Do you want to learn how to become an accredited investor? Here is a detailed guide about who an accredited investor is and how to become one.
An accredited investor has the opportunity to access better investment options. But, to do so, they must meet specific criteria set out by the Securities and Exchange Commission (SEC).
In reality, some investment options are not accessible to everyone wanting to grow an investment portfolio. These are, however, open to accredited investors who meet specific criteria. For instance, they either must earn more than $200,000 or have a net worth above $1,000,000.
This article teaches about what it takes to become an accredited investor, as well as the pros and cons of becoming one. With this, you can understand what you need to do to access most of the investment opportunities which were impossible for you before.
You will also learn how to take advantage of the accredited investor status to change your financial situation. Remember, a diversified portfolio is paramount in wealth creation.
Who Is an Accredited Investor?
The first thing in learning how to become an accredited investor is to first understand what it means to be one. What is the exact definition of an accredited investor?
Well, the best way to get a clear picture of this is by understanding the Securities Act 1993 Section D. This clearly defines who an accredited investor is by either their net worth or income.
According to this Act, an accredited investor is;
- Any natural person with a personal net worth or a joint one with their spouse that exceeds $1000,000. This excludes the value of the residence of the natural person.
- A natural person whose individual income has exceeded $200,000 in the past two recent years. Also, a joint income with the spouse that exceeds $300,000 in each of the two years is considered. But, they must have reasonable anticipation of a similar level of income in the current year.
Note the last part of the first bullet since it’s a recent addition to the definition. It was added in 2010 during the passing of the Dodd-Frank Act. Before this became law, a person’s net worth included the value of their primary residence. And after the passing, individuals with accredited investment status at the time weren’t affected.
An individual or a financial entity can become an accredited investor. And by doing so, they get to participate in unregistered investments, which are always deemed risky. The goal of accredited investing is to prove prowess in investing, which includes handling the tough times.
Usually, registered securities fall under the US Securities and Exchange Commission (SEC). You can take the risky route and target unregistered securities as an accredited investor. Accredited investors have reasonable expectations, and are always ready, no matter the outcome.
How Do You Become an Accredited Investor?
Jurisdictions differ when it comes to the rules that govern accredited investors. For example, in the US, the Securities and Exchange Commission (SEC) provides the exact definition of an accredited investor. This falls under Rule 501 of Regulation D.
Essentially, the two definitions listed above clearly detail what it takes to qualify as an accredited investor in the US. An individual must have a net worth of over $1000,000, which doesn’t include their primary residence.
In addition, one should have an individual minimum annual income of $200,000. But if you and your spouse's combined annual income is above $300,000, you can also qualify to be an accredited investor.
As for other entities, they’re considered an accredited investor if the organization or private company has assets exceeding $5000,000. An entity is considered an accredited investor on its own if the equity owners are accredited investors.
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What Are Some of the Recent Changes to the Accredited Investor Definition?
Investment advisors and registered brokers now fall under the category of accredited investors. This is after a modification to the accredited investor definition by the US Congress.
On 26th August 2020, the US SEC made an amendment to the accredited investor definition. The SEC press release stated that defined measures of professional knowledge make it possible for investors to qualify as accredited investors.
As such, knowledgeable employees, especially from a private fund, or individuals with certain professional certifications, can now get accredited investor status. However, they require certifications or experience together with a net worth or income test. The certification includes those issued by FINRA (Financial Industry Regulatory Authority)
These requirements of an accredited investor are crucial and serve a purpose. For instance, regulatory authorities in different markets need to protect investors. At the same time, they have a responsibility to market investments.
There is indeed a vested interest by regulators to market investments in a market. Such investments carry high risks despite having the potential to make huge returns. Also, the chance of failure is high, but the return is huge when successful.
At the same time, the regulators must protect investors with little to no knowledge of how much the investments work. These individuals usually don’t have any financial cover when things don’t work out as expected. This is why it’s crucial to have accredited investors with financial qualifications and investors who understand the market.
The only way to be an accredited investor is to follow steps set up by sellers of securities. This helps verify individuals' or entities' status with ambitions of becoming accredited investors.
Unfortunately, a formal process to become an accredited investor doesn’t exist. As such, issuing companies require your financial statements and credit report to ascertain that you qualify.
Is It Possible for a Non-accredited Investor to Invest?
Yes, it is possible to invest as a nonaccredited investor. But, you must keep in mind specific restrictions. For example, let's say company X wants to raise private equity to help it start a new business or invest in something different such as a hedge fund. In this case, anyone, including unaccredited investors, can invest in company X.
However, their opportunities aren't the same as those of accredited investors. How? As per SEC's Regulation D, only 35 accredited investors are permitted to provide funding for this company. The rest should be accredited ones.
As such, about 80% of investors are locked out of investment opportunities because of Regulation D. This leaves room for those with a high net worth or income to participate in investing.
Some of the states that allow nonaccredited investors to get equity or invest in startups include:
- Wisconsin
- Idaho
- Michigan
- Alabama
- Washington
- Colorado
- Indiana
- Tennessee
- Maine
- Georgia
- Maryland
How to know if you have Accredited Investor Status?
The best way to determine if you are accredited is by measuring your wealth. Remember, you have to have a personal wealth surpassing $1000,000. And this can’t include your primary residence listed as an asset. Measuring your wealth means determining your total net worth.
Economic resources or real goods with monetary value can be termed wealth. The total market value of the tangible and intangible assets minus the debts equals your net worth. Many people determine their net worth based on financial capability.
Apart from net worth, you can also determine if you qualify as an accredited investor based on your income. A qualifying factor is a personal annual income of $200,000 or a combination with a spousal income of $300,000.
A broad range of investment opportunities is available once you qualify as an accredited investor. If a trust or a business has assets worth $5 million, it qualifies as an accredited investor. Still, it’s possible even for nonaccredited investors to access the same opportunities.
The different investment opportunities that accredited investors qualify for include:
- Angel investing/Venture Capital funds
- Hedge Funds
- Commercial Real Estate
- Real Estate Syndications
- Farmland Crowdfunding
- Real Estate Crowdfunding
Further diversification is possible for folks who can access these different investment options. The risk is high, but so are the potential returns. It’s important to research and understand each investment opportunity and the potential risks.
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Pros and Cons of Becoming an Accredited Investor
Being an accredited investor has its good and bad days. Weighing the pros and cons can help shed more insight into the world of accredited investors.
Pros of Accredited Investors
There’s a definite financial advantage that comes with being an accredited investor. For starters, this isn’t something open to many individuals. At this point, you already earn a high income or have a top-tier net worth.
Such financial success makes it easier to access better investments. And such investments are out of the reach for folks with a lower income or net worth.
This is a chance that makes it possible to increase wealth because of the high rate of return. Such investments have better diversification and numerous positive attributes for wealth building. And, best of all, you can build this wealth at a shorter duration than most.
Accredited investors benefit greatly, for example, from hedge funds. They’re the only people with access to hedge funds because of the high minimum investment needed to join. It’s worth noting that the returns might be high, but so is the risk.
Cons of Accredited Investors
Being an accredited investor also has its fair share of challenges. To start with, there is a high-risk factor that accompanies investments open to an accredited investor. For instance, hedge fund strategies tend to carry high risk since it can be quite tough to beat the market.
On top of high risk is the high minimum investment required for funds. Take, for instance, private equity funds or hedge funds; it takes more than a few hundred dollars to get in. This requires anywhere from a hundred thousand dollars to millions to participate in accredited investing – if things go haywire, you lose everything.
In addition, the fees charged for investments done by an accredited investor are high. Charges include management and performance fees that range from 15% to 20%.
Lastly, access to your capital isn’t easy since the money can be locked up. This happens mostly in hedge funds and can last many years. It’s not the same as buying stocks since you can pull out your money whenever you want. Illiquidity is low when you become an accredited investor.
FAQs
How much can an accredited investor invest?
Generally, accredited investors have no limits as to the maximum amounts they can invest in their overall investment portfolios. However, every fund has its own limitations as to how much anyone can invest, whether accredited or unaccredited.
What are the accredited investor eligibility criteria?
In the US, you are considered for accredited investor status if your annual income is equal to or more than $200,000 or if your combined annual income with your spouse is at least $300,000. Also, if your net worth surpasses $1000,000, you qualify to be an accredited investor.
What's the benefit of being an accredited investor?
One, you are able to invest in a high-return investment like a hedge fund. This gives you an upper hand in growing your wealth even more. But you should note that these investments also have higher risks than most other investments.