Investment Clubs Not So Chummy Lately

Some lessons are learned the hard way.

The market slump has not been kind to investment clubs, whose members left in droves as clubs underperformed the market. Over the past two years, the Better Investing Top 100, an index tracking the 100 stocks most widely held by investment clubs, fell 26%, while the S&P 500 fell 22%.

Since 2000, more than 4,000 investment clubs have closed, while membership in the National Association of Investment Clubs (NAIC) has fallen 23%. And the problem isn't going away -- NAIC membership is off 2% since the beginning of 2002.

This is quite a departure from performance during the bull market. From 1997 until 2001, the Better Investing Top 100 had a five-year annualized gain of 12.2%, easily topping the S&P 500's five-year annualized gain of 9.2%. As the bull market raged, NAIC membership skyrocketed, peaking near 600,000 in 1998. People rushed to form investment clubs, which typically have 15 members who pay dues, attend monthly meetings and manage a group portfolio.

But a combination of underperforming tech stocks and the recent disclosures of accounting problems at companies has trimmed the ranks. "Even if the market goes up, I don't think there's any question that Enron and Global Crossing have scared off investors," says Kenneth Janke, president of the NAIC.

The School of Hard Knocks
From 2000 until 2002, the Better Investing Top 100 dropped...	...while the S&P 500 only dropped...	As a result, the NAIC has lost...	and...
26%	22%.	more than 130,000 members	4,000 clubs.
Source: NAIC

Indeed, clubs can be a great introduction to investment. The NAIC offers a variety of educational publications, stock study guides and workshops through its Web site, www.better-investing.com.

Moreover, investment clubs provide a variety of perspectives to draw on as the group decides what to do with their capital -- and this could lead to better decisions. Clubs also can be a great source of investment ideas for personal portfolios, says John Nofsigner, assistant professor of finance at Washington State University.

For investors who can't afford Berkshire Hathaway at $72,000 a share, pooling money with other investors creates more purchasing power than they would have had alone. And the regular meetings encourage a discipline that many lack when operating independently, says Janke.

Plus, the clubs are fun. Many groups, such as the Totem Investment Club in Seattle, hold meetings at restaurants, while others serve alcohol and play music.

Fun, Not Necessarily Profit

But recent performance indicates that some investment clubs make better social gatherings than investments. "The whole logic behind it was that you get more ideas out of it and you get different perspectives. You should come out with a better portfolio," says Peter H. Calfee, president of Calfee Financial Advisors in Cleveland. "Somewhere along the line that gets lost."

For example, when the Scripps College Student Investment Fund, a $218,000 student-managed fund at the Claremont, Calif., school, inherited decimated tech stocks from the 2001 graduating class, members realized they weren't diversified, says treasurer and outgoing senior Elizabeth McCann.

Moreover, the recent spotlight on alleged acounting improprieties has shown that inexperienced investment clubs may not be able to decipher complicated balance sheets that can stymie professionals. "I don't think you can run an investment club with amateurs these days. You need training. Finance is so technical," says Chinmoy Ghosh, professor of finance for the University of Connecticut.

A major disadvantage for investment clubs is that they don't have a chance to time the market, because meetings often take place once a month. And because most clubs don't use automatic stop-loss orders, which automatically sell stocks when they drop below a certain point, Ghosh says, clubs that waited until December's meeting to sell Enron were too late. "People always think in terms of which stocks to buy, not which stocks to sell," he says.

In an inexperienced group, a herd mentality can form, especially if a few members dominate, Calfee warns. When times get tough, clubs can fall apart as members begin pointing fingers. And some simply lose interest -- taking their money with them.

Join the Club?

People who aren't comfortable letting other people have a say in where their money goes shouldn't join a club. "An investment plan should be tailored to your own personal objectives, not those of a group," says John Nester, investor education spokesperson for the Securities and Exchange Commission.

If you're looking to have a successful club, be prepared to work. Most clubs ask members to present an investment idea once a month and require attendance at meetings. After all, if you just wanted to contribute money without any input, you could buy a mutual fund.

And if you're extremely knowledgeable about markets, you may end up educating instead of investing. "Savvy investors won't want to be teaching all the time. And when a vote is different than what they want to do, they may be frustrated," Nofsinger says.

Investment clubs are a great way to learn about the market, but may not be a great way to invest in them. While clubs can be social, investing must be taken seriously. "Otherwise, you can hand out Monopoly money once a month and see how you would have done had it been real money," Calfee says.