We probably all wish to have a friendship like Warren Buffett and Charlie Munger. Decades of enjoying each other's company – and generating a market-beating annual return of nearly 20%.
Their story seems to prove the adage: two brains are better than one. Together, they achieved more than either likely would have alone. That might be worth consideration for those who aspire to become a better investor.
As Buffett put it: "It's better to hang out with people better than you. Pick out associates whose behavior is better than yours, and you'll drift in that direction."
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This kind of camaraderie may help explain why investment clubs are coming back into fashion. Easier access to markets through apps, strong stock market performance and exciting new assets like cryptocurrency have all drawn more people into the investing world.
An investment group or club can be a good place to start, especially for those eager to learn by doing. But should investing be a team sport? Here's what to know.
What are investment groups?
An investment group or club generally brings people together people to pool modest amounts of money. The goal is to build a portfolio, learn about investing and apply those lessons to their respective personal finances. Members can include friends, family, coworkers or even strangers brought together through investment club organizations like BetterInvesting.
Investment clubs have existed for decades. Charles Sachs, CFP® Ambassador and chief investment officer at Imperio Wealth Advisors, even credits his career to his early involvement in an investment club. "I got involved in investment clubs and, shortly thereafter, had to start planning my mom's retirement and estate planning. I found that I really loved doing this for a living. Fast forward 30 years, I'm now doing this for many clients."
How investment groups work
Investment groups often resemble social clubs where members share and debate ideas. Most clubs consist of six to 12 people, meeting monthly to discuss and vote on investment ideas like the best stocks or exchange-traded funds (ETFs) to buy. Between meetings, members stay connected via email or text.
After an initial lump sum, members typically contribute $50 to $100 each month, with larger contributions granting a bigger stake. Clubs need a system to track each member's share of assets as members may join or leave.
Most groups open a brokerage account, often in the group's name. Formalizing as a legal partnership or LLC isn't required but can simplify accounting, provide liability protection, and ensure proper tax documentation.
Investment groups can also have specific focuses, such as particular industries or investment styles. Sachs says the key is finding a structure that matches your interests. "I think the main thing is if it's a safe place for you to get an education, then you can apply it."
Benefits of an investment group
With only 26 states requiring high school students to take a personal finance course to graduate and most Americans considered financially illiterate, investment groups provide real-world education.
"It's a catalyst for learning how to do it on your own," Sachs says. "You can take all of that information and start applying it for yourself."
Beyond financial education, investment groups offer the chance to build social connections, which is increasingly important in an age of growing loneliness. And of course, there's the potential to build wealth while gaining valuable investing experience.
But as with all investing, there are risks, and expectations should be set accordingly.
Risks and drawbacks of group investing
When joining a group, trust is critical. Sachs advises that you only join clubs where you know and trust the members. "I would be extremely suspect if you're in an investment club and all of a sudden they're wanting you to write big-ticket checks. That could mean there's an ulterior motive behind who's running it."
Keeping the group small helps. Larger clubs can struggle with decision-making or spend more time arguing than investing. Sachs notes, "If you have 10 people in there sharing their various opinions, it's easy to get turned around. Even professionals can't predict market outcomes with certainty."
Investment groups also require a commitment to structure and accurate accounting. Without these, things can quickly go wrong.
For instance, the cautionary tale of the Beardstown Ladies highlights the importance of getting the numbers right. This group of Illinois women gained fame in the 1990s for reportedly achieving 23.4% annualized returns – until auditors revealed their calculations mistakenly included member contributions, reducing their actual returns to 9%, below market performance.
Is an investment group right for you?
If you want to use a small portion of your savings to learn about investing and connect with others, an investment group may be right for you. However, it's no substitute for a retirement savings plan such as a 401(k) or an IRA. "This is never meant to be a large percentage of your overall investable portfolio," Sachs emphasizes.
It's important to be realistic about your expectations – investment groups are better for gaining experience than for achieving eye-popping returns. In other words, don't expect to replicate Buffett and Munger's track record.
A University of California, Berkeley study titled "Too Many Cooks Spoil the Profits" found that investment clubs not only failed to beat the market but also underperformed individual investors. High trading costs and poor investment choices were the main culprits. The study concluded that while clubs foster learning and camaraderie, they are unlikely to produce better returns.
When it comes to achieving your long-term financial goals, teamwork may not always make the dream work. But as a way to learn, grow and better understand the markets, it's a good place to start.
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