One of the questions I asked in my accredited investor post is whether the current definition of accredited investor is fair or not. 61% of you voted that the Securities And Exchange Commission (SEC) should not dictate who can and cannot invest in private offerings. Only 31% of you said the definition is currently fair, while the other 8% voted the SEC should raise the income and net worth limits.
As expected, some people shared their frustration in the comments section.
“I am not familiar with that term here in Canada but I was recently rejected for something I wanted to invest in because the company set terms for investors that I could not meet. It is a farmland REIT and investors must make $125,000 each year with the expectation that they will make that in the coming years and that they must have a net worth in excess of $400,000.
Very frustrating to be barred from solid investments. People must feel the same about the accredited investor title.
I will have to start buying lottery tickets if I want to hit accredited level.
The company I was interested in investing with, Agcapita, sells units in $5,000 blocks. I could easily manage that but I am still not welcome.
I spent an entire day ranting to family and coworkers and I felt a lot of resentment towards the company and the 1%. I am over it now but this is a very sound investment and I am stuck outside with my nose pushed up against the glass looking in feeling like the best investments are being kept from lower income people like me.”
“Living and working in silicon valley, I’ve had several opportunities to invest in friends or colleagues startups. However, not being an accredited investor, I’ve had to pass.
It’s incredibly frustrating knowing the tech and the people but not being able to share in their success.”
We know that the wealthy tend to get more access to everything – politicians, elite private schools, tax experts, better health care, more private deals, etc. Life isn’t fair and it’s easy to resent the rich. But let me tell you something that happens often in accredited investor land that may surprise you.
MISSING VERIFICATION PROCESS
When I invested in a particular private equity investment a long time ago, I had to fill out a form and check a box saying I was an accredited investor. Since the definition hasn’t changed in 30+ years, I still had to earn over $200,000 or have a net worth of over $1 million dollars. That particular year wasn’t a great year for bonuses and my W2 was definitely under $200,000. I also don’t think I had a million dollar net worth yet.
Despite not technically being an accredited investor, I checked the box saying I was and proceeded to invest $75,000 into the company. My rationale for saying that I was an accredited investor was basically what 61% of those who filled out my survey felt: the government shouldn’t dictate what I can and cannot invest in. I wanted to help my friend build his company and nobody could stop me from trying to participate. Furthermore, I had a strong belief that I would eventually become an accredited investor if I continued with my career in finance.
I’ve since talked to a dozen people about their first accredited investor investment and they all said they were either not accredited or borderline when they made their initial investments. Nobody I know has ever been penalized because they technically weren’t accredited investors at the time of investment.
We’d like to think the SEC established the accredited investor definition 30+ years ago to protect individuals from losing lots of money in private, illiquid, and potentially higher risk investments (not if you invested in Uber!). Lots of people became accredited investors due to activities that had nothing to do with investing in the financial markets. But one of the big reasons for the accredited investor self-approval process, as the Financial Samurai community has wisely pointed out, is that the offering entity also wants to be protected.
Imagine if the next “hot deal” was open to everybody. You can easily see some people who might not have a lot of money invest all they have for the chance of getting rich. Greed is a very powerful force, especially during a frenzy. If the investment goes south, the investment offerer doesn’t want to receive backlash from people who can’t take the financial hit. By self-accrediting, the investor essentially acknowledges that they have enough money to be eligible for the investment. Therefore, those who falsely self-accredit don’t have much recourse.
The government doesn’t have an accredited investor system in place to police everybody who wants to invest in a private offering.
INVEST WITHIN YOUR MEANS
The only way to never lose money is to never spend or invest any money. If you are truly an accredited investor, you’ve begun to focus more on capital preservation. Let’s say you’ve been able to accumulate a $2 million dollar net worth excluding your primary residence after 35 years of work. The last thing you want to do is shoot for a risky investment that may return 50% or lose you 50%! If you get down to $1 million by investing in something sour, you’ve got to make a 100% return just to get back to even.
I’m not telling people to say they are an accredited investor if they really aren’t by the government’s definition. I’m just letting folks know that I’ve never heard of the government punishing someone for saying they are an accredited investor when they aren’t. The only way I can see the government slap you in the face is if you are defiant enough to go after the investment offerer, despite knowing all the risks, and saying you had the money, even though you did not.
People who make over $200,000 a year or have over a million net worth shouldn’t gain preferential access to alternative investments over people who have less. If Yale University’s ~$25 billion dollar endowment has a 50% alternative investments target allocation, why can’t regular investors partake in just a 15% allocation towards alternatives? Surely the importance of growing an individual’s nest egg is equally as important as growing an endowment.
Invest within your means. Invest in what you know.
Note: The next step up from accredited investor is “Qualified Purchaser.” QP basically states you need to have more than $5 million in investable assets to participate in a particular private investment offering. There are nine points from the Investment Act Of 1940 that defines QP. Also, Title III of the JOBS Act passed, meaning that all Americans are allowed to invest in private companies after January 2016. The limit is $5K for income up to $100K and $10K for income between $100K – $200K.
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About the Author: Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $210,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
Updated for 2017 and beyond.