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To purchase certain investments, you must be an accredited investor. But what does that mean, and how do you know if you qualify?
What is an accredited investor?
An accredited investor is a person or a legal entity (like a financial institution or a corporation) who is allowed to participate in investments not registered with the U.S. Securities and Exchange Commission. 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.
According to the SEC, an individual accredited investor is anyone who either:
Earned income of more than $200,000 (or $300,000 together with a spouse) in each of the last two years and reasonably expects to earn the same for the current year, or
Has a net worth over $1 million, either individually or together with a spouse (excluding the value of a primary residence).
Legal entities that can be considered an accredited investor include banks, investment broker-dealers, insurance companies, any entity in which all equity owners are accredited investors, and trusts with assets that exceed $5 million.
How do you become an accredited investor?
There’s no certification offered to prove you’re an accredited investor. Instead, companies selling investments to accredited investors are required to take steps to verify you qualify.
That likely will mean you must release financial statements — such as W-2s, tax returns, bank and brokerage statements — showing your current net worth is more than $1 million (your primary place of residence not included) or that you had income in the past two years that qualifies.
» Find your net worth by using our net worth calculator
In August 2020, the U.S. Securities and Exchange Commission expanded its definition of individuals and organizations that qualify as an accredited investor. The updated rules allow individuals who are "knowledgeable employees" of a private fund to qualify as accredited investors, as well as financial professionals who have Series 7, Series 65, and Series 82 financial securities licenses.
For most retail investors, the biggest change will be allowing a "spousal equivalent," such as a live-in significant other, to be considered when looking at total household income or savings to determine if you qualify as an accredited investor.
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Why do you have to be an accredited investor?
The rules regarding accredited investors are governed by SEC Rule 501 under Regulation D of the Securities Act of 1933, a government response to the Great Depression.
Also known as the “truth in securities” law, this act improved financial disclosure requirements so investors are informed about the investments they are buying. It also tightened rules prohibiting fraud and misrepresentation in the sale of securities.
The accredited investor exemption seeks “...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,” the SEC says.
Examples of investments that require accredited investors:
Hedge fund investments. Since hedge funds can invest in more speculative investments, they only accept accredited investors.
Can nonaccredited investors invest?
Yes. Any publicly traded stock, bond, mutual fund or publicly traded real estate investment trust, or REIT, is available to any adult who opens a brokerage account. Many of these investments are also available within retirement accounts, like 401(k)s and individual retirement accounts.
Because these investments are listed, they meet SEC requirements that help safeguard average investors. But remember that no investment is without risk, and you can end up losing some or all your principal investment.