Potential Pitfalls from THe Motley Fool...

Investment Clubs Potential Pitfalls

Investment clubs, like many other things, offer much promise -- if you successfully avoid a few obstacles. Lest any Fool be caught off guard by these obstacles, we offer some words of warning below.

The Pitfall of the Pernicious Co-Member

Know that people you meet online or offline may not always be what they seem. This is far from merely a hazard of cyberspace -- its even been known to happen among friends. Theres always a chance that youll end up with a dastardly, unscrupulous person in your investment club. This is why, if your club is one that pools money and invests jointly, its important to set up the club formally. Dont neglect to draft legal agreements and bylaws. Take some precautions. Perhaps set up your systems so that two people have to sign off on any financial transactions. This is important even if your club consists of family members.

The Danger of Under-Delegation

This danger might seem less terrifying than the last one, but experienced investment club members have asked us to stress it. As one Fool noted: Delegate, delegate, delegate... or you will be stuck with most of the work. Take note of your groups dynamics and make sure that the work is being shared by all. Anyone who isnt contributing his or her fair share may be enjoying the free ride and/or may be losing interest because theyre not very involved. Anyone whos taking on too much may come to resent other club members and may burn out. Some might be reluctant to volunteer because theyre not confident of their stock-researching capabilities. Help these folks learn. Its in everyones best interest to get all members up to speed so that all can contribute.

The Entanglement of Ennui

Over time, club members might start to lose interest. This can be especially true if the market has been rising relentlessly (causing people to doubt the need for a club when it seems that any monkey can succeed in investing) or falling relentlessly (causing people to think that success in investing is impossible to achieve). It can be due to a club sticking to the same routine for several years, without injecting anything new. Keep your club alive. Take the pulse of your members (figuratively). Are they still excited to be in the club? Do you all need a field trip or guest speaker to liven things up? If you ever feel your club is in trouble, tap the experience and counsel of others in our Investment Clubs message folder.

The Jeopardy of Jelly Donuts

Club members can tire of the same snacks each month. Try new treats. Perhaps refreshment duties should be rotated among all members. Dont let your fellow members fall into a not-jelly-donuts-again stupor.

The Snare of Subterfuge

A club that isnt paying attention might find itself derailed by a member who has veered off toward unsound investing principles. Be vigilant. If a member is all excited about some article that sings the glories of technical investing, or a friends enthusiasm over a particular penny stock, be careful. Stick to the fundamentals, such as a companys earnings, growth, competition, and future. Otherwise, you might wake up one morning and find that your clubs portfolio has half its funds invested in South American gold mining ventures!

The Booby Trap of Time

Investment clubs take time. Make sure that you and your fellow members have the time to devote to it and are willing to devote that time. If you figure about one to three hours for a monthly meeting and two to four hours of research or work preparing for the meeting, that comes to three to seven hours that youll have to commit each month. This is probably manageable for most people, but make sure that everyone has clear expectations. Broken up, it could be two or fewer hours per week.

If this still sounds like a lot of time, consider the alternative. If you want to invest successfully, youre still going to have to spend some time researching stocks and following companies youve invested in. For many people, participating in an investment club isnt adding significantly to the amount of work theyd do anyway. And remember that you also reap the benefit of the hours of work of many other club members.

The Menace of Math

This may seem obvious and silly, but make sure that youre performing your math correctly. An incredible example of what we mean by this is provided by none other than the Beardstown Ladies. Apparently, their impressive 20-something-percent average annual return is kind of wrong. It seems that when calculating their return, they counted as appreciation all the dues they had contributed. Using such a system, even if their investments returned zero percent, they would still have sizable gains from the dues that were continually added to the pile. Fear not, though. This doesnt have to happen to you. The National Association of Investors Corp. (NAIC) offers instructions and software on how to keep track of your contributions and gains -- and your friends at the Fool hope to offer such stuff, as well, in the near future.

Its true -- there is math involved in investing. But you can get by just fine using good old addition, subtraction, multiplication, division, and percentages. Calculus, trigonometry, and logarithms are not required.

The Hazard of Humorlessness

Keep things fun, fellow Fools! Remember the words of that great investor of yore, Mary Poppins (if she invested, can you imagine her being anything but great at it?): A spoonful of sugar helps the medicine go down. Learning about investing isnt as bad as swallowing some bitter tonic, but its sure easier to do when youre having a good time. Never think that a sense of humor detracts from sound investing. If you ever find yourself forgetting this rule, check out some of Warren Buffetts enlightening and amusing annual letters to his shareholders -- available at http://www.berkshirehathaway.com/letters/letters.html.

-- Anonymous, January 05, 1999