What Is an Investment Club?
An investment club refers to a group of people who pool their money to make investments. Usually, investment clubs are organized as partnerships—after the members study different investments, the group decides to buy or sell based on a majority vote of the members. Club meetings may be educational and each member may actively participate in investment decisions.
Key Takeaways
- An investment club refers to a group of individuals who each contribute money to a pool that is then invested for the shared benefit of the group members.
- You can think of an investment club as a small-scale mutual fund where decisions are made by a committee of non-professional club members.
- Clubs can be informal or established as a legal entity such as a partnership. Either way, the club may be subject to regulatory oversight and must account for taxes properly.
Understanding Investment Clubs
Investment clubs are usually a group of amateur investors who learn about investing by pooling their money and investing it is a group. In the United States, there are two formal definitions of investment clubs that are complimentary. The Securities and Exchange Commission (SEC) has defined investment clubs as:
"Generally a group of people who pool their money to invest together. Club members generally study different investments and then make investment decisions together — for example, the group might buy or sell based on a member vote. Club meetings may be educational, and each member may actively help make investment decisions."
The Internal Revenue Service (IRS) has also defined investment clubs:
"An investment club is formed when a group of friends, neighbors, business associates, or others pool their money to invest in stock or other securities. The club may or may not have a written agreement, a charter, or bylaws."
The IRS goes on to say that investment clubs tend to operate informally, with dues paid regularly (such as monthly). Some clubs employ committees that recommend investments while others involve each member in the process. Clubs subject any actions to a vote by membership. For more information, interested parties can refer to the chapter in IRS Publication 550 on investment clubs.
Advantages of Investment Clubs
The advantages to investment clubs are that they are the easiest and most economical entities to form, operate, and maintain. Pooling money to do larger market transactions means that the members all enjoy lower transaction fees. The investment club's income and losses are passed through to its partners and are reported on their individual tax returns. Investment clubs are, above all else, a terrific way to learn, make valuable contacts, and meet people interested in the same topics. Some clubs have made significant returns for their members, but even the money losing investment clubs provide important lessons that members will take with them into the future.
Special Considerations
How to Start a Club
When setting up an investment club the following steps are recommended:
- Organize membership: Be sure to find candidates that want to actively participate. Consider utilizing an entry fee and a monthly membership fee to weed out the unengaged. Members should be trustworthy, open to performing research and able to afford such activity.
- Choose an organizational structure: Who will lead the club and how will they be selected and succeeded? How often will it meet? What are its rules? How will records be kept?
- Choose a legal structure: The most common structure is a partnership. This is important because a brokerage account cannot be opened without a legal structure. The club will need to get an Employer Identification Number (EIN) from the IRS.
- Decide on goals and objectives, and create an operational plan on how to achieve them. This should be a group effort to build a consensus.
Taxation and Regulation of Investment Clubs
In general, investment clubs are unregulated. In United States, the SEC requires any entity with more that $25 million to register under the Investment Advisers Act of 1940. Individual states may require registration but generally investment clubs do not have to if they have a small number of clients or participants.
In the United Kingdom, investment clubs are considered unincorporated associations and are not regulated or taxed as corporations. In each case, individual members are responsible for reporting gains and losses on their individual tax returns. In the U.S., income earned by investment club members is treated as partnership pass-through income. As such, members are required to file a Form 1065 and a Schedule K-1 each year. In the U.K., investment club members are required to file Form 185 Capital Gains Tax: investment club certificate.
Alternatives to Investment Clubs
An investment club usually refers to pooled money being managed by members through an established structure, but there are alternatives that also use the name. Informal investment clubs exist online and in the real world where members simply meet to discuss investing and what they are looking at. The members of these informal investment clubs can then choose whether or not to trade a particular asset that was discussed in their personal portfolio. Moreover, the advent of low and no fee brokerage accounts have removed one of the key advantages to investment clubs in terms of lower overall commissions and fees. This may well lead more people to join informal investment clubs for the knowledge and insight without the commitment.
Investment clubs are fascinating collaborative endeavors where individuals pool resources and knowledge to invest collectively. The concept involves a shared financial interest among members, usually organized as partnerships. Evidence from both the Securities and Exchange Commission (SEC) and the Internal Revenue Service (IRS) supports this definition. The SEC defines investment clubs as groups pooling money to invest, making decisions collectively based on members' study of various investments. Meanwhile, the IRS emphasizes the informal nature of these clubs, where friends or associates join forces to invest, often with regular dues and potential committee-based decision-making.
Regarding their advantages, investment clubs offer a practical learning platform for amateur investors. They facilitate larger transactions, resulting in lower fees, and enable shared tax responsibilities. They aren't just about financial gains; they provide valuable learning experiences, networking opportunities, and shared interests among members.
Starting an investment club involves careful planning, including structuring membership, defining organizational rules, selecting leadership, and deciding on goals collectively. The process includes establishing a legal entity, often a partnership, to obtain necessary IRS identification for a brokerage account.
In terms of taxation and regulation, investment clubs in the US typically operate without stringent regulations unless they exceed $25 million, requiring SEC registration. Individual states might have their own requirements, but generally, smaller clubs remain unregulated. Taxation involves members reporting gains and losses individually, with income treated as partnership pass-through income, requiring specific IRS filings like Form 1065 and Schedule K-1.
For those exploring alternatives, informal investment clubs, both online and offline, provide a less structured but knowledge-sharing platform. The rise of low or no-fee brokerage accounts has somewhat lessened the financial advantage of traditional investment clubs, potentially steering individuals toward these informal setups for insights without the commitment.
This comprehensive overview covers the fundamental aspects of investment clubs, from their definition and advantages to taxation, regulation, and potential alternatives, offering a well-rounded understanding of this collaborative investment model.
