I’ve written several articles recently on the lack of participation and planning on the part of business owners when it comes to preparing for retirement. Small-business owners tend to concentrate most or all of their wealth in one asset: their company. This can be very risky, as businesses take a long time to succeed but can fail overnight. Losing your only source of income and your only asset can be devastating especially if you’re close to retirement.
The solution is to diversify by taking some of your wealth and investing it in something other than your company. Many business owners nod their heads in agreement when hearing this, but fail to act because they don’t like the idea of relinquishing control by having someone else manage their money. There’s a solution to this problem, and it doesn’t involve hiding your money under a mattress. Instead, you could start or join an investment club.
Investment clubs have been in existence since the late 1890s and are a proven solution for investors who want to play an active role in the management of their assets. The members meet on a regular basis—typically monthly—and discuss potential investment opportunities. They then vote on which opportunities to pursue and invest the club’s pool of money accordingly. All members must contribute to the pool and retain a proportional share of ownership of the funds. This investment model has several important advantages:
- It provides discipline and structure. Investing safely for long-term success requires discipline, which many people lack. If you’re running your business, have family commitments and like to take some time off on weekends, it’s likely that researching potential investments will be perpetually postponed. The social pressure of an investment club fights back against these risks. The structure of the club also ensures that you won’t invest based on emotion or foolishly try to time the markets. Since club funds are only invested on set regular intervals, you can’t act on a “hot tip”; you have to wait until the next meeting.
- It lowers transaction costs. Investment clubs need to work with a brokerage firm to execute the buying and selling of securities. By pooling investment capital, the members collectively pay what each member would have paid in transaction fees, reducing costs significantly. By having pooled assets, your investment club also becomes a more attractive client to a brokerage firm gaining access to discounted fees or better research tools.
- It minimizes risk of loss. If you’re investing your own money, you run the risk of entering the “echo chamber” where you see a potential investment opportunity and then sell yourself on its merits instead of analyzing it critically. In the club each member is assigned research “homework” to evaluate different opportunities, which are then presented at the meetings. This provides great feedback from members who have a vested interest in success and are able to provide a different perspective without the bias that the researcher normally injects.
- It allows members to learn. Investment clubs are designed as learning opportunities. Members learn via the research they conduct, the resources they consult and from each other. Business owners with experience in various industries can provide important insight for large companies in their sector while learning about investment methods and research processes from more seasoned investors.
- It permits members to play an active role. This satisfies the micromanager inside all business owners who prefer to stay involved in their investment strategy.
Getting Set Up
Investing is serious business and so is managing an investment club. A separate legal entity needs to be formed; typically a general partnership is used. Initial members should be selected carefully. Officers of the partnership need to be selected based on their ability and willingness to play an active role. All clubs must have an operating agreement or bylaws (depending on the structure) that outlines how decisions should be made and who has a voice in making them. An attorney with expertise in setting up investment clubs should be consulted by the founding members.
Principles for Success
BetterInvesting is a nonprofit organization formed over 50 years ago to support individual investors and investment clubs. They recommend clubs follow these principles to ensure investing success:
- Invest regularly. Don’t try to time the market by buying a certain security when you think it’s low and selling it when you think it’s high. If a particular stock is a good long-term investment, it’s best to accumulate shares at regular intervals even if the price fluctuates. This is more likely to succeed than waiting until the price goes down to buy it.
- Reinvest earnings. If the club owns stocks that pay dividends, they should be reinvested into the club pool instead of taken out and distributed. This can have a tremendous impact on your overall return.
- Buy growth stocks and mutual funds. The purpose of the investment club is to grow your capital, and the investments should reflect that. This isn’t for cash that you may need in a medical emergency or to cover monthly expenses.
- Diversify. Participating in an investment club is a way to diversify your assets from the equity in your business, but the club itself should ensure that it maintains a well-diversified portfolio in terms of investment type, sector and level of risk.
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Mike Periu is the founder of Proximo, a leading provider of training and educational programs in finance, entrepreneurship and information technology. He is a nationally-recognized speaker, blogger and writer on small-business finance.