October 18, 2012
At a time of high-frequency robotic trading, market volatility and elephantine economic uncertainty, joining forces with your family and neighbors for an investment club might sound like a sucker’s game.
The truth is that most investors won’t beat the market once they subtract transactions costs, timing errors and holding onto losers. So perhaps it’s no surprise that when finance professors Brad Barber and Terrance Odean of the University of California researched returns in the 1990s at the height of the investment club boom they found that about 60 percent of the clubs failed to beat a market index.
But there’s more value to pooling your resources than just comparing your returns to the S&P 500. Investment clubs still make sense because they bootstrap fundamentals. You focus on how to analyze a company for its sales, earnings and future direction. You scrutinize management for its ability to increase profits and earnings per share.
Instead of picking companies based on familiarity or gut feeling, you work with rational models of long-term stock picking. Over time, you figure out how to create a portfolio of solid companies, re-invest dividends and save money.
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There’s a great deal of learning that happens in a social setting that you may not be able to do by yourself or by browsing online. That’s why even though membership numbers have plummeted since their heyday when there were 35,000 clubs in 1998, there are still some 8,600 local clubs across the country run through BetterInvesting.
I have to admit that I’m not the least bit impartial about investment clubbing. My family had been involved in a club for more than 15 years, until we liquidated our holdings in 2009 to pay emergency medical expenses. I researched and wrote about the movement in my Investment Club Book (Warner Books, 1995) and addressed club fairs from Seattle to New York. (Disclosure: Outside of token gifts, some book sales and travel expenses, I’ve not received honoraria or direct compensation from speaking to any club chapter.)
LEARNING IS FUNDAMENTAL
What I found in my time in an investment club is learning a complex and often intimidating subject with friends and family is a lot more productive than trying to tackle it alone. There’s a powerful social incentive with investment clubs. With peers or family members, investing can not only be a social event, it offers encouragement to stay the course in all kinds of markets and regularly invest fixed monthly amounts.
Although we got hit hard like all stock investors during the years we were invested, we survived the dot-com and 2008 crashes with enough money for a reserve fund. We held on – and even bought more shares – when most investors were bailing. Remember “buy low, sell high?” That’s what you’re better able to do in a group setting with a consensus. Here’s what you need to know if you’re thinking about forming a club:
1. Form a club with people you know, like and trust. BetterInvesting (www.betterinvesting.org) offers a wealth of support such as a magazine, software, local chapters and investment classes if you join, but there are also plenty of other resources online.
2. Invest on a regular basis, re-invest dividends. Most large- and medium-sized companies offer dividend-reinvestment plans that will plow dividends back into buying new shares at no commission cost.
3. Emphasize quality and consistency in stock selection. Look at how earnings, sales and earnings per share may grow. Pick companies with solid franchises, leadership in their industries and reliable dividends.
4. Buy low and hold, and don’t try to time the market. If share prices dip – and the fundamentals of your companies look solid – buy more shares. “Dollar-cost average” this way and you won’t pay top dollar for shares over time.
5. Stay the course. Club members will come and go or get discouraged. Markets will always be jittery. Set a fixed monthly amount to invest and vote on how to invest and diversify. It’s a group effort that doesn’t have to result in a huge profit. You’re doing this to learn about investing and save money. It should be fun.
If you choose to start a club, go into it with eyes wide open. Almost no one is going to beat the market after all expenses are tallied. My family club didn’t even come close. And you’re probably going to hold onto losers for purely emotional reasons and not buy and sell at optimal times. But what you gain from analyzing companies, reinvesting dividends and building wealth slowly is priceless.
(The author is a Reuters columnist and the opinions expressed are his own.)