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The world of finance is as complicated as you think it is. Most investors have access to a whole slew of financial instruments:
- Mutual Funds
- Exchange-Traded Funds
- Index Funds
- Real Estate
While there are more financial vehicles to invest in, these instruments provide enough upside to satisfy most financial goals and just enough downside to limit most losses.
However, there are some financial instruments you may not know about. They are complicated and come with potentially huge risks for those who aren’t educated. This is why these instruments are limited to accredited investors only.
You might be asking what that is and how you can become one. We’re here to talk about that, so let’s dive in.
What Is an Accredited Investor?
Most of your investments will be registered with financial authorities such as the SEC. However, there are many instruments, such as hedge funds, that are not required to be registered. These come with restrictions regarding who is allowed to invest in them.
The term for those allowed to invest in unregistered financial instruments is “accredited investor.” If a company or individual sells an unregistered investment, they must sell only to accredited investors.
How Do You Qualify as an Accredited Investor?
To be considered an accredited investor, you only need to meet one of the below requirements:
- You have a net worth exceeding $1 million individually or with your spouse or partner. This does not include the value of your house – you need investments, cash, or cash equivalents exceeding $1 million.
- You have a gross income of more than $200,000 individually or more than $300,000 with a spouse or partner. This must be the case for at least two calendar years. In other words, you need your tax return to exceed those numbers depending on your situation. Even then, you have to show proof that you can continue making that sort of income.
- You have any of the accepted professional certifications or credentials.
Some of the certifications accepted include the Series 7, Series 65, and Series 82 licenses. These are the licenses issued by the Financial Industry Regulatory Authority (FINRA) for the General Securities Representative, Uniform Investment Advisor, and Private Securities Offerings Representative, respectively.
The first point may be fairly straightforward, but the second point is a bit tricky.
Let’s look at a quick example. As an individual, you made $201,000 (just made it!) two years ago, so you’re good.
You got married the next year, congratulations! You made $190,000, and your wife made $120,000 for a total of $310,000. This year you expect to make about the same.
You, in this example, would not qualify as an accredited investor. While you met the requirements two years ago, you need to meet the same individual requirement the second year and during the current year to qualify as an accredited investor.
Even though your combined income met the minimum for a married couple, you need to meet the requirement individually or as a married couple for the previous two years and the current year. It can’t be mixed and matched.
What Are the Benefits of Being an Accredited Investor?
If you do manage to qualify as an accredited investor, you gain the ability to invest in several types of securities that you wouldn’t as a regular investor. Hedge funds bring in most of the accredited investors. Though it’s simplifying it a bit, hedge funds trade funds for investors who must qualify as accredited investors.
In this way, they operate like any other managed mutual fund, except the fees, potential risks, and potential returns are higher. Other investments available to accredited investors include venture capital and angel investing, real estate investing (certain types), private equity investments, and equity crowdfunding. It is important to note that you don’t have to be an accredited investor to buy an investment property or a REIT.
Who Can Be an Accredited Investor?
Earlier examples were for individuals, but accredited investors could also be institutions and corporations such as banks, brokerages, trusts, LLCs with at least $5 million in assets, and investment advisors.
How Do Firms Determine Whether You are an Accredited Investor or Not?
It takes more than a smile and a handshake for an investment house to verify that you’re an accredited investor. You need to provide financial statements, tax returns, credit reports, or the certifications we mentioned as part of the application process.
Bottom Line: What Is An Accredited Investor?
The requirements to become an accredited investor shouldn’t be considered the same thing as a velvet rope keeping you out of a great party. Investing in hedge funds, tech startups, and commercial real estate sounds fun, but it’s not the same as buying a meme stock.
If you’ve amassed the money and income, the assumption is that you’ve taken care to educate yourself to a certain level about where your money is and what it is invested in. Whether or not this is true, remember that the first step in any investment should be fully understanding what you’re investing in.
Doing this repeatedly may get you to those minimums or at least get you on the right track.