Most mutual fund investors would be hard pressed to name more than one or two of the top holdings within their favorite funds. This is because fund investors tend to compare mutual funds on the basis of their performance, without giving much thought to the specific stocks, bonds and other financial instruments held within the fund. By their nature, mutual funds are a passive form of investment: we trust that the mutual fund manager has the expertise to choose the "right" investments that will provide the best returns in our portfolios.
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As individual investors, we rarely have a large enough portfolio to make individual equity or bond selections on our own. As a result, the average retail portfolio is usually insufficiently diversified with individual stock picks, and we mutual fund holders are subjected to undue risk from one or two bad choices forming a large percentage of our total holdings. For these reasons, retail investors who are dissatisfied with the passive approach of mutual funds and want to take a more active role in choosing equities would do well to join an investment club. (Find out more in Benefit From A Winning Investment Club.)
The Benefits of an Investment Club
You can think of an investment club as a small-scale mutual fund where decisions are made by a committee of non-professionals. In fact, an investment club can be established as a legal entity, either as a legal partnership or as a limited liability corporation, making its framework similar in principle to that of a mutual fund. Best of all, an investment club avoids the often burdensome management fees that all mutual funds levy on their unit holders - fees that can have a significant impact on the overall return provided by mutual funds.
But the benefits of an investment club come with a major caveat: the returns (or losses) that the club realizes entirely depend on club members and their abilities to choose the right investments for their pooled funds. When we purchase mutual funds from the major fund companies, we are effectively purchasing the education, experience, skills and discipline of the mutual fund managers entrusted with our money. When we join an investment club, we are attempting to replicate (and improve upon) some of those management attributes, but in a non-professional setting.
A typical investment club will meet on a regular basis (usually every month) to review its existing portfolio and to take suggestions from club members regarding new investment opportunities. The monthly meeting is an open floor, where each club member is able to voice his or her opinion about the suitability of new investments and other concerns regarding the performance of the pooled funds. Unlike any mutual fund, the investment club is a true democracy: here, the collective wisdom of the club members, combined with information they've gathered through intensive research, serves (in theory) to produce the best investment decisions.
Principles of a Successful Investment Club
The National Association of Investors Corporation (NAIC) is the pre-eminent advocate of collaborative investing. It maintains extensive archives of information for starting and maintaining investment clubs. The NAIC advocates four simple principles which apply as much to making excellent individual investment decisions as they do to making democratic decisions in a club setting:
- Invest regularly.
- Reinvest dividends and capital gains.
- Discover and own leadership growth companies.
- Prudently diversify by company size and industry.
These principles are very much in keeping with a buy-and-hold strategy, characterized by low portfolio turnover rates. The average holding period for equities within NAIC-advocated portfolios is more than six years. The NAIC's principles and strategies have enabled it to claim that "on average, the long-term performance of NAIC members has generally outperformed market benchmarks." The NAIC boasts a large membership consisting of both individual investors and investment clubs, and it offers services for introducing individuals to clubs in their area. (Learn more about investment clubs in Investment Clubs Pool Assets, Expertise and 4 Tips For Joining An Investment Club.)
You don't need to belong to the National Association of Investors Corporation to see the value in its overarching principles of discipline, diversification, reinvestment and careful selection of top companies. Indeed, you don't even need to belong to an investment club to adopt these principles as part of your individual investment strategy.
But there are clear benefits to the discipline and decision-making typical of investment clubs. By maintaining a strict regimen of regular meetings, investment clubs force individual investors to adopt an active investment style, in which portfolio review is ongoing and investment decisions - whether to buy, sell or hold - are constantly made.
Furthermore, the decision-making power of the investment club resides in its democracy. Each member brings his or her own education, experience and skills to the group, all of which are used to their fullest when evaluating and debating a decision. The power of the mutual fund comes from professional management that may be able to beat average market returns. The power of the investment club comes from the collective talents of numerous individual members.