential for a lot of unpleasantness."

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