What Does It Mean To Be An Accredited Investor?

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Some investment options such as hedge funds are only available to “accredited Investors.” Commission-based salesmen of these types of investments will often characterize this exclusivity as a feature saying something like, “You know not just anyone is allowed to get into this investment. You have to be an accredited investor in order to be eligible for me even to make this offer.” Such salesmanship is not technically lying, but it is certainly not being truthful either.

It is true that the current definition of an accredited investor is anyone whose net worth with their spouse but not including their primary residence is over $1 million or whose income exceeds $200,000 or $300,000 together with a spouse. But the investment’s exclusivity is in no way a selling point.

Here is the definition of an accredited investor from the Securities and Exchange Commission’s (SEC’s) investor bulletin “Accredited Investors (emphasis and italics part of the SEC’s document)

What does it mean to be an accredited investor?

Under the federal securities laws, a company or private fund may not offer or sell securities unless the transaction has been registered with the SEC or an exemption from registration is available. Certain securities offerings that are exempt from registration may only be offered to, or purchased by, persons who are accredited investors. One principal purpose of the accredited investor concept is to identify persons who can bear the economic risk of investing in these unregistered securities.

Unlike offerings registered with the SEC in which certain information is required to be disclosed, companies and private funds, such as a hedge fund or venture capital fund, engaging in these exempt offerings do not have to make prescribed disclosures to accredited investors. These offerings, sometimes referred to as private placements, involve unique risks and you should be aware that you could lose your entire investment.

To be clear: Being an “accredited investor” means that companies can sell you investments such as hedge funds without complying with all the regulation and disclosures that would normally be required. It is simply the SEC assuming that you should know better all by yourself and therefore they don’t require any of the regulations that normally aim to protect less experienced investors. Hedge funds use Rule 506 as their exemption since it provides unlimited investing to accredited investors.

Not all investments using exemptions are bad investments. But being an “accredited investor” is not a selling point. Any hedge fund salesmen who leaves you with the impression that an investment’s exclusivity is a selling point is misleading you. You should run from any so-called financial professional who misleads you. You can’t make a good investment with a bad person.

Hedge funds break several of our safeguarding your money principles: The hedge fund normally has custody of your assets. They market their past performance while ignoring the graveyard of funds they have closed. They invest in illiquid assets. Some include options that on average go down. They imply their have secrets of how to make money. And they often lock your investment for several years.

These are some of the important reasons to avoid investments such as hedge funds. But just because someone has a net worth of $1 million doesn’t mean they know these principles on how to safeguard their money. The threshold of $1 million of investable assets was originally set in 1982. When adjusted for inflation that is the equivalent of $2.6 million at the end of 2017. But any definition based on net worth is still a flawed definition. Many people who have over $3 million in investable assets have little investing experience. SEC regulation will not protect you from the wolves of the financial services industry. But after reading this article you can protect yourself.

Run from any so-called financial professional who leaves you with the impression that being an accredited investor gives you access to exclusive and therefore better investments like the ones he or she is offering. And judge every investment and investment advisor by the principles of safeguarding your money.

Photo by Ali Marel on Unsplash

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.