Musings on Starting and Managing an Investment Club

Introduction

In 2006, a member of my wife’s family started a family investment club, and this planted a seed of an idea in my brain.  It was shortly after this, that I decided to give an investment club, comprised of friends and associates, a try.

The investment club that I spearheaded, which began to be organized in the summer of 2006, and was officially kicked off, through a registration of the assumed named for the group with the State of Minnesota, in January of 2007.  The group was formed as a general partnership governed by the laws of Minnesota. Our checking account was with Minnesota-based bank (and continues to be with this company to this day).  There was also a business savings account and was opened as a place to put cash while the group figured out meeting cadence, general investment philosophy, and to build up enough money to make our first purchase of stock something of [subjective] significant value.  The brokerage we went with was a small firm in New York.  At the time, they had the lowest commissions at $6.95 per trade.

The investment club still exists and is quite active.

On to the musings and some nitty gritty things.

Group Governance

A lawyer-friend, who recently joined our group, was pleased to see that our operating agreement — the document that spells in dry terms how the group is to be operated – had a provision for both exiting the group voluntarily and exiting the group upon death.  There are other provisions that I feel were more instrumental in keeping the group together for over a decade, and these are the provisions that relate to disallowing loans from the group to members, provisions governing that if a member wants money from the group, that person must leave the group – there is no borrowing of money from the partnership allowed.  There is also a provision that governs the amount of time the group has for the return of an exiting member’s money that they are entitled to receive.  More on this, shortly.  As it has turned out, we treated and continue to treat our operating agreement a bit like a living document. We periodically update it through amendments to reflect how group is actually functioning. Much of this living document mentality is a reaction to how I saw other investment groups being managed.  This rigidity included votes on motions had to be in person, cash was collected at these in person meetings, and so on. 

The in person meeting requirement was in our original operating agreement, but when members started to move away from the home turf of northeastern Minnesota, it became apparent that we needed to update our documents that stated how the group was to function.  This was accomplished by amending our operating agreement to allow any and all business to be completed through email.  This was instrumental in allowing an adoption of no longer having members physically located near one another.

When a member wants to call it quits and exit being apart of the group, there is a requirement to provide in writing – email is allowed, of course – at least 30 days prior to when the member wishes to officially leave the group. In addition, the group has up to one year plus a day to return the exited member’s money.  This exceptionally long time that is allowed for the return of moneys was originally thought of as a way to keep the group financially stable. With five original members, each with 20% ownership of the group, it was seen as being potentially catastrophic for the group to need to sell a significant investment simply to quickly payout for a departing member.

This provision was cited by a person in the group as preventing them from exiting the group when this person was in need of money to repay a court fine.  It was also cited as a reason that this same member does not think or worry much about their ownership in the group — it is just out of arm’s length for them to touch it and feel that they could spend it on something.

In all, we have amended our operating agreement at least six times.  Aside from striking down the in-person meeting and voting requirements and opting for a more modern way of conducting business, after several years of operation, the original members had built up a tidy amount of money in the group.  Friends of members were interested in joining the group, but did not feel they could invest an equal amount to the original members. A compromise was thought up where members with a certain amount of money in the group would have a full vote on business matters, while others with an amount of money lower than this amount, would receive one half vote.  This amount is calculated first by finding the following ratio: one divided by two times the number of votes in the group.  Then multiply this ratio by the total value of the group’s portfolio.  Above this amount, people get a single vote on group matters, and below this value, people get a half vote.

This has normalized voting power.  For example, at some point in the group’s existence, we removed, through an amendment, the requirement for equal ownership amongst the members.   For example, if two people in group were to conspire with each other, and amass a significant ownership stake, the thinking was that they would have undue influence.  Instead, even if a person was to own 95% of the group, they would still only have one vote on group matters. Instead, someone with just over 5% ownership in the group would also have a single vote, while those falling under this percent, would have a half vote.  Without this normalizing, and bucketing of vote strength, it would be easy for one person to essentially take control of the group.

The group has two “official” leader positions, a Director, and Assistant Director.  The Director and Assistant Director are both elected positions.  There is no term length defined, however, if someone in the group feels that someone else should be in one of these roles, they can call for an election by way a motion, and recommend a person for the position.

Within the operating agreement, we have different levels of agreement.  We have a simple majority in the affirmative for an action – this is simply over 50% are in agreement.  We have a supramajority vote that is defined as over 66% are in agreement.  We also have a vote classification that requires an agreement of 100%.  General actions like buying 10th anniversary custom coffee mugs required a majority vote.  The action to buy or sell an investment position requires a supramajority vote in the affirmative.

Since the group has all of its business conducted through electronic means, it was important to capture “an official record” of communications and actions.  Since the beginning, the group has had a mailing list. When we adopted the amendments striking down requirements to physically meet, we also added provisions for keeping, maintaining, and making available to members all communications from the mailing list.

Monetary Contributions

We have no set contribution amount for members.  At one time, we did, but we eventually reached what we felt was a sufficient dollar amount in the group, and we removed that requirement.  In theory, someone could join the group, contribute nothing and still have a half vote on business matters. This has not been the case, however. We have two members, each with a half vote, that made one time contributions, and have contributed no other money.

How do monies make their way into the group’s accounts?  The majority of contributions are through direct deposit. 

One of the key takeaways from my wife’s family’s investment club and the one that I started was automate as much as possible with regard to contributions.  Handling of actual money and having to make regular trips to the bank, when that is not something that you might normally do, is time consuming.  With members now spread all over the eastern half of Minnesota (and one beyond), physical collection would be too burdensome.

Bookkeeping

We use spreadsheets.  Our general accounting calendar is on a six month period. January 1 and July 1, mark the starts and ends of terms.  At the start of a new term, the portfolio’s value and any cash held in the saving and checking accounts is added up, the regular contributions from the members are verified, and a percent and dollar ownership value is calculated for each person.  This gets carried over to the next term, and is used as a way to gauge that next term’s gain or loss.

At the end of each calendar year, I generally write A Year in Review newsletter. It contains my general thoughts on the previous year’s investments for the group, as well as any administrative things that I see coming in the next year — such as people who have expressed interested in joining the group.  January, by the way, is when we admit new members. It means no new tax related things until the following year, and it gives the new person time to settle into the group’s ways of communication. The newsletter is definitely not up to the Warren Buffett level of musings, but it’s an attempt, at a macro level, to communicate where I see the group heading.  Each member’s newsletter, in the introduction section of the letter, has a personalized summary of how much their ownership in the group is worth, and how much of the group they own.

The one issue with bookkeeping in this six month rolling time frame, is that most of the information you are able to give members is out of date.  If a member is used to being able to log into their Fidelity Investment account, and get a daily snapshot of their mutual fund holdings, the method that we use is sadly lacking.  The timeframe of six months could be brought down to a finer grained span of time, but the disparate accounts (checking separate from the brokerage firm) makes it so there is limited cross visibility.  There are programmatic means, like Plaid, but this service does not provide the who a deposit was made on behalf of, you just know that a $25 deposit came from the University of Minnesota and was made into the account.  When you have four people in the group who all work at the University, this is not a helpful bit of information.

Likewise with being cumbersome, the brokerage does not have programmatic access to accounts. 

The group has a domain name and some hosting space/services that are used for the communications archive, in searchable form, available to members, as well as enough information to give members an end of day snapshot of where the group’s portfolio sits.

Takeaways

At least for a time, consider treating the money as throwaway money.  It is not say that you only make moonshot investment choices or put all of the money into a Canadian penny stock, think of the money as being unavailable to use for other things, as well as initially not thinking of this as a retirement account, was important in the early days.  It has also been important to make withdrawing completely from the group a very long process. It helped shape people’s mind in thinking the money was too troublesome to easily get at when there was an impulse to quickly get money.

Make contributing as frictionless as possible.  Direct deposit or any other no to very low cost way to moving money into the group has really helped with people just setting it, and forgetting it.

Make communication and decision making as frictionless as possible.  You still want checks and balances (e.g. 66% approval on making a money decision), but you want communication to be easy, and facilitate discussions.  It could be a mailing list, it could be a Google Group, it could be a Facebook group, or other thing that allows clear communication. Requiring each member to say in an email, “Yes” or “No” on a given action can help to eliminate uncertainty when coming to making actions.

Be open to investment ideas from all, discuss, learn, and develop a general group philosophy.  Maybe that means, you trend toward growth stocks, or maybe more toward value stocks.