While the Securities and Exchange Commission (SEC) does not regulate investment clubs specifically, some club activity can fall within the purview of the SEC, which lays out a basic structure and rules for clubs. For instance, if the club invests in securities, it must register with the SEC under the Investment Company Act of 1940.
Alternate definition: Self-directed investment clubs let members research and select investments together, but each member invests their own money individually. Funds are not pooled.
In some cases, investment clubs 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. Investment clubs can do the same thing; they are just managed by the group instead of a fund manager.
How Investment Clubs Work
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 selective and shop wisely for the right fit. To join the investment club, a new member will usually contribute a lump sum, and then pay a set monthly amount, such as $100. 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.
Pros and Cons of Investment Clubs
Pros Explained
Pooled funds lead to higher returns: Each member of the investment club can add value and share it with all the other members—translating into potentially higher returns than any individual would have achieved. Avoids professional charges like brokerage fees: When you join an investment club, you can avoid the fees and commissions of investment advisors or stockbrokers.
Cons Explained
Success depends on the activity of its members: An investment club will only be as good as its members. If you have no experienced investors in the group, you’re unlikely to succeed. The club’s outcomes will also hinge on how actively everyone in the group participates in the investing decisions.Requires a certain threshold of members to be worthwhile: Before you trade the experience of a fund manager for a collective effort, be sure you have a committed group with enough experience to make your investment club worthwhile.
Requirements for Investment Clubs
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 that case, the investment club would need to register with the SEC.
