By Jamie Johnson, WCI ContributorAccredited investors have access to high-risk, high-reward opportunities that aren’t available to the general public, like hedge funds and early-stage startups. However, you must meet certain eligibility requirements to take advantage of these opportunities. Oftentimes, you'd have to be an accredited investor.
The SEC limits access to these investments to individuals or entities that meet certain income, net worth, or licensing standards. If you're interested in becoming an accredited investor, it's important to understand what it takes and whether it aligns with your financial goals.
What Is an Accredited Investor?
When you buy stocks, bonds, or mutual funds, you’re investing in regulated securities. Though you can always lose money on these investments, they’re regulated by the Securities and Exchange Commission (SEC) to provide a certain level of safety and transparency to investors.
In comparison, private placements and certain cryptocurrencies aren’t regulated by the SEC, so they have fewer investor protections and they are considered riskier investments. As a result, these investments are only available to accredited investors.
An accredited investor is an individual or entity allowed to invest in securities that aren’t registered with the SEC. Based on either their income or financial expertise, the SEC authorizes accredited investors to buy riskier investments.
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What Are the Requirements for Becoming an Accredited Investor?
The SEC sets the requirements for accredited investors, and these requirements primarily center on an individual’s net worth and professional licenses. You can qualify if you meet one of the following three criteria:
- Your earnings exceed $200,000 for each of the previous two years or $300,000 in combined spousal income. You also reasonably expect to earn the same amount during the current year.
- You have a net worth exceeding $1 million, either by yourself or with your spouse.
- You hold a Series 7, 65, or 82 license in good standing—you should consult FINRA rules to see if any state rules apply to you.
The SEC puts these rules in place to ensure accredited investors are financially savvy enough for riskier investments and that they can weather any financial losses. These regulations protect lower-net-worth individuals from high-risk investments that could potentially wipe out their life savings.
Pros and Cons of Becoming an Accredited Investor
Pros
- Unique investing opportunities: Accredited investors can participate in deals that aren’t available to the general public. For example, you could invest in early-stage startups or participate in private placements of established companies.
- Potential for higher returns: Accredited investors gain access to alternative investments like hedge funds, private equity, and venture capital, which historically offer higher returns than traditional investments. In particular, private equity and venture capital funds can generate substantial returns by identifying and investing in high-growth companies before they go public.
- Diversified portfolio: As an accredited investor, you have access to diversification opportunities beyond just stocks and bonds. Real Estate Investment Trusts (REITs), commodities, and infrastructure investments can help diversify your portfolio and provide protection against market downturns. This diversification can be especially valuable during periods when traditional markets are struggling.
Cons
- Higher risk: Investments that have the potential for high returns are also associated with higher risks. Private companies can fail, and hedge funds can employ aggressive strategies that result in substantial losses. Many of these investments are speculative in nature, and it's not unheard of for accredited investors to lose their entire investment on a single deal.
- High minimum investment amounts: Most accredited investor opportunities require high minimum investments. This means you’ll need to have enough capital to not only qualify as an accredited investor but also to participate in these opportunities. High minimum investments can make it difficult to diversify across multiple alternative investments, forcing you to put all your money in just a few opportunities.
- Lack of transparency: Public companies are required to file detailed quarterly and annual reports with the SEC. In comparison, alternative investments often lack that same transparency since they aren’t regulated or listed on the open markets. This lack of transparency makes it harder for you to evaluate the potential risks or monitor your investments.
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How Do Firms Determine Whether You’re Accredited?
Firms will evaluate your income, net worth, and any professional credentials to verify your status as an accredited investor. Depending on which criteria you meet, you may need to provide the following documents:
- Income verification: If you qualify based on income, you’ll likely need to provide your W-2, 1099, or tax returns, along with a written explanation that you expect to maintain the same income level for the current year.
- Net worth verification: If you qualify based on net worth, firms may request recent bank statements, brokerage account statements, or credit reports to verify your financial status.
- Professional certifications: If you hold certain financial licenses, you’ll need to provide documentation of your active certification status, like a FINRA record.
- Third-party verification letter: You may be able to use a letter from a licensed attorney, CPA, or registered investment advisor confirming they’ve reviewed your documents and that you meet the criteria.
Once you've been verified, your accredited investor status may last for up to five years, depending on that firm’s policy.
The Bottom Line
Accredited investors have access to unique opportunities, but there are more risks involved. If you're considering becoming an accredited investor, make sure you meet the SEC's requirements and have your documentation in order.
But keep in mind, just because you have the ability to invest in something doesn't mean you should. Take the time to evaluate each new opportunity to ensure that the investments are in line with your long-term strategy.
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