Member contributions - how much money should we put in?

Money is a key factor in the success or failure of an investment club. It is vital that there is agreement on the level of financial commitment required at the start.

Monthly financial contributions

Most investment clubs require monthly financial contributions from members. Many clubs also decide to set an initial lump sum payment at formation to enable the club to make its first investment quickly. At your first club meeting, you should decide on an appropriate subscription level. In most clubs, all members contribute the same amount. There is, however, nothing to prevent members having varying subscription levels. From time to time, a member may also find themselves in financial circumstances where they wish to temporarily reduce their contribution.

Other questions your club might want to consider are:

  • Should unanimous agreement be required in order to change the monthly subscription?
  • In the case of temporary financial difficulty, should a member be able to miss a limited number of payments? (this would of course need to be reflected in the number of units the member holds)
  • Should a penalty be imposed for late payment of subscriptions?
  • Should varying subscription levels for different members be permitted?
  • Should new members be required to contribute a stake equal to that already held by existing members, or should they simply make the regular monthly contributions?

Contributions by new members

When it comes to new members, there are two main approaches.

  • The first is to require the new member to make a lump sum contribution equivalent to the holding of current members.
  • The second is for the new member to simply start making the same regular monthly contributions as existing members.

The advantage of the first approach is that it means that all members have an equal financial stake in the club. While for many clubs maintaining equal stakes is not an important consideration, other clubs prefer all members to remain on an equivalent financial footing. The disadvantage of this approach is that it can put up a significant barrier to new members. This barrier becomes larger the longer the club has been operating, and the more successful it has been.

The advantage of the second approach is that it means a new member will not have to find a large lump sum to join. On the other hand, the club must have an accounting system that accommodates unequal stake holdings. The Unit Valuation System is such a system.

Keeping account

The accounting system discussed in Keeping Account easily handles varying contribution levels. If varying levels are agreed, those members contributing more will of course own a proportionately larger percentage of the club’s investments. Longstanding members will also have a bigger financial stake than those who have more recently joined the club.

Voting power

There are two schools of thought as to whether a member’s voting power in the club’s decisions should reflect their economic interest in the club. Some clubs operate on the principle of one person, one vote. Others provide that members have a say in the club’s operation in proportion to their financial commitment. There are arguments in favour of both options.

  • The one person one vote approach is simpler, with a show of hands being all that is necessary to make decisions. You may, however, decide that the proportional voting power approach is fairer, those members with more at stake financially having a greater say. This is particularly relevant when new members are admitted. If the club has been running for several years, it may not be fair to award a new member equal voting rights to longstanding members who have built up a sizeable stake over the life of the club.
  • To avoid any one member becoming a majority owner, many clubs have a rule providing that a member may not build a stake larger than, say, 20% of the total value of the club. Whatever approach your club decides to take to the question of voting power, it is important to spell it out in the Partnership Agreement. Remember that many members of investment clubs also invest on their own account. If a member wants to make larger contributions than other members are willing to make, an alternative is simply to use the extra money to invest as an individual.

What proportion of money should you commit to a single investment?

One of the most important principles of investing is diversification – the principle that your money should be spread over a range of investments. This means that your overall investment results do not depend entirely on the success or failure of any one investment.

  • It is wise to make sure your initial purchases are well-researched and relatively ‘safe’. In a perfect world, a club might wait until it has sufficient funds to invest in, say, five stocks before making any share purchases. The reality is that most clubs will be keen to start investing as soon as possible. Unless you decide to make a substantial one-off contribution at the outset, it is unlikely you will have the funds to make several investments straight away. Build up a strong base to your portfolio before you consider speculative investments.
  • Once you have been operating for a while, you will have built up a spread of investments. You should always remember the principle of diversification, but at the same time not spread limited funds too thinly. If you invest amounts that are too small, you will also find that transaction costs such as brokerage become significant as a proportion of the total investment.
  • The size of each parcel should be large enough that your successful investments return a significant amount. It is inevitable, if you invest for long enough, that some of your investments will be unsuccessful, and therefore important that your winning investments generate enough money to compensate for the losses on the unsuccessful investments.  If you spread your funds too thinly, this may not be the case.

Next topic: How are units valued?