Alto provides access to wide variety of investment platform partners across a range of asset classes, some of which require investor accreditation. So if you’re new to alternative investing, you may be wondering what an accredited investor is, what qualifies someone as accredited, and how to become an accredited investor.
While there are definite advantages to being an accredited investor—namely expanded investment opportunities—you need to meet certain conditions in order to qualify.
Here, we’ll be discussing what an accredited investor is, the benefits of being one, and the requirements for accreditation.
What Is an Accredited Investor?
An accredited investor is a person or entity allowed to invest in most securities not registered with the Securities and Exchange Commission (SEC). This means they have access to a broader range of securities and investment possibilities than the majority of people who are not accredited investors. Such alternative investments include:
- Venture capital
- Private equity
- Hedge funds
- Certain real estate investment funds
- Specialty investment funds
To qualify as an accredited investor, however, you need to meet specific requirements related to personal income, investment experience, or net worth.
Why? The SEC affords accredited investors greater opportunities because it sees them as having a higher degree of financial sophistication and investment expertise, as well as a greater capacity to absorb large losses on their investments.
The requirements for accreditation are demanding since many of these investments that are not registered with financial authorities like the SEC have limited transparency. This means that there is no obligation to disclose much information to the general public, increasing the level of uncertainty associated with these investments.
Accredited investors are expected to be able to withstand these risks without much regulatory intervention. Additionally, private investment products often are complex and difficult to understand, which is why, for better or for worse, the SEC seeks to “protect” non-accredited investors from what they deem “riskier” investments.
Unfortunately, this has the unintended consequence of preventing many retail investors from participating in opportunities with the potential to generate outsized returns or from adding meaningful diversification to their portfolios. Luckily, you don’t have to be an accredited investor to invest in all alternative assets thanks to recent legislation including the JOBS Act, which has made it possible for millions of everyday investors to participate in offerings that had been historically restricted from them.
Alternatives—such as startups, private equity, and more—offer:
- The potential for higher returns than can often be achieved in public markets. In fact, private equity has materially outperformed public market indices over long periods.
- An opportunity to add true diversification to your portfolio, as many have a low historical correlation with returns of traditional investments like stocks and bonds.
That said, there are still many investments that do require accreditation status. Next, we’ll discuss the requirements to become accredited.
How to Become an Accredited Investor
To qualify as an accredited investor, you must fulfill at least one of the following criteria:
- Have an income of more than $200,000—or $300,000 if combined with a spouse’s or spouse-equivalent’s income—the past two years with the expectation of the same minimum level of income in the current year.
- Have a net worth (assets minus liabilities) of over $1 million, either alone or with a spouse or spouse-equivalent. (Keep in mind that the net worth calculation excludes the value of your primary residence, but can include the value of your retirement accounts.)
- Hold in good standing any of the following securities licenses: Series 7, 65, or 82.
To explain how net worth is calculated, let’s assume you have the following hypothetical balance sheet:
|Bank account||$150,000||Student loan||$35,000|
|Stock market investments||$500,000||Car loan outstanding||$20,000|
Your net worth is determined by subtracting your total liabilities ($55,000) from your total assets ($1,105,000). So in this case, your net worth would exceed $1 million, meaning you fulfill the second requirement for accreditation.
It’s worth noting that when calculating net worth, your primary residence and related mortgage values are typically not considered. However, there are two exceptions to this rule:
- If your loan amount exceeds your fair market value. This kind of loan is called an “underwater mortgage,” and the excess of the loan over the value of the house is counted as a liability.
- If you have a remaining balance on a home equity line of credit, meaning you borrowed against your existing home equity.
No formal agency confirms accreditation status or issues certification, but in connection with certain securities offerings, the SEC does require those selling to accredited investors to verify the investor’s status. If you invest in such offerings, you may be required to prove you qualify for accreditation by submitting bank statements, brokerage statements, W-2s, or letters from an accountant or attorney. For most private offerings, however, self-certification on the issuer’s website is sufficient.
Who Can Be an Accredited Investor?
In August 2020, the SEC amended the definition of an accredited investor and broadened it to include more qualifiable entities. As per the amendment, the following entities can now be classified as accredited investors:
- Individuals with specific professional qualifications, certifications, or credentials
- “Knowledgeable employees” of a private fund
- SEC- and state-registered investment advisors, among others
Based on the criteria outlined, accredited investors tend to include:
- High net worth individuals (HNWIs)
- Large banks
- Insurance companies
- Brokerage firms
- Employer-sponsored retirement plans
- Certain trusts
- Registered Investment Advisor (RIA) firms
- Limited liability companies with $5 million in assets
- SEC- and state-registered investment advisors
- Exempt reporting advisers
- Rural business investment companies
Still, it must be noted that while the new language is a step in the right direction, it stopped short of providing the opportunity for anyone to “test in,” and accreditation remains out of reach for many.
How Do Investment Funds Verify You Are an Accredited Investor?
If you’re looking to invest in a fund that requires accreditation, you’ll likely be asked to fill out a questionnaire to verify your qualifications to be an accredited investor.
You may also need to submit financial documents such as balance sheets or income statements to establish whether you meet the aforementioned qualifications. They may also choose to examine your credit history.
The concerned fund or company is responsible for conducting their due diligence and ensuring applicants are accredited. Failing to do so could result in their offering being disqualified under securities laws.
Regardless of status, it’s up to you to do your due diligence. Investors should always read a fund’s prospectus and investment mandate before making an investment. And as always, consider hiring a financial advisor or investment professional to help guide you and provide recommendations.
Things to Keep in Mind About Alternative Investments Requiring Accreditation
Some alternative investments come with high levels of risk. Strategies like private equity utilize large amounts of debt to achieve higher returns, while hedge funds use derivatives to enter long and short positions, increasing risk.
Additionally, there are often restrictions on withdrawing capital from such investments. So if you need a certain amount of liquidity at regular intervals, these investments may not be the way to go. (It’s for this reason that a self-directed IRA can be a great vehicle for alternative investments, as you must wait until account maturation to take distributions without being penalized.)
It’s also worth noting that many private investments charge high fees, including operating and performance fees. For example, hedge funds and private equity typically have a “2 and 20 structure.” This means 2% of the net asset value (NAV) of the fund is paid as management fees, and 20% of the profit is a performance fee, which is paid to the manager if a specific hurdle rate or a high-water mark is crossed.
Alto Gives Accredited and Non-Accredited Investors Alike Opportunities to Invest in Alternatives
As an accredited investor, you can invest in private equity and other unregistered securities not available to the general public. It is up to the firms selling the unregistered securities you’re interested in to put you through their own screening process and determine whether you’re an accredited investor.
Even if you don’t qualify as an accredited investor, you still have access to myriad investment options.
Alto provides opportunities for accredited and non-accredited investors to do more with their tax-advantaged retirement funds. Open an Alto IRA today to start investing in alternative assets, including private equity, venture capital, real estate, securitized collectibles, and even crypto.