In discussing becoming an Accredited Investor people tend to think of it opening some special door to wondrous investments. So what exactly is an Accredited Investor? How do you become one? Does it open the door to riches or is it just another overhyped milestone?
What is an Accredited Investor? So what is an Accredited Investor? An Accredited Investor is someone who under SEC rule 501 regulation D is allowed to purchase unregistered securities. In essence, there are certain investments that can’t be registered with the SEC. An Accredited Investor is allowed to purchase these securities.
Why Are Some Investments Not Allowed to be Registered with the SEC?
These securities may be unregisterable because they invest in instruments that are less transparent. For example, a hedge fund that does not report it’s holdings to others so they can’t copy it’s investment choices. Or it could be to invest in an instrument where the requirements to provide the information necessary to register may be too costly. A good example where registration may be too costly might be a syndicated crowdfunding investment in commercial real estate.
Why are there Limits on whom can Invest?
The general purpose of these rules is to protect unsophisticated investors. To this end the SEC limits accredited investors to those that meet one of two requirements:
- Exceed 1 Million dollars in Net Worth as a household excluding your home.
- Have an income of at least $200K as an Individual or $300K as a household for each of the last 2 years. There needs to be an expectation of making the same amount next year.
How are Accredited Investors Validated
In general, the firm you are doing business with has a duty to screen you for these requirements. Each firm decides what that screen involves including various levels of verification. In my personal experience most verification processes are fairly lax, merely taking your attestation that you exceed the requirements. Some companies do actually check your financial statements or W-2, but I have found that to be rare. Still, I would not recommend you pretend to qualify when you do not. Should an impropriety occur somewhere down the road by your investment provider it would make it exceedingly difficult to get your money back in court.
Accredited Investor Rules Do Not Ensure Sophistication
So before we go any further I have to point out. It is kind of ludicrous to expect that income or Net Worth defines a sophisticated investor. How many lottery winners lose all their money due to poor investment choices? How about sports stars or actors? Even doctors tend to have a reputation as poor investors. All of these folks tend to have higher net worths or income, yet as a whole have a reputation of making poor investing choices. This leads me to one conclusion. The real value of setting the bar of income or wealth for an accredited investor is probably one of the following:
- The ability to sue someone for financial shenanigans?
- The ability to survive losing your investment.
Not exactly a comforting scenario to contemplate as an accredited investor. But does that mean all such investments are a bad choice? Or like in my opening supposition are the rich just keeping people out of the good investment options?
There are Many Poor Accredited Investments
Well, there certainly have been some real stinkers as accredited investments. Bernie Madoff’s hedge fund comes to mind. In fact, most hedge funds come to mind as they tend to lag index fund investments.
But what about other types of accredited investments? There are venture capital, equity crowdfunding, private placements, and even private equity. Are some of these investments good choices for the newly crowned accredited investor?
Our Accredited Investment Experience
Well, without revealing too much about our assets or income, we have been accredited investors for some time. So what investments have I done during this time? The answer, none. Now I certainly have considered some accredited investments. I have considered equity crowdfunding of real estate, real estate syndication, and honestly, I might even be tempted to buy some private equity.
Honestly, I haven’t invested in these areas not because these investments are universally bad. No, the real reason is I have yet to find the right investment. In fact, I even wrote a piece on my future plans to participate in real estate crowdfunding, so I am not closed to the possibility.
Accredited Investments are Not Vastly Superior
Which really brings me to my own conclusion. Just like non accredited investments, the vast majority of choices for accredited investments are crap. There are some diamonds in the rough, but not so much as to provide vastly different outcomes pre or post qualification. I.E. there is some value to becoming an accredited investor, but it’s not really a case of the rich having vastly superior significant choices over the rest of us.
Lack of Transparency Means More Risks and More Due Diligence Needed
But… unlike the regulated investment world, the accredited world has additional risks. The lack of transparency leads to more events like what happened with Madoff. Even those investments not involving ripoff artists tend to skew towards taking advantage of the opaqueness. That means to have a successful investment in one of these areas you need to step up your due diligence significantly.
Accredited Investments have their Place, but also should be Limited
Most private investors just don’t have the time necessary to do that due diligence on any scale. Which really means that even if you become an accredited investor it is doubtful that such investments will ever become a significant portion of your investment choices (at least if you are not a full-time investor or foolish).
Ultimately the accredited investor requirements are quite absurd and a bit classist. But honestly, that still doesn’t make this class of investment the right choice for most investors. It might open some doors to a few more options, but don’t let it appreciably change your investment approach.
So what do you think? Are you an accredited investor? Have your investments changed significantly since becoming an accredited investor?