The definition of an “accredited investor” has not changed since 1982. Should it be changed? There is talk at the SEC of changing the definition. Besides, why should you care? The answer is that several years ago, some of you reading this article already lost hundreds of thousands of dollars each due to lack of understanding the concepts discussed in this article and the rest of you should avoid losing hundreds of thousands of dollars in the future. Only you can decide if you can or cannot afford investing 5-10 minutes reading this article.
Before we discuss whether the definition should be changed and how it should be changed, you may want to review the current definition of accredited investor according to the Code of Federal Regulations (CFR) shown here.
While the definition of accredited investor in section 230.501 of the CFR is somewhat complex, a simplified summary for individuals is:
(a) “any natural person whose individual net worth, or joint net worth with that person's spouse, exceeds $1,000,000,” though “the person's primary residence shall not be included as an asset”
OR
(b) “any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year"
In my never humble opinion, there should be three conceptual criteria for defining an accredited investor.
1. Does a person, couple or entity have enough “knowledge” (combination of financial literacy, analytical capability and willingness to apply intellect), to perform proper due diligence on an investment, preferably multiple types of investments?
2. The person, couple or entity can afford to lose the investment at a certain level without being financially devastated
3. The person, couple or entity should not be over-leveraged, which in my never humble opinion means capping portfolio-wide leverage at 70%.
Whereas the first two criteria are conceptually in line with the current two criteria for individuals, the third criterion I am suggesting would be very controversial.
The reason I add the third criterion is that I have seen too many people lose everything due to over-leverage which means that they really could not afford to make the decisions they made and take the actions they took.
Many of you reading this not only know people who lost everything during the last downturn, I know that at least a couple of dozen of you reading this article, lost hundreds of thousands of dollars each by private lending money to people who did not meet the third criterion.
The sad reality is that many people who should be reading this discussion about the definition of accredited investors are not reading this article and are not aware of the risks they take. If you know someone like that, be a good friend and urge them to read this article, especially if they intend to become a private lender.
More importantly, every investor, wannabe investor, private lender and potential private lender should watch our training video “Leverage of OPM: The Good, The Bad and The Ugly in Real Estate Investing.”
For a nominal cost, you may avoid losing hundreds of thousands of dollars like some of our readers already did. Don’t you wish you would have known about how to avoid the risks of private lending to people who were over-leveraged and who were not accredited investors?
If you are a private lender or are considering becoming a private lender, now watch our training video "Private Lending Is Great...Until It Isn't - 19 Things That Can Wrong When Private Lending"
You need to think about what is an accredited investor because that will help you greatly make your most impactful investment decisions using money you have worked hard over decades to accumulate.
