Certain types of loosely regulated investments are considered by the SEC to be high risk, or too complex for mainstream investors. Unlike publicly traded stocks and fixed income assets such as bonds, participation in these investments is restricted to more experienced individuals. In some cases a limited number of people who are considered sophisticated investors are permitted to participate in them as well.
Essentially, a sophisticated investor is a person who has the capital, experience and net worth to be expected to be capable of evaluating the potential benefits and risks of a minimally regulated investment. While the phrase sophisticated investor is not considered an official term per se, these people are characterized by the SEC as having “sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.” This characterization also assumes the individual has the capability of absorbing a sizable loss without experiencing financial ruin.
Of course, this is all subjective, as wealth can be inherited and investing experience can also be gained by those of more modest financial means. In this way, the definition of sophisticated investor is less cut and dried than that of an accredited investor.
An accredited investor is an individual with a net worth exceeding $1 million — excluding the value of their primary residence. People with an annual income of $200k for two consecutive years and the expectation of continued earnings at that level are also considered accredited. Married couples earning $300k annually, within the same parameters, also qualify as accredited investors. Institutions with assets exceeding $5 million are considered accredited as well.
However, like accredited investors, a certain number of people considered to be sophisticated investors are allowed to participate in certain alternative investments such as pre-initial public offerings, swaps, private equity deals, collateralized debt obligations, private stock offerings and complex currency derivatives., even though they aren’t considered accredited.
The SEC’s Regulation D outlines the parameters of private placement exemptions to permit the raising of capital through the sale of unregistered equities and debt securities without having to register the offerings with the SEC. This enables the funding of such opportunities more expeditiously and at lower cost than public offerings. Regulation D also includes guidelines governing the participation of sophisticated investors in such offerings.
A critical aspect of becoming a sophisticated investor is the ongoing and concerted effort to accumulate financial education. Information provided about private placement investment opportunities can be rather complex, sometimes intentionally. This can result in information asymmetry , putting investors at a disadvantage. For this reason, it is essential to read all documentation thoroughly and to seek assistance if data provided is too difficult to comprehend. Before agreeing to participate, a sophisticated investor will ask the seller to provide a more transparent summary or engage the services of an investment attorney to help evaluate offerings.
Sophisticated investors put in the time and exercise the discipline to manage their investments carefully. They also make a concerted effort to remain knowledgeable about current events. These people have numerous subscriptions to financial publications and read them thoroughly. Further, they consult a wide variety of information and mediums, including print, broadcast, digital and peers. The sophisticated investor keeps an eye on political, social, psychological and environmental factors to help inform their decisions.
Sophisticated investors are also aware of their limitations and seek the assistance they need to fill gaps. The market is an ever-evolving organism, so a concerted effort is required to remain abreast of its changes. These investors delegate where needed, curry productive relationships and meet with their management teams regularly to ensure meaningful, bilateral communication to guide investment decisions.
The sophisticated investor acknowledges the folly of trying to know everything and seeks needed help — before investing. Another trait of sophisticated investors is having a firm grasp of their net worth. In other words, they are aware of their financial position and manage their activities accordingly.
Traditional portfolio asset allocation envisions a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split incorporating 20% alternative assets may make a portfolio less sensitive to public market short-term swings.
Sophisticated investors can invest in alternatives unencumbered by most SEC regulations. Real estate, private equity, venture capital, digital assets and collectibles are among asset classes deemed “alternative investments.”
Broadly speaking, such investments tend to be less correlated with public equity, and thus offer potential for diversification. These assets were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors who buy in at very high minimums — often between $500,000 and $1 million. Yieldstreet was founded with the goal of dramatically improving access to alternative assets by making them available to a wider range of investors.
The resulting diversification can help protect a portfolio of assets during periods of extreme volatility, thus helping to preserve hard-won net worth.
The term sophisticated investor tends to be rather broadly defined. The truth is that there are few hard and fast rules governing the designation, such as those applied to accredited investors. This could be interpreted to mean that just about anyone can invest in securities bound by minimal requirements in terms of oversight, disclosure, and regulation. However, this does not mean doing so on ones own is advisable.
Truly sophisticated investors make it a point to figure out what they don’t know and take steps to rectify that situation. The good news is firms like Yieldstreet are making determined strides toward providing equal access to these types of investments, along with the understanding and guidance needed to make informed decisions about them.
Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information. Diversification does not ensure a profit or protect against a loss in a declining market.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.