myICLUB Blog

I'm not a fan of Exchange Traded Funds (ETFs) in investment clubs.

Some ETFs may hold securities that are problematic for partnership tax return preparation, such as commodities, precious metals, foreign companies, partnerships, or trusts. These ETFs present the same problems for treasurers as if the club owned the underlying securities.

ETFs may make distributions during the year that are recategorized after year-end. The distribution transactions previously entered into myICLUB must then each be modified by the treasurer to match the breakdown of transaction types as they were recategorized by the ETF management.

These types of after-the-fact adjustments can impact any member withdrawals that were made in the year, perhaps minimally (but that may not always be the case) and the club won't be able to correct any withdrawal overpayment.

Holding ETFs that track the broad market are quite possibly undoing the club's work at building a stock portfolio. If the club is going to invest in ETFs and not truly focus on building a portfolio, the only accomplishment of the investment club for members is to enforce a savings program that any member could undertake on their own at their own brokerage firm with whatever market ETFs they want to hold.

Some clubs also like to park excess cash in a broad market ETF. I don't like this process -- there are always, in every market, plenty of high-quality stocks that are great for clubs to own, so this practice of parking cash isn't really advancing the club's goals and may make members complacent about the portfolio.

With all of this said, members are certainly free to hold whatever they want in their portfolio as long as they are aware of the issues. I can see situations in an investment club that might be appropriate to use a targeted ETF to provide portfolio diversification aspects. For instance, a club may find financial stocks more difficult to analyze, and so may decide that a financial sector ETF could bring important diversification to the portfolio. Utilities and energy stocks are often difficult to analyze on the Stock Selection Guide because of the typical characteristics of companies in those sectors, so the club might decide to hold sector ETFs in those areas to improve the club's portfolio diversification.

Beyond that, it's hard to be able to justify holding ETFs or mutual funds in an investing partnership.

• DOUG GERLACH