Access to Private Investments Becoming More Available, But Beware of Risks
Experts warn that while more investors are gaining access to private investments previously reserved for the wealthy, it may not be suitable for everyone. Private investments, such as private equity funds, hedge funds, venture capital funds, and early-stage company stock, typically require investors to be accredited. Accredited investors must meet certain income or wealth criteria set by the Securities and Exchange Commission (SEC) to protect against the unique risks associated with private investments.
Why More People May Meet Accredited Criteria
The problem is that the financial thresholds for accredited investor status have not been adjusted for inflation in decades. As a result, the percentage of households qualifying as accredited investors has increased over time. In 1983, only the top 1% to 2% of households qualified as accredited investors, compared to 13% or about 16 million households in 2019.
The Risks and Rewards of Private Investments
Private investments differ from publicly offered investments. While anyone can buy stocks of public companies on a stock exchange or invest in publicly available mutual funds and exchange-traded funds, private investments allow individuals to invest in unlisted companies. However, non-accredited investors have limited investment options in private start-ups compared to accredited investors who have access to better deals.
Why Private Markets Are ‘Two-Tiered’
Private markets are considered “two-tiered” because institutional investors like pension funds often have access to better investment opportunities than individual investors. Pensions have teams of experts who specialize in evaluating private companies and funds, giving them an advantage over average investors.
The Risks of Private Investments
Private investments offer the potential for higher returns but also come with greater risks. Private equity funds, for example, have outperformed the S&P 500 stock index in recent years. However, private investments have a wider dispersion of returns than public markets, meaning the range of investment outcomes can be significant. Betting on a single private investment instead of diversifying through a fund increases the risk even further.
What to Know Before Investing in Private Investments
Investors should only invest money they are willing to lose in private companies and stick to industries they are familiar with. It’s crucial to have access to information about a company’s financials, business plan, and competitive standing before investing. Mutual funds and ETFs are often recommended as a more suitable long-term investment approach for most individuals.
Hot Take: Approach Private Investments with Caution
Gaining access to private investments may seem enticing, but it’s important to proceed with caution. While these investments offer the potential for higher returns, they also come with greater risks. Non-accredited investors should carefully consider their risk tolerance and financial knowledge before venturing into private markets. It’s essential to invest only what you can afford to lose and stick to industries you understand. Remember that slow and steady progress is often more sustainable in the long run.
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