Investment Fund Qualifications: What You Need To Know

Investing in an investment fund is a great way to build a diversified portfolio at a low cost. Investment funds are a supply of capital from multiple investors, used to collectively purchase securities. There are various types of investment funds, including mutual funds, exchange-traded funds (ETFs), money market funds, and hedge funds.

To invest in an investment fund, one must meet certain qualifications. These qualifications vary depending on the type of fund and the investor's status. For example, hedge funds are typically only available to accredited investors, who meet specific wealth or income thresholds or hold relevant professional certifications.

Accredited investors are individuals or entities allowed to invest in securities that are not registered with the Securities and Exchange Commission (SEC). They are considered to have the financial sophistication to understand the risks of such investments. To become an accredited investor, an individual must meet certain income and net worth criteria, such as having a net worth exceeding $1 million or an annual income of over $200,000.

It's important to note that investing carries risks, and it's essential to understand these risks before making any investment decisions.

Income exceeding $200,000 for individuals or $300,000 for couples

To become an accredited investor, an individual must meet certain income and net worth guidelines. One of the criteria to be classified as an accredited investor is to have an income exceeding $200,000 for individuals or $300,000 for couples in each of the two most recent years, with a reasonable expectation of the same income level in the current year. The income criteria must be met in all three years, and the same method (single or joint) must be applied to the income test.

The income threshold is determined by Rule 501 of Regulation D of the Securities Act of 1933. The income threshold for individuals and couples was introduced during the 2010 passage of the Dodd-Frank Act.

Accredited investors are allowed to invest in securities that are not registered with the Securities and Exchange Commission (SEC). The SEC allows companies and private funds to skip registering certain investments as long as they are sold to accredited investors. This allows accredited investors to invest directly in private equity, private placements, hedge funds, venture capital, and equity crowdfunding.

The pros of being an accredited investor include access to unique and restricted investments, high returns, and increased diversification. However, there are also cons, such as high risk, high minimum investment amounts, high fees, and illiquidity of the investments.

It is important to note that there is no formal process or certification to become an accredited investor. The burden of proving an individual's accreditation falls on the investment vehicle rather than the investor. Companies issuing unregistered securities are responsible for conducting due diligence to determine a potential investor's status before the sale.

Net worth greater than $1 million

To become a millionaire, it is important to start saving early and consistently. Building savings over time allows one to take advantage of the power of compounding interest. For example, if a 20-year-old contributes $6,000 to an individual retirement account (IRA) annually for 40 years, their nest egg would be worth over $1.3 million, assuming a 7% rate of return.

One can also aim to save 15% of their income, cut unnecessary expenses, and increase their income through raises, side hustles, or selling items. It is also important to stay away from debt and avoid unnecessary spending, especially on high-interest credit cards.

Additionally, working with a financial advisor can be beneficial in creating a personalized retirement plan. This can include maximizing retirement contributions, such as taking advantage of employer matches in 401(k) plans, and investing in taxable brokerage accounts.

For those who are self-employed or freelancers, opening a traditional or Roth IRA is an option. Traditional IRAs allow one to deduct contributions in the year they are made, while Roth IRAs are made with after-tax money and offer tax-free withdrawals in retirement.

It is important to note that becoming a millionaire is not solely dependent on one's income but also on their spending habits and investment choices.

Hold relevant professional certifications

Holding relevant professional certifications is one of the ways to become an accredited investor. Accredited investors are individuals or entities that meet certain wealth or annual income thresholds. They are allowed to invest in securities that are not registered with the Securities and Exchange Commission (SEC).

The SEC broadened access to private investments in 2020 by recognising criteria based on financial experience and sophistication. This means that individuals who hold certain professional certifications, designations, or credentials can now qualify as accredited investors.

The following licenses are recognised by the SEC:

• Series 7 securities representative license
• Series 65 investment adviser representative license
• Series 82 private securities offerings representative license

Additionally, employees who are considered "knowledgeable employees" of a private fund are also considered accredited investors regarding that fund.

Be a knowledgeable employee of a private fund

Being a knowledgeable employee of a private fund is one way to be considered an accredited investor. Accredited investors are individuals or entities that meet certain wealth or annual income thresholds or hold relevant professional certifications. They are allowed to invest in securities that are not registered with the Securities and Exchange Commission (SEC).

The accreditation requirement is meant to ensure that investors in private securities are either financially sophisticated enough to evaluate the risks and merits of an investment or have sufficient wealth to bear any potential losses. Private market investments include shares of private companies (e.g. startups) and private funds (e.g. private equity funds, hedge funds, and venture capital funds).

The SEC defines accredited investors differently for individuals and institutions. For individuals, accreditation is based on wealth, income qualifications, or financial expertise demonstrated through specific credentials or certifications.

For an employee to be considered knowledgeable, they must meet one of the following criteria:

• Have a net worth over $1 million, excluding their primary residence, either individually or jointly with a spouse or partner.
• Have an income over $200,000 individually or $300,000 with a spouse for at least the past two years, including the current year.
• Hold in good standing a securities representative license (Series 7), an investment adviser representative license (Series 65), or a private securities offerings representative license (Series 82).

It is important to note that companies selling unregistered securities are required to verify an individual's eligibility by requesting documents such as W-2s, tax returns, bank statements, and other information.

Be a qualified purchaser with $5 million in investments

To be a qualified purchaser with $5 million in investments, you must meet the criteria to be classified as a qualified or accredited investor.

Firstly, you must demonstrate that you have a sufficient level of income or net worth. This can be done by providing evidence of either:

• A net worth greater than $1 million (either by yourself or combined with a spouse), excluding your primary residence and automobile.
• Income exceeding $200,000, or $300,000 when combined with a spouse, during each of the previous two full calendar years, and a reasonable expectation of the same for the current year.

Secondly, companies selling unregistered securities are required to take steps to verify your eligibility, such as by requesting your W-2s, tax returns, bank statements, and other information. So, if you plan on putting money into an unregistered investment, expect a thorough verification process.

The term "qualified investor" is often used interchangeably with the term "accredited investor". However, there is a notable difference between the two in terms of the financial thresholds required. For accredited investors, the net worth threshold is set at $1 million, whereas qualified purchasers must have at least $5 million worth of investments.

In addition, accredited investors are defined based on annual income and net worth, while qualified purchasers are defined based on the value of their investments. This distinction is important as it grants qualified purchasers access to a broader range of investment opportunities.

By meeting the criteria and becoming a qualified purchaser, you will be able to access more investment options, including larger 3(c)(7) funds, which can accommodate up to 2,000 qualified purchasers. This is in contrast to 3(c)(1) funds, which are limited to 100 accredited investors or 250 accredited investors under certain conditions.

It is important to note that the burden of proving that you are a qualified purchaser does not fall directly on you but rather on the investment vehicle you wish to invest in. They will ask you to fill out a questionnaire and provide certain documents, such as financial statements, credit reports, or tax returns, to verify your eligibility.

Frequently asked questions