What is the Unit Valuation System?
Want to totally confuse the
new members in your club? Try talking to them about the unit valuation
system. Truthfully, it's not a difficult concept, but it seems many
investment club members cannot grasp it. Hopefully, this article will
help you to make some sense out of it.
Most investment clubs operate
their accounting with something called the unit valuation system. The
unit value of the club is a representation of how the club is doing.
It's best to give an example.
Let's say there are only two
people in your club, you and John. You initially give $100 into the
club, while John gives $200. Most clubs start out with a unit value
of 10. Where you start the unit value really means nothing; 10 is just
a nice round number to start at.
If the unit value of the club
is 10, John bought 20 units (or shares), while you bought 10 units.
John - $200
/ 10 = 20
You - $100 / 10 = 10
So, you have $300 in your club.
You decided to buy Cisco (CSCO). 10 shares of Cisco cost you exactly
$300 with commission. Cisco has a great month, and rises to $40 by your
next meeting. Let's check the club valuation:
Total Net Worth
of the Club = $400 ($40 times 10 CSCO shares)
Total Units in the club = 30 (You have 10, John has 20)
To find the current unit value,
divide the Net Worth of the Club by the total units.
$400 / 30 =
The club has done well, so
the unit value of the club has risen. Next month, you give $200 to the
club, while John gives $100. Let's see how much we can buy.
John - $100
/ 13.33 = 7.5 units
You - $200 / 13.33 = 15 units
John now has 27.5 units in
the club, while you have 25, even though you both gave the same amount
of money. This is because John put more money in when the unit value
was cheaper, thus buying more units. You put more money in when the
unit value was more expensive, thus buying fewer units.
As your club evolves, the unit
value will fluctuate every day, depending on how the stocks you own
perform. Hopefully, if your club does well over the long-term, your
unit value will rise. The unit value will never change when members
make payments. It will only change due to stock performance, interest,
club expenses, and/or dividends from stocks. Let's check back to our
Now there are 52.5 units in
the club, and the net worth of the club is $700 ($400 plus the $300
just added). The unit value remains at 13.33 because making payments
never changes the unit value. Using a unit value system is a great way
to dollar cost average as well.
Remember, the unit value is
priced for purchase only on the valuation date of the club. Most clubs’
valuation date is the monthly meeting date. Be sure to state a specific
valuation date in your bylaws (monthly meeting date, 1st Sunday of every
Unit Value vs. Equal-share
Unit-based accounting is almost
universally replacing the "Equal-share" system. Why? Equal-share
systems can work when a club is just starting out, but when a club matures,
the buy-in for new members becomes too high. For example, if each member
of an equal-share club owns $5,000 in the club, that means that a new
member must contribute $5,000. Most experienced equal-share clubs end
up converting to a unit-based system.
Unit-based systems are fair,
and allow members to start out giving very small amounts, even $20 to
start. Some clubs don't like unit-based clubs, stating that the difference
between what an experienced member owns and what a new member owns can
be divisive. True. If one member owns $10,000 in the club, and another
owns $200, the newer member may not be as willing to work. This could
happen no matter what a club does, but it is important to put a cap
on what one person can own. For example, the club could state that no
member can own more than 25 percent of the club.
Where to Start?
Some clubs have set up spreadsheets
that compute the unit value. Today, there are many programs that will
do the work for you. We recommend getting your club started with myiclub.com,
which, for example, can print up-to-date reports of club holdings, member
share, capital gains, graphs of club performance, and even required
Federal Tax forms.