The Accredited Investor Test: Are You Qualified for This Role?

There is a term in the world of finance that is becoming more commonplace nowadays: the “qualified investor.” Not to be confused with the term “qualified purchaser” or “qualified client” which has different meanings, a qualified investor is often attributed to the accredited investor requirement for certain investments.

Qualified or Accredited

A qualified investor is an individual that is meets a predetermined set of qualifications set by an issuer to invest. Often times, they are accredited investors who are considered to have a certain level financial sophistication or wealth, and therefore not required to submit to certain United States regulations that protect the majority of investors. Under certain federal securities laws, companies that desire to raise capital from individuals without the process of issuing registered securities are required to confine their search to accredited investors. In this scenario, the general public is excluded from investing opportunities such as hedge funds and privately held companies – both of which can pose certain particular risks. They don’t meet accredited investor test requirements and are not allowed to invest in those companies.

The Criteria

Arising from the Securities Act of 1933, and according to Reg. D, qualified, or otherwise referred to as accredited investors, are classified according to certain criteria. For instance, they must have an annual income of $200,000 at a minimum in each of the previous two years or $300,000 for married couples. Alternatively, they must hold a minimum net worth of $1 million. Additional restrictions and criteria stipulate that the net worth may be held with a spouse jointly and not include the home’s value. There are other criteria for certain entities as well.

Measures of Sophistication

The basic premise behind the reasoning stated above is that it is dangerous to allow unsophisticated investors to participate in riskier, less regulated investments. Investors need to know exactly what they’re doing when it comes to such investments. The sophistication level involved is defined or measured by the wealth of the individual. The reasoning is that an individual with greater income or net worth will be able to understand all the risks involved in the investment and can make an informed decision. To some, this may seem like a somewhat questionable means of evaluation.

There have been many wealthy individuals who have made very serious mistakes. These include Nobel winning economists, as well as others. On the other side of the coin, some start out with nearly nothing and do very well. These individuals may not have had the qualifications necessary to meet the accredited investor test requirements, however, they nevertheless had the requisite knowledge to make intelligent informed decisions on what to invest in.

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