You’ll have to jump a financial hurdle to become an accredited investor, but the reward is access to a larger pool of investment opportunities.
You may have heard the term “accredited investor” thrown around in investment circles and wondered what you have to do to get such accreditation in the U.S. The simplest answer is that you need to have a lot of money or a sophisticated relationship with investments. If you qualify as an accredited investor, you can access investments that are not regulated by the Securities and Exchange Commission and participate in private capital markets.
What does it take to become an accredited investor?
In the U.S., there are specific rules and regulations that separate accredited investors from everyone else. The Securities and Exchange Commission defines an accredited investor in Rule 501 of Regulation D. The rule sets out several ways for the average person to become an accredited investor. You can qualify as an accredited investor in the following ways:
- If you have an individual net worth, or joint net worth with your spouse, of more than $1,000,000. This does not include your primary residence.
- If you have an individual income of $200,000 or more in the last two years or a joint income with your spouse of $300,000 or more in the last two years. You must also have a reasonable expectation of reaching the same income level in the current year.
- If you are a general partner, executive officer, or director for the company that is issuing the unregistered securities.
- If you have professional knowledge, experience, or certifications that prove your understanding of unregistered securities.
You won’t get a fancy-looking certificate in the mail when you reach such an income or knowledge threshold. That’s because the company or person with whom you’re investing is the one responsible for guaranteeing you meet the requirements. As such, expect to provide them with receipts for your net worth or income or professional qualifications before being allowed to invest.
What does the income of an accredited investor look like?
Everyone’s income and income stream looks different. If you’ve met the income threshold of $200,000 per individual or $300,000 per couple for the last two years and have expectations of that continuing, you won’t need to fuss with additional computations.
If you don’t meet the income test, you’ll need to assess your net worth. Your primary residence doesn’t factor in the assets category, but it could factor in the liabilities category if you’ve taken out a home equity line of credit or are underwater on your mortgage.
To start, add up any balances on your bank accounts, 401Ks or IRAs, other investments (such as investment properties), and the value of any other assets (vehicles, art, jewelry, etc.). Next, subtract money owed on loans (car, student debt, etc.), any liabilities (including mortgages on investment properties), and any money owed on a home equity line of credit or the amount your mortgage is underwater. Finally, subtract your liabilities from your assets. If the end number is greater than $1,000,000, you qualify as an accredited investor.
Here’s an income scenario that meets the $1,000,000 threshold:
- Value: $650,000
- Mortgage: $400,000
- Bank accounts: $40,000
- IRA/401Ks: $350,000
- Brokerage accounts: $200,000
- Investment properties: $800,000
- Other assets: $50,000
- Total: $1,440,000
- Home equity line of credit: $0
- Vehicle loan: $20,000
- Investment property mortgage: $400,000
- Total liabilities: $420,000
Assets ($1,440,000) – Liabilities ($420,000) = Net worth ($1,020,000)
Why care about being an accredited investor?
Reaching this level of financial security allows you to buy and trade securities and investments in private capital markets where the risk is high due and there is less regulation. Accredited investors are able to invest money into
- Private equity funds
- Private placements
- Hedge funds
- Venture capital
- Equity crowdfunding (some crowdfunding platforms do accept from non accredited investors), and
- Real estate syndications
Risk vs. rewards of being an accredited investor
The U.S. government sets a relatively high threshold for becoming an accredited investor because the risks of such investments can be high. It wants to make sure that investors are financially savvy and can withstand the losses. On the flip side, the potential for return on investment can be higher than with traditional investing.
Ways to increase your earnings and net worth
To become an accredited investor, you may need to increase your wealth. You might switch jobs for bigger earnings or look to real estate to grow your own net worth. Flipping houses, building a rental property portfolio, and other real estate investments can be done with surprisingly little money down.