Home Extra Income 10 Things To Know Prior To Purchasing an “Accredited Investor” Investment

10 Things To Know Prior To Purchasing an “Accredited Investor” Investment

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investments, passive income, retirement

I’ve talked plenty prior about accredited investors, what qualifies you as one, and what opportunities are available to you as a result. I personally spend a lot of my investment dollars in these deals, so it’s a good reminder to hear another person’s take on it.

Today’s Classic is republished from the White Coat Investor. You can see the original post here.


It has been nearly three years since I wrote about “accredited investors” and the investments available only to them. Robert Kiyosaki, in his popular, although widely criticized Rich Dad, Poor Dad, was quick to point out that “the rich” are allowed to invest in different stuff than the rest of us. I’ve been dabbling a bit in these “special investments” during the last few years and thought it was time to write about them again.

1. These Investments Are Completely Optional

If you’re not aware of what I’m talking about, these investments are only available to “rich folks.” Basically, that means you’ve had an income of over $200K a year for the last couple of years or you have more than a million in investable assets.

Physician Financial ServicesThe theory is that you’re either smart enough to not need government approval of your investments or that you have enough money that you can afford to lose a big chunk of it. In fact, most of these investments require you to sign a statement affirming both of those facts. There are 10 facts that you ought to know prior to purchasing one of these.

There is no reason you HAVE to invest in these sorts of things just because you can. Plenty of high-income professionals have retired just fine buying only investments that can be bought and sold every day and whose price is listed in the WSJ every day. If the thought of having to analyze these suckers stresses you out, hit the “back button” on your browser right now and life will go on just fine.

2. You Should Ignore Any “Prestige” Factor

Please don’t buy into these investments just to feel smart and rich because they are offered to you.  If you really need to purchase a status symbol, just get yourself a Tesla or perhaps Dave Ramsey’s “Status Symbol of Choice”– a paid-off mortgage.

3. Remember the Point

The point of buying into these special investments is to get high returns and low correlation with the rest of your portfolio, preferably both. If you are not getting these, what’s the point? Go buy some stock and bond index funds.

MLG real estate investingFor example, I have been offered the opportunity to invest in some unique investments where the expected return was 5%. My usual response is that it is very hard for me to get excited about 5% (and you can see why I get even less excited about 3-4% returns available with a life-long commitment to a whole life policy.)

It wasn’t that many years ago when I could get 5% in a Money Market Fund at Vanguard. If you want me to go to the effort to do due diligence, much less take on all the unique risks of an investment offered only to accredited investors, you’d better be paying me more than 5% for it.

Now, these higher returns are my main attraction to these investments. It doesn’t take a math genius to see that compounding your money at 12% instead of 8% makes a monstrous difference in eventual outcomes. ($50K per year invested for 30 years grows to $13.5M instead of $6M.)

When you start considering that future stock and bond market returns may be far lower than 8%, these higher returns become even more attractive. If nothing else, taking on some of these other risks sure makes your Total Stock Market Index Fund look pretty tame, since it takes a once in a generation bear market just to lose 50% of your investment, and even that is PROBABLY temporary.

Low correlation to the rest of my portfolio is also very attractive to me. You can get that with Peer to Peer Loans or Syndicated Real Estate.  One of the investments whose low correlation really excites me is Life Settlements. I mean, how long people live has pretty much zero correlation to the performance of stocks, bonds, cash, gold, and real estate. (Although my wife put the veto on that one, which is fine – there are no called strikes in investing.)

At any rate, if you’re not getting high returns and/or low correlation with the rest of your portfolio, there’s zero point to looking outside the public markets.

4. Returns May Be Higher Due to Higher Risk

There are reasons why expected returns in these investments are often higher than the expected returns in the public markets. For one thing, the level of risk is often higher. Higher return = higher risk.

For instance, consider my investments in Peer to Peer Loans. While I’ve since excited this investment for non-return related reasons, it was pretty nice to be earning 12% while treasuries were paying less than 3%.  (Yes, I know these aren’t technically for accredited investors only, but you are required to have an income of at least $70K and a net worth of at least $250K to invest.)

Why were my returns higher? Part of it is the hassle factor, some is the lack of liquidity (a major pain as I exited), but mostly it is simply because individuals are far less likely to pay me back than the US government, and Lending Club is far more likely to go out of business than the US government. The risk is a lot higher.

5. Returns May Be Higher Due to Less Liquidity

Remember that with a stock or bond index fund, you can pretty much cash out any weekday of the year. However, I have several real estate investments I can’t get out of for 5-7 years. I don’t mind giving up liquidity on some of my portfolio, but I expect to be paid for it.

6. Returns May Be Higher Due to Due Diligence Requirements

Whatever you may think of the work of the SEC, there is no doubt they are at least doing something. If you are not familiar with the Securities Act of 1933 and the Investment Company Act of 1940 and the protections they provide for mutual fund investors, you probably should not readily give up those protections in order purchase investments available only to accredited investors.

Each of these investments is different, and doing due diligence on one of them does nothing for any others. This is one reason that syndicated real estate investors will often stick with one real estate team that they trust–it is simply too much of a hassle and too expensive to do due diligence on multiple firms. Likewise, this is one of the benefits of using some of the crowdfunding sites–they do at least some of the due diligence for you.

7. Returns May Be Higher Due to Difficulty Diversifying

Diversification still matters. In fact, all of the principles of investing you have previously learned in the public markets still apply- keeping costs low, the better your purchase price the higher your returns etc. But diversification can be pretty tricky for someone on a “lowly doctor’s income.” You see, many of these investments require significant minimum investments.

I have found investments with minimums as low as $2000, but I have also seen them with minimums as high as $250,000. $3K at Vanguard gets me part of 10,000 different companies. But $100,000 may only get me an investment in a single company when it comes to accredited investments.real estate debt investing

You need a strategy to allow you to still avoid putting all your eggs in one basket. Dishonest and incompetent managers are far more likely to thrive in an environment with less government regulation. Guard against your own ignorance by diversifying. Part of the reason returns may be higher, of course, is that acquiring real diversification is so darn difficult.

One approach to this is that I have used in the past was to only put the minimum into these sorts of investments, whether that is $2K or $10K, and then to avoid those investments with a high minimum relative to my portfolio size.

For example, I had a real estate investor approach me a while back to purchase a share in a hotel in Boise (and to hopefully advertise it to my readers.) The minimum purchase was $250K. I’m not sure how rich he thought I was at the time, but plunking a quarter of my portfolio into a single business certainly didn’t meet my diversification needs.

Rick Ferri has given some rules to use when considering adding an asset class to your portfolio which I have written about before. Basically, they are as follows:

  1. High returns
  2. Low correlation with the rest of the portfolio
  3. Ability to adequately diversify the asset class (preferably with an index fund)
  4. Ability to keep costs acceptably low

Keep those in mind when looking into these special investments and if you’re going to bend these rules, make sure it is for a good reason and bend them as little as possible.

8. Returns May Not Be Higher At All

One thing to keep in mind with investments for accredited investors is that these high returns you seek may not actually be higher at all. When people started looking at the actual performance of the average hedge fund, the classic investments for accredited investors, they found it was disappointingly low. Granted, many hedge funds were not trying to get high returns, they were simply trying to “hedge” but still, that’s pretty crummy.

The situation with real estate syndicators could be analogous. Nobody is looking at what they are returning on average. It is truly the Wild West in terms of what’s going on out there. Sometimes returns are spectacular, and sometimes the entire investment is lost. But we do know what kind of returns we see out of the big publicly traded real estate companies (i.e. REITS.)

If their long-term returns are similar to the stock market, why would we expect smaller companies to do much better? The only reason is that we believe the market they are investing in is inefficient and that they are able to add value through their expertise and nimbleness. But remember, that for every bit of alpha added, somebody else lost alpha. Make sure your investment is with an alpha generator.

9. Expenses Are Usually Much Higher

The real estate crowdfunding companies generally predict returns of 14-18% for their equity investments. It is interesting to look at their assumptions in hitting those returns, and considering how those assumptions could be wrong. An 18% expected return can become a -10% return very easily with a minor change in assumptions. To be fair, these companies sometimes beat expectations too. Sometimes they project 17% returns and get 24% returns, but I would expect that most projections are at least a little on the rosy side.

One thing you can almost surely expect is that you’re going to pay a lot more for these investments than you are for your index funds. These can range from 1% to as much as 2% plus 20% of profits. Every dollar you pay in fees and expenses is a dollar taken out of your return. But also keep in mind that what you’re really interested in is the after-expense return.

If the investment will pay you enough to pay the high fees and still give you an acceptable return for the risk taken, it may still be worthwhile to you. Just don’t think that the expenses are going to be anywhere near the 5-10 basis points you’ll pay for a Vanguard index fund. In fact, look at enough of these investments and you’ll realize just how miraculous index funds are–you get to own thousands of companies for basically free.

10.  These Opportunities Will Be More Common In the Future

The JumpStart Our Businesses Startup (JOBS) Act was signed into law in 2012 by President Obama. This basically made it easier to start small companies and crowdfund them. This has made real estate syndicating far easier to do (mostly lowering minimum investments), and it bleeds over into many other types of investments.

The number of crowdfunding companies has exploded since the JOBS Act passed. So, if you’re interested in adding some of these investments to your portfolio, feel free to do so. But if you choose to go that route, remember the principles of investing still apply- diversify widely, purchase different asset classes that have low correlation with each other, keep costs as low as possible, try to be tax-efficient (although it is particularly hard to put many of these investments inside retirement accounts,) do your due diligence, and don’t take on too little or too much risk.

Also, I would recommend adding these investments onto a core consisting of a broadly diversified, low-cost index fund portfolio. There is certainly no reason your portfolio should miss out on the benefits of publicly-traded stocks and bonds using index funds inside retirement accounts.


1 COMMENT

  1. Qualifying as a “sophisticated” or accredited investor certainly does not make you immune to mistakes.

    These investments are a great way to diversify from the market but a lot of care has to be done on the front end to make sure what you sign up for is what you get.

    The biggest thing for me is typically not the investment itself but the syndicator. Millionaire Doc did a great post on it by saying you need to bet on the jockey not the horse and it rings true. A good syndicator will be transparent and trustworthy and have a great track record. The investments usually require fairly large sums (50k minimum for most) and you really are taking a leap of faith initially when you invest with a syndicator for the first time.

    For me once I found one I like the subsequent deals were much easier to vet.

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