How to Start an Investment Club: What You Need to Know

Investment clubs are popping up all over the country and little wonder: Investing as a group is much more easy and fun than investing alone and this is leading to more and more people wanting to learn how to start an investment club.

Whether you’re just starting out as an investor or have been investing for years, investment clubs provide the following advantages:

• Risk is spread throughout the group. By diversifying your investments, you minimize your risk of losing all your money on just one or two investment vehicles. By investing at regular intervals throughout the year (i.e., dollar cost averaging), you reduce your chance of buying an overpriced stock, property or other commodity.
• Members are better informed. As evidenced in the past stock investment article series, sound investments take a long time to fully research. Having extra members to assess financial documents such as the income statement and balance sheet can save time and result in everyone having more information about a company, franchise, etc.
• Emotional investing is minimized. You won’t be able to justify your investment choice to other club members      by simply stating “I have a good feeling about this one.” As a result, you’ll also minimize making impulsive investment decisions.
• Investing discipline is maintained. Most investment clubs require that their members make a monthly contribution. This forces you to regularly set aside and save some money every month.

How to Start an Investment Club

While this isn’t a comprehensive guide, these are the first basic steps you need to take:

1. Select your members.

Do you know several (online or other) friends or relatives who have mentioned investing and who are responsible with their money?

If yes, then these individuals could be valuable members in your investment club.

Try to pick individuals who would be willing to dedicate their time and their money to an investment-focused group and meet their commitments faithfully month-to-month.

Otherwise, your investment club will simply become a social club (and probably serve beverages of a refreshing nature, à la Homer’s Hunting Club).

2. Decide on your club’s size and geographic range.

Investment clubs can be small (fewer than 15 members) or large (more than 15 members) and local or online.

There are advantages and disadvantages to each club type. For example, a small local club can get business done quickly and easily and have lots of face-to-face contact.

The disadvantage of this approach is that every member may have the same, narrow investment viewpoint.

Alternately, a large online club offers its members many different investment viewpoints and a wide range of experiences.

The disadvantages with this type of club are that virtual meetings may seem impersonal and full member attendance will almost never occur.

3. Decide your club’s investment vehicles.

Your club could focus solely on stock investments or diversify with real estate, person-to-person loans, mutual funds or some other investment vehicle.

Deciding on your choice of investment now will determine if your club needs to open a brokerage or other account type later.

4. Name your investment club.

Giving your club a name should take some time and effort and be agreed upon by all its members.

The name of your investment club will also be used on its bank account, member statements and tax reports, so make sure it’s a name that you and your club members can all agree on.

5. Draft and sign a partnership agreement.

For business as well as federal taxation purposes, you will need to draft a partnership agreement and have all club members sign and date it.

The partnership agreement should contain the club’s formation date, fiscal year and profit/loss sharing structure.

Member initiation and termination rules should also be included here. A sample partnership agreement is located at iClub.com and can be used as a template when creating your own club partnership agreement.

6. Draft your club’s constitution and rules.

Your investment club’s constitution and rules need to be carefully considered and stated in order to protect it from being audited by the IRS or even sued by a disgruntled member.

Be sure to include the following items in your club’s constitution and rules and have all members sign and date the document:

• Number of allowed members, including new member initiation procedures and requirements.
• Number of officers, election rules and service terms.
• Required monthly contributions from all members.
• Bank account details such as the account’s purpose (e.g., to collect member dues and club income) and signatories (i.e., who can write and cash checks).
• Brokerage account details such as the authorized investor/trader and investment/trading rules.
• Member voting powers and expectations as well as what voting percentage constitutes passage of a motion.
• Grounds for member expulsion.
• Monetary procedures following member expulsion, resignation or death.
• Tax collection and procedures.

A more complete guide to generating your club’s constitution and rules is located at TimetoTrade. You can also use this guide as a template for your own documents.

7. Elect club officers.

Decide who will fulfill the roles of president, vice president, treasurer, secretary and designated investor/broker.

Typically, the president or vice-president calls the club to order and makes announcements.

The treasurer is in charge of collecting member contributions and filing forms with the IRS.

The secretary records meeting minutes and attendees and later distributes this information to all members via mail or email.

The designated investor/broker holds the account in the club’s name and makes the actual investments/trades. 

Additionally, there may be a designated auditor who is not an officer and audits the club’s accounts.

Requirements to Running an Investment Club

These items exist because anytime you have a business entity that is making money, the law and (especially) the IRS will be very interested in your club’s dealings.

This is NOT a comprehensive list.

Please check with your local and state laws to make sure your investment club is in full compliance. This list is just an idea of some things you may need.

1. Investment Club Tax ID or EIN

Once you have named your investment club and its officers, you will need to obtain an employer identification number (EIN), which will be used when you file the club’s tax return.

The EIN is, in essence, like a social security number that identifies your club as a unique entity to the IRS. 

Despite its official sounding jargon, the EIN can be obtained in a matter of minutes by going to  the IRS website and filling out Form SS-4.

You can also call 1-800-tax-form (1-800-829-3676) for help.

2. Club Accounts

It is imperative that you open one or several bank accounts in the investment club’s name and use them solely for the purposes of club business.

Unless your investment club forms an LLC, you will first need to obtain a “doing business as” or DBA (i.e., Registration of Firm Names) document from your local city hall.

If your club starts investing in equities (e.g., stocks), you will also need to open one or more brokerage accounts also in the club’s name.

Some brokerages may charge significant fees to facilitate equity transactions like stock purchases.

To this end, you and your club partners may want to look into becoming members of the National Association of Investors Corporation (a.k.a. Better Investing), a non-profit organization which provides its members with discounts on stock trades.

The NAIC also offers a wealth of educational materials, accounting software and legal forms.

And now for the not-so-fun stuff…

3. Filing Tax Returns as a Club

Filing club taxes is usually the duty of the club’s treasurer and can be a stressful task for him or her; however, by following these guidelines, the process should become simpler with time (and more rewarding if followed by several gifts of beer from other club members).

To begin with, the investment club, if formed as a “pass-through entity” (e.g., partnership), is not required to pay federal or state taxes.

Instead, all club partners are expected to report their investment profits (or losses) on their personal tax returns.

Still, just because the club itself is exempt from paying taxes doesn’t mean it gets off scot-free; investment club treasurers must file an information return, called Form 1065 (U.S. Return of Partnership Income), each year by the April 15th deadline.

Furthermore, if even one of the club’s partners resides in a state other than that of the investment club, the treasurer should contact that state to find out if it requires its own return (e.g., IL-1065 for Illinois) as well.

Keep in mind that Form 1065 is applicable to all kinds of partnerships and not just investment clubs.

In fact, the majority of Form 1065 has nothing to do with investment clubs. Thus, especially if this is your first year gathering partner data and filing out the form, it may be better to utilize the services of a tax professional or accountant.

Alternately, the NAIC provides tax software that can easily track club investments, profits and forms for each partner.

Each club partner must be provided with a Schedule K-1 which details that partner’s investment profits, costs and transactions.

As such, the K-1 is akin to Form 1099 which brokerages and other financial institutions send to their clients each year. Unlike the Form 1099, though, which has a “send-by” deadline of February 15th, the K-1’s “send-by” deadline is actually April 15th- yes, April 15th.

This is because the IRS realizes that investment clubs may need extra time to gather up investment materials as well as all the 1099 forms from their brokers (at which point they can file for an extension).

However, if you, as the club treasurer, decide to wait until the morning of April 15th to notify fellow club members about how much they owe the IRS on their personal returns, you may end up with several of those members never speaking to you again. So, DON’T wait until April 15th.

Ideally, given that all the 1099 forms should be received by February 15th, your investment club should shoot for a K-1 “send-by” deadline of late February.

4. Club Partner Expectations

Once all the legal and tax obligations are settled, your investment club’s success will depend on each partner fulfilling his or her obligations to the club.

In most cases, those obligations are as follows:

1. Attend all club meetings.
2. Pay club dues.
3. Research current and pending club investments.

Each club partner should understand that the investment club is a business and, like any business, will probably not see a profit in its first few years of operation.

Thus, any partner who decides to “cash out” of the club cannot expect to get back all the money that he or she originally invested. 

There is also the matter of trust in the formation of an investment club:

Since you are going into business with 15 or so other individuals, you should be able to trust those individuals (and vice versa).

Hopefully, you will also like your partners and enjoy their company as you consider your mutual investments and learn from one another. After all, these are the end purposes of forming an investment club.

The Investment Club Bottom Line

Starting an investment club is a little more complicated than just asking a few friends to pool some money. You are taking risks with your money, and more importantly, other people’s money.

Take the proper steps in making sure your investment club is legally compliant and talk with a local accountant to make sure everything is being done above board.