Do you know the accredited investor definition? It takes money to make money. Becoming an accredited investor takes a lot. It also opens the door to various new investment opportunities to diversify a portfolio. Accredited investors can open almost any investment door not governed by the SEC they want with little opposition. It doesn’t even require a membership card or any certification.
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Requirements to Become an Accredited Investor
There are a few requirements to fulfill, but it is up to the investment managers to verify that all the boxes are checked. So how does one become an accredited investor, and what doors open up? Let’s find out.
Every day investors need very little to open a cash account and begin their investment journey. The case is similar for accredited investors.
However, they must fulfill certain requirements that the investment managers may check if they choose to. What are these requirements?
1. Accredited Investor Definition of Income
In terms of income, an individual must have at least $200,000 in each of the previous two years. For spouses, income must be at least $300,000. In both cases, there must be a reasonable expectation to maintain this income in the current year.
Income isn’t sufficient to be considered a part of the accredited investor definition. In addition, individuals or spouses must have an individual or joint net worth of at least $1M at the time of purchase.
It’s important to note that as of 2010, the value of the principal residence does not count in the net worth. However, cash, investments, secondary properties, and other assets are counted in the net worth.
Fun Fact: In 2020, over 13M accredited investors were in the US alone. This represents over 10% of the population and a total wealth of over $73T. In the last two years, this number most likely increased.
2. Other Qualifications
In 2020, the US Securities and Exchange Commission (SEC) added a few clarifications regarding accredited investors. Those who do not meet the requirements above can still be considered a part of the accredited investor definition if they meet any of the following requirements.
- Those who have applicable certifications, designations, and credentials (FINRA Series 7, 65, 82)
- Knowledgeable employees of a private fund
- Registered advisors with the SEC and the state
- Entities with over $5M in assets
3. Membership Card
Unlike most official accreditations, there isn’t a membership card, a course to pass, or an agency to contact. Likewise, there isn’t an official process to become an accredited investor. Instead, the company issuing the investment is responsible for performing the due diligence on their buyers. They perform a screening process and determine who is qualified.
Every country has a separate process for accredited investors. The requirements differ across countries. For example, Canada, Singapore, and Australia have similar requirements to the US.
In Europe and Norway, there are three tests (investment knowledge, quantitative test, and work in the financial sector). In India and Switzerland, a local counsel determines the eligibility.
What happens if someone lies? First, of course, the blame falls on the investment issuer. However, there can still be repercussions for the investor in the future. Therefore, it is best not to lie about it.
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Accredited Investor Pros and Cons
Access to a brand-new world of investments may seem mainly positive. However, the stock market is never an easy ride.
Pros
New investment opportunities: In the next section, we’ll discuss specifics. As I said, new doors are opened that some of us may never see.
Higher return potential: High risk, high reward. Some investments may exceed popular benchmarks such as the S&P or the DJIA.
Diversification: Don’t put all your eggs in one basket is a very popular metaphor among traders. More diversity doesn’t automatically mean higher returns, but it protects our capital and spreads the risk among many sectors and investment vehicles.
Cons
High risk: New investments such as hedge funds and private placements are riskier than an ETF or an index fund. There is a reason these investments are limited to knowledgeable and financially responsible investors.
Minimum investment: Certain investments require hundreds of thousands of dollars as a minimum investment. For some, this can be a sizeable proportion of their portfolio. However, not everyone can afford this.
Fees: Some investments charge high management and performance fees. Hedge funds used to live by the 2 and 20 rule. In other words, they take 2% as a management fee and 20% of profits. Nowadays, these numbers are much lower due to competitiveness. Today, the average is around 1.4% and 16.4%.
Time frame: Certain investments, such as private placements, have a long life. Returns don’t come quickly. Companies aren’t always profitable from the get-go. Growing and becoming profitable can take many years or even a decade. Hence, some investments have a very long time frame.
Investments Available to Accredited Investors
The investment vehicles below are all associated with higher risk. Therefore, before investing in any of them, it is important to perform proper due diligence.
1. Hedge Funds
Hedge funds seek to be profitable yearly, regardless of market conditions. Easier said than done. To attain this goal, hedge fund managers use various investment tools with varying degrees of risk.
Hedge funds will offer a presentation and previous returns to anyone qualified. Some truly benefit the rich, while others underperform the S&P. Don’t forget the hedge fund fees mentioned earlier.
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2. Startups
Anyone can become a millionaire. Startups grant generous stock options to their employees. They can also be very advantageous for early investors. There are many ways to invest in a startup. The most popular is through a venture capital company or a private placement. Below, we will discuss both. Recently, it also became possible to invest in a startup via crowdfunding. They are risky but can be worthwhile if the investment pans out. Indiegogo, SeedInvest Technology, StartEngine, GoFundMe, Patreon, WeFunder, and NextSeed are popular platforms. It’s important to note that most startups lock your capital for the long term.
3. Venture Capital
When an investor puts their money in a venture capital firm, the funds are usually spread across many investments and startups. It can be compared to a fund invested in different stocks, but the companies are much riskier, and the money is locked up for longer. Popular venture capital companies are YieldStreet, PeerStreet, and Cadence.
Accredited Investor Investments Definition
Private Placements: A private placement or private equity happens when a private company, such as a startup, requires funds for growth. Private companies can be at different stages of growth and industry presence. Reasons for funding can be to pay a debt, acquire a competitor, merge with another company, research & development, or stay above water.
Real Estate Investment Funds (REITs): Recently, REITs have been gaining popularity. They offer good returns, solid dividends, low risk, and added diversification. REITs invest in mortgages, commercial properties, and other real estate investments. It is possible to invest with them with a mutual fund, ETF, or directly in a public company related to real estate.
Simon Property Group (NYSE: SPG), Prologis (NYSE: PLD), and Public Storage (NYSE: PSA) are public REIT companies investing in different spheres of real estate.
ETFs are also very involved in the REIT business. Here are a few with the most Assets Under Management (AUM).
Vanguard Real Estate Index Fund ETF (NYSEARCA: VNQ) – $44B in AUM
Charles Schwab US REIT ETF (NYSEARCA: SCHH) – $6.5B in AUM
iShares US Real Estate ETF (NYSEARCA: IYR) – $5.1B in AUM
However, private REITs can offer even better returns to accredited investors. Remember, it takes money to make money. Yeah.
Final Thoughts
Knowing if you qualify as an accredited investor is now easy. Your eligibility depends on your income and net worth or specific certifications and qualifications. If you are, a variety of new and risky investments are available. Most of them are riskier than the average stock or ETF. Some even offer better returns. Furthermore, they offer some quality diversification for our portfolios. It is always important to perform adequate due diligence before investing.
If you want to learn more about profiting from the stock market, head to our free library of educational courses. We have something for everyone, including trading options for those with small accounts.
