Guide to Starting an Investment Club: Definition and Key Benefits

What Is an Investment Club?

An investment club allows a group of people to pool money and make joint investment decisions, often structured as legal partnerships. Members engage in educational meetings and may benefit from lower transaction fees and shared insights into the investment process.

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.

Diving Deeper Into Investment Clubs

Investment clubs are typically made up of amateurs who learn by pooling money and investing together. 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 notes that investment clubs often operate informally, with regular, usually monthly, dues. Some clubs employ committees that recommend investments while others involve each member in the process. Clubs require a membership vote for any actions. For more information, interested parties can refer to the chapter in IRS Publication 550 on investment clubs.

Benefits of Joining an Investment Club

The advantages to investment clubs are that they are the easiest and most economical entities to form, operate, and maintain. Pooling money for larger transactions helps members benefit from lower fees. Club income and losses are passed to partners, who report them on their 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 yield significant returns, but even those losing money offer valuable lessons for the future.

Important Considerations for Investment Clubs

How to Launch Your Own Investment 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, crucial for opening a brokerage account. 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.

Navigating Taxation and Regulation for Investment Clubs

Generally, investment clubs are unregulated. In the U.S., the SEC requires entities with over $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.

Exploring 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.

The Bottom Line

Investment clubs offer an accessible and engaging way for individuals to pool their resources for collective investment. These clubs, often structured as partnerships, provide members with educational opportunities, lower transaction fees, and the chance to be actively involved in investment decisions. While forming a club involves certain steps like organizing membership, choosing legal and organizational structures, and understanding tax obligations, the benefits can be substantial.

However, regulatory considerations and individual tax responsibilities should not be overlooked. Ultimately, investment clubs serve as a convenient platform for learning, networking, and potentially yielding returns, with participants able to decide their level of involvement in a supportive community.