Withdrawal Penalty

There is often considerable misunderstanding about the use and consequences of withdrawal penalties/fees. The BetterInvesting sample partnership agreement has always included (paragraph 20, Terms of Payment) a 3% "penalty" on cash withdrawals (but not on withdrawals paid by transfering securities). This sample agreement was written in the 1950's when broker commissions were much higher than they are today. (See the BetterInvesting Investment Club Operations Handbook, 2004, page 60.  The sample agreement is also available here and here on the BetterInvesting web site.)

Some clubs think a withdrawal penalty will cut down on members leaving, or that they deserve a fine for the 'trouble' of processing a withdrawal. We all should keep in mind that membership in an investment club is NOT a marriage, ‘til death do you part. People have a right to move on when appropriate for them, without leaving part of their money behind for others to have an increase in their unit values. Treat members as you want to be treated.

It has been my observation that constant withdrawals reflect problems within a club. Perhaps something is going on in the club that is making meetings unproductive or tense, lack of cooperation, one group overbearing, etc. Educational growth may be lacking, resulting in poor portfolio choices. Another factor is members are taken in too casually, without expectations being clear, and when they realize they are expected to put in some time and effort, they bail out.

If your club is working well, members are learning, taking part in their assignments, good portfolio choices are being made and the atmosphere is organized but fun, then people won't be leaving all the time.

Perhaps the following example, exaggerated for clarity, will illustrate the inequity of imposing anything more than actual costs on member withdrawals. Assume a club with a market value of $10,000 and five members (A, B, C, D and E), each with a value of $2000. The club has a 10% WD penalty. (All values have been rounded to dollars.)

A withdraws $2,000, less 10% penalty of $200, receives $1,800.
Four members remain, now worth $2,050 each. Club value is $8,200.

B withdraws $2,050, less penalty of $205, receives $1,845.
Three members remain, now worth $2,118 each. Club value $6,354.

C withdraws $2,118, less penalty of $212, receives $1906.
Two members remain, now worth $2,224 each. Club value $4,448.

D wants out so the partnership disbands, as it cannot continue with just one member.
Fees cannot apply upon disbanding, so D and E each leave with their $2,224.

D and E received their original $2,000 value plus 11% extra (the accumulated withdrawal fees from A, B and C). Everybody else lost. If the club had used no penalties (beyond deducting any actual cost, which would not change club value) each member would have left the club with $2000.

Now, which method is more fair to each and every member, whom we hope are at least friendly colleagues? And do you really think the average prospective member can foresee this effect when they are told about or read the paragraph about a 3%, 5%, or higher withdrawal fee?

Rather than a withdrawal fee, I would suggest clubs have a minimum three visit application process, and use a new member fee, say a flat $50 to $75, that does not buy units. This is fair if everyone pays it. This tends to discourage too early withdrawals, as most would stick around long enough to recoup that amount in gains.