Too Many Cooks Spoil the Profits: Investment Club Performance

Abstract

The financial press makes frequent and bold claims regarding the performance of investment clubs. One oft quoted figure from a National Association of Investment Club survey states that 60 percent of investment clubs beat the market. Are these claims myth or reality?

We analyze the common stock investment performance of 166 investment clubs using account data from a large discount broker from February 1991 to January 1997. We document that the average club earned an annualized geometric mean return of 14.1 percent, while a market index returned 17.9 percent. In addition, 60 percent of the clubs we analyze underperform the index. Not only did the average club fail to beat the market, it failed to match the performance of the average individual investor, who earned 16.4 percent during our sample period.

There are two reasons for the poor performance of investment clubs relative to individuals during our sample period -- trading costs and investment style. Despite having roughly similar account sizes, clubs execute smaller trades and hold more stocks than do individuals. Thus their proportionate cost of trading is higher. These higher proportionate trading costs account for approximately one-third of the clubs' performance shortfall relative to individuals. The remaining two-thirds of the shortfall are accounted for by investment style. Relative to individuals, clubs tilt more toward large stocks and growth stocks. During our sample period, large stocks underperformed small stocks (by 15 basis points per month) and growth stocks underperformed value stocks (by 20 basis points per month).

Investment clubs serve many useful functions: They encourage savings. They educate their members about financial matters. They foster friendships and social ties. They entertain. Unfortunately, their investments do not beat the market.

JEL Classification: G00, G12, G14