The Death of Investment Clubs: Why It Could Be a Good Thing

The Death of Investment Clubs: Why It Could Be a Good Thing

Some Americans use the stock market as a reason to drink beer together, gab about the economy and pick their next investment. Investment clubs—small groups of people who gather to learn and practice investing together—were once very popular.

In fact, in 1998, there were over 400,000 Americans participating in local investment clubs around the country. Today, according to the Wall Street Journal, that number has shrunken by about 80%.

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After five years of erratic and, frankly, mediocre stock market performance, investment clubs have lost a lot of their cachet. Even the National Association of Investment Clubs has changed its name to BetterInvesting to reflect the new reality—Americans just aren't that into investment clubs anymore.

We’re Turned Off by Investing Itself

One of the broadest measures of the stock market, the S&P 500, has been up about 12% over the past five years—which isn’t so great, considering that the stock market’s historical return is an average of around 10% per year. And that’s piled on top of our collective memory of the stock market dropping over 50% between 2007 and 2008.

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It’s not just that people are disinterested in investment clubs … they’re shying away from investing as a whole. We can see this in historically low stock market volumes: The average number of shares traded daily on markets like the New York Stock Exchange hit a five-year low in 2012.

Since Americans aren’t that excited about their investing options, they seem to be voting with their feet—by leaving investment clubs.

Old-school investment clubs may have also given way to a new form of social investing that’s happening online. According to Nielsen, more and more investors are turning to financial sites, ranging from Morningstar.com to The Motley Fool, to research investments and get advice.

LearnVest certified financial planner Ellen Derrick has watched technology outpace these old-fashioned clubs: "I remember working with some investors back in late 1999 when they would all pool money to buy a couple shares of stock. Now, you can cheaply buy ETFs, which are so much better in terms of diversification and trading cost." So perhaps it makes sense that investment clubs have gone the way of the floppy disk.

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Are Investment Clubs Even a Good Idea Anymore?

Once considered as American as baseball and apple pie, investment clubs yield better results than going it alone … according to common wisdom, at least.

In 1998, the National Association of Investors Corporation (NAIC) reported that 60% of the 35,000 investment clubs in the U.S. regularly beat the stock market. However, two academics found that the opposite was true: Terrance Odean and Brad Barber determined that around 60% of investment clubs actually underperform the market. They also found that investment clubs actually perform 20% worse annually than individual investors picking their own stocks.

The culprit?

It appears that investors who participate in investment clubs pick riskier investments and trade more frequently, which makes sense when you think of the peer pressure involved with trying to outperform your friends.

In a nutshell? It may be good that we’re collectively giving investment clubs a rest.

How to Use This Trend to Your Advantage

Investors are a fickle bunch. We tend to display herd behavior, piling into the stock market just as it’s peaking, and fleeing from stocks at the very bottom of a bad market. This means that our intuitions are just plain wrong sometimes.

Investor sentiment—the collective measure of how positive or negative we're feeling about the stock market—is a contrary indicator because it is frequently wrong. If you want to predict which way the stock market is trending, you should probably do the opposite of what the majority thinks. Research has shown that it’s good to invest when sentiment is low.

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Currently, the relatively anemic number of shares traded daily on the stock market indicates that investors probably don’t think the stock market is headed higher, in spite of the fact that the S&P 500 is up over 10% during the past three months. Investing is always a risk, but investors’ negativity means that there could be a lot more room for the market to rise.

So, if you have an emergency fund, and you're ready to start investing, now could be a good time. The reality is that you shouldn’t be investing in individual stocks because the risks don't usually merit the rewards, yet investment clubs encourage just this. Bottom line: We're all for investing—but not in an investment club.

You Can Still Harness the Power of Clubs

When it comes to money issues, everyone can use the support of others at some point or another. "One thing that I have learned from working with clients is that peer pressure can be really good when you are trying to reach small milestones," says Derrick. "Your friends may not be able to help solve all your money woes, but they can certainly be the encouragement you need to not buy something at the spur of the moment."

But rather than getting together to prove who’s the most macho investor of ‘em all (like the investment clubs of old), utilize the power of your community by starting a money club with a group of supportive friends. You don't need to trade investment ideas, but you can encourage each other to invest in the first place—and keep each other's spirits up when the market experiences hiccups.

This is especially important nowadays, Derrick notes. "Having the support of a network of friends is crucial when the market is volatile because we tend to panic," she says. "People can easily understand buying low and selling high, until it comes to real dollars, and then all logic goes out the window!"

One of the pitfalls of old-school investment clubs is that they encouraged people to do what their friends were doing. "I used to do enrollment meetings for companies, and it would make me cringe to hear someone say, 'I'm just choosing the same fund that Bob chose,' " recalls Derrick. "Well, Bob happened to be 20 years younger, and probably had no clue which box he'd just checked."

Since everyone has a different life plan and level of risk tolerance, your portfolio should be tailored to you ... not to your friends. Instead, Derrick suggests getting together to discuss why you chose the same or different funds and how to read performance numbers, so you gain a better understanding of your own account.

For Derrick, there's an added bonus from learning from each other's experiences. "Hearing from Bob that he has no idea what he's doing," she notes wryly, "might give someone a reason to pause before following in his footsteps."

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