The Surprising Worry for Accredited Investors

And why they may not be as investment-savvy as they might seem

Ric Edelman: It's Thursday, January 18th. If you want to be at the top of American wealth, you want to be an accredited investor. These are people who are designated by the SEC as sophisticated, experienced investors. And by virtue of this, you're allowed to buy investments that ordinary people are not allowed to buy. To be designated as an accredited investor, you have to be an investment professional in good standing who holds a securities license. That's the Series 7, 65 or 82. Or you have to be a director or an executive officer or a general partner of a company that sells securities, or you have to be a member of a family office, meaning your family is super rich and you have an investment team that works only for your family office, or you have to be a knowledgeable employee of a private investment fund. And I'll bet you don't qualify under any of that.

But check this out. You also qualify as an accredited investor if you have a net worth of more than $1 million, excluding your primary residence, or if you're single, and in each of the past two years, your income was over $200,000 or 300,000. If you're married or you have a partner and you think your income will be that high again this year. So a lot of people qualify as accredited investors, $1 million net worth. That's not a lot these days. Annual income of 200 grand. That's in the reach of a surprisingly large number of people. 300 grand for marrieds, even more so. 

So yeah, a lot of people are accredited investors. And like I said, if you're accredited, you are considered to be an experienced and sophisticated investor. The premise being you needed to be one in order to help you build all that wealth.

Now, accredited investors don't just limit themselves to stocks and bonds and ETFs and mutual funds. They often invest in private, unregistered securities that are offered to them by their financial advisors. We're talking private equity, venture capital and hedge funds mostly. Is there a problem here? Yeah, but the problem is not what you're thinking. You're probably thinking that these accredited investors aren't really sophisticated and experienced. Well, a lot of them are. And you're probably thinking these high-risk investments are scams or they're real, but they fail to produce a good return.

Well, that's not true either. A lot of these investments have performed very well. That's why brokerage firms and RIAs offer them to their clients, and it's why their clients buy them. But you can't buy them unless you're an accredited investor, because these investments have details and risks and limitations that the SEC says are not appropriate for ordinary investors. So like I said, there's a problem here. But if you're an accredited investor, it's not your lack of experience and it's not a problem with the investments themselves. The problem was just revealed in a working paper that was written by two professors at the American College of Financial Services and William Paterson University.

The problem with accredited investors is that they tend to be older, and that makes sense, since it takes a long time to amass the wealth necessary to become accredited in the first place. And because you're older, say you're in your 60s or 70s or 80s, you become vulnerable to cognitive decline. And their research, they found strong evidence that only 20% of accredited investors of ages 80 and older score better than unaccredited investors on financial literacy tests. These older investors might have been sophisticated and experienced earlier in their lives, but now that they're suffering cognitive decline, they actually know less and are able less to make sophisticated investment decisions than younger, unaccredited investors. In fact, this paper shows that these older accredited investors knew less about money than people who don't even have a high school diploma. And the worst part is that older, accredited investors don't seem to recognize that their financial skills have deteriorated. This is a problem because the private securities they buy, like Reg D offerings, they often have high fees, limited liquidity, significant risks, and yet they're often recommended to these older, rich people because they pay high commissions to the brokers who sell them. 

So let me ask you, are you an accredited investor? If you're a financial advisor, do you have clients who are accredited investors? Of course you do. Can your clients pass a financial literacy quiz? Well, tomorrow I'm going to give you the chance to find out. We're going to do the quiz. So join me tomorrow. Let's see if you can pass the test.

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