Per the United States Securities and Exchange Commission (SEC), certain types of investments are only available to “accredited investors”.
You qualify as an accredited investor if you have:
- At least $1 million in net worth or
- More than $200,000 in earned income during the past two calendar years.
You can also be considered an accredited investor if you are an investment professional holding a series 7, 65 or 82 license.
The accredited investor rule is designed to protect small investors from unregulated investments.
What is an accredited investor?
An accredited investor is an individual or organization that are permitted to invest in riskier investments that are not registered with the SEC. Most often, accredited investors are high-net-worth individuals or investment companies like family offices or hedge funds.
The U.S. Securities and Exchange Commission defines an accredited investor as an individual that:
- Earned income in excess of $200,000 (or, with a spouse, $300,000) in each of the last two years. You must “reasonably” expect to earn the same this year.
- Has a net worth of at least $1 million, either alone or with a spouse, not including the value of your primary residence.
- Is a “knowledgeable employee” of a private investment fund.
- Is a financial professional who holds a Series 7, Series 65 or Series 82 securities license.
The accredited investor rule is in place to ensure that investors have either the means or the know-how to invest in risky investments and absorb potential losses.
The rule is meant to help prove investors have the sophistication and means to invest in potentially riskier investments, as well as weather any losses.
As you might expect, not everybody believes the government should be dictating who can and cannot make certain investments. In 2023, Congress passed multiple pieces of legislation that will expand the definition of accredited investors. The expanded qualifications include:
- Individuals the SEC determines to have “professional knowledge through educational or professional experience”.
The SEC has discretion in defining what experience or credentials will satisfy this requirement, and the organization is required to review those requirements every 5 years.
Aside from individuals, certain entities can be accredited investors, too. Such entities include:
- Investment brokers
- Insurance companies
- Charitable organizations
- Trusts with more than $5 million in assets
- Any legal entity in which all shareholders are accredited individuals
Why are investments limited to accredited investors?
According to the SEC, the accredited investor rule is in place “…to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain the risk of loss, thus rendering unnecessary the protections that come from a registered offering”.
Investments that are limited to accredited investments include:
- Some online fractional real estate investing apps (e.g. Fundrise and Crowdstreet)
- Hedge funds that make speculative, highly-leveraged investments
- Private equity funds that invest in early-stage companies or risky takeovers
At the end of the day, the accredited investor rule is designed to protect investors from making an investment they either don’t understand or can’t afford to lose. All investments involve risk, but no investor should hand over their hard-earned money without fully understanding an investments risks and being prepared to suffer potential losses.
As an example, consider the difference between an SEC-registered exchange-traded fund (ETF) that you can buy on the stock market and a private equity fund. Both investments have risk, but the ETF meets stringent SEC requirements and is likely invested in a diversified mix of well-established public companies. The private equity fund, on the other hand, is not subject to the same onerous SEC requirements and invests in early-stage companies. While the potential reward for investing in the private equity fund may be far greater, there is also a significantly higher probability investors will lose 100% of their investment. That’s a prospect unaccredited investors may not be able to stomach.
How do I become an accredited investor?
The best way to become an accredited investor is to save and invest your way to a $1 million net worth. Although you can qualify as an accredited income by having an annual income in excess of $200,000, you must maintain that income for at least two years and expect to keep earning at least that much.
Although amassing a $1 million net worth seems like a lofty goal, plenty of everyday people are able to achieve this awesome financial milestone every year. The key is to begin saving as much of your income as possible and start investing for the long-run in a diversified portfolio.
Where can I invest as a nonaccredited investor?
You don’t need to be an accredited investor to invest in any publicly-traded stock, bond, mutual fund or real estate investment trust (REIT). You can open an account at any robo-advisor or online brokerage account and begin trading.
You can also invest via a retirement account such as IRA or 401(k).
All of the above investments are registered with the SEC and must follow strict requirements designed to protect the interest of everyday investors.
That said, many private investments are available to nonaccredited investors, too. You can obtain your own funding to purchase an investment property or start your own business. Indeed, individual real estate investing and entrepreneurship mints more millionaires each year than investing in the stock market!
To be an accredited investor you must have at least $200,000 of annual income or a net worth exceeding $1 million, not including your primary residence. You may also qualify if you are an investment professional holding certain licenses. The accredited investor rule is designed to protect investors from making investments they either don’t understand or can’t afford.
While being an accredited investor opens up a few new types of investments you otherwise wouldn’t have access to, there are plenty of ways to invest as a nonaccredted investor, too.