The phenomenon of inflation is not only affecting the cost of goods and services but also influencing the investment landscape. According to a recent report by the Securities and Exchange Commission (SEC), there has been a significant increase in the number of accredited investors in the United States. Accredited investors are individuals or households who meet certain financial requirements and are eligible to invest in private companies and exclusive investment opportunities such as private equity and hedge funds.
In 2022, approximately 24 million U.S. households, accounting for around 18.5% of the total, qualified as accredited investors. This marked a substantial rise of 8 million households since 2019. The primary reason behind this surge can be attributed to inflation itself. As inflation drives up household incomes and net worth, more individuals and families meet the financial thresholds necessary for accreditation.
To become an accredited investor, individuals or couples must meet specific financial criteria. Currently, the thresholds are either a minimum annual earned income of $200,000 for individuals or $300,000 for married couples, or a minimum net worth of $1 million, excluding the value of their primary residence. However, these financial thresholds have not been adjusted for inflation since they were established in the early 1980s.
Without factoring in inflation, the number of accredited investors is projected to continue to grow exponentially. By 2052, the SEC predicts that nearly 119 million households, or approximately 66% of all households, would qualify as accredited investors. These outdated financial thresholds raise concerns about maintaining the intended purpose of accreditation as a consumer protection measure.
Consumer advocates argue that the continual increase in the number of accredited investors dilutes the efficacy of this consumer protection measure. Micah Hauptman, the director of investor protection at the Consumer Federation of America, states that “If we don’t do anything, the standard will be rendered meaningless.” Without adjustments to the financial thresholds, the original intention of accreditation to ensure financial sophistication and risk tolerance is undermined.
The SEC estimates that if the financial standards had been indexed to inflation since the 1980s, a couple would need a net worth of approximately $3 million or a joint income of $911,352 in 2022 to be considered accredited. Under these revised thresholds, only 5.7% of households, roughly 7.4 million, would meet the criteria. This significantly smaller pool of accredited investors would help maintain the exclusivity and intended purpose of private investment opportunities.
The distinction between public and private investments is vital in understanding the implications of expanding the pool of accredited investors. Public investments, such as stocks and funds available for purchase on a stock exchange, are widely accessible to the general public. However, private investments offer the opportunity to invest in companies not listed on public exchanges.
Proponents of broadening the pool of accredited investors argue that private investments often yield higher average returns compared to public investments. For instance, the annualized returns of private equity have outperformed the S&P 500 stock index by 1% to 5% since 2009, according to J.P. Morgan Asset & Wealth Management. They believe that opening up private investments to a larger pool of investors would democratize wealth creation and provide more individuals with the potential for higher returns on their investments.
However, critics caution against the expansion of private investment opportunities without considering the potential drawbacks. Private markets are known to be less transparent, making it challenging for investors to access and evaluate information about companies and funds. This lack of transparency exposes investors to heightened risks as they make investment decisions without necessary insights into the company’s value.
Moreover, private investments are generally illiquid, meaning that investors may need to commit their capital for extended periods, sometimes up to 10 years. This adds an additional layer of risk, as the investor’s funds are tied up and cannot be easily accessed during this period. Certified financial planner Paul Auslander emphasizes the importance of thoroughly understanding the fine print and risks associated with any investment, including private investments.
Apart from inflation, other trends have contributed to the growing number of accredited investors over time. The shift from traditional pension plans to individual retirement savings accounts, such as 401(k)-type plans, has played a significant role. The SEC notes that approximately 85 million people actively participated in 401(k)-type plans in 2020, three times the number in 1982. Retirement savings, included in the calculation of net worth, have contributed to the increasing number of accredited investors.
However, this shift from employer-managed pensions to individual retirement savings has also raised concerns about investor protection. Individuals who are responsible for making their own investment decisions may lack the necessary knowledge and experience to effectively manage investment risks. This shift in responsibility has created additional considerations for investor protection, an aspect that was not prevalent when pension plans were more commonplace.
The impact of inflation on the number of accredited investors raises consumer protection concerns. The outdated financial thresholds fail to account for inflation and have resulted in a significant increase in the number of accredited investors. While some argue that expanding access to private investments can democratize wealth creation, others emphasize the potential risks and lack of transparency associated with such investments. Striking a balance between opening up opportunities and maintaining investor protections is crucial, necessitating a review of the financial thresholds and ensuring the continued relevance and effectiveness of accreditation.