The Secret Investments of the Wealthy 1%

Jan 11, 2024

Are rich people secretly investing their money in a special way that others don't know about? Yes, there is a hidden world of investments for the wealthy, but it's not because they're trying to keep everything to themselves. In fact, it's the opposite.

When people talk about the secret dealings of the rich, it's not because they're selfishly keeping opportunities to themselves. However, it is true that the one percent have access to investments and information that the rest of us don't.

So, why is there this exclusive world of investments? To understand that, we need to go back to the 1930s and look at how it all started.

Securing Stability: The Securities Act of 1933 and the Birth of Regulation D

In the early 1930s, things were pretty tough due to the Great Depression. The financial situation in the United States was in bad shape. Banks were failing, and the stock market crash in the late 1920s made it worse.

During the 1920s, many people invested their money in the stock market, thinking they could get rich easily. However, when the stock market crashed, it led to a crisis. People panicked and rushed to take their money out of the banks because there weren't strong laws protecting their savings like we have today.

To address this, the government took action. In 1933, they passed the Securities Act to safeguard Americans and their investments. Before this, the financial world was like the Wild West, with fewer regulations. The government wanted to ensure a well-regulated market, creating what we now know as the public markets.

One part of the Securities Act, known as Regulation D (or reg D), aimed to shield investors from private securities. Private securities are investments or assets offered by private companies, not public ones. The idea was to help regular people, who may not be experts, avoid getting into investments they didn't understand.

Private securities don't necessarily pool money together; they are offerings from private companies. Whether people pool their money or invest individually, they need to follow the rules set by the Securities and Exchange Commission (SEC), which regulates the securities industry. This regulation was put in place to make sure that individuals engaging in these private markets meet certain qualifications.

From Accredited Investors to Economic Downturn

The government set certain criteria to be considered an accredited investor. As an individual, you needed at least a million dollars in investable assets. If you were a family, the requirement was an income of $200,000 or more (or $300,000 for a family) and a professional status, like holding a Series Six or being part of a family office. This professional status needed government approval to qualify as an accredited investor. Generally, three to four and a half percent of the population meet these criteria.

Now, let's discuss how the market deteriorated quickly. In 2008, there was another significant economic downturn, marked by a burst housing bubble. Single-family homes, which are a significant portion of the average American's wealth, saw their values plummet as shown in the chart below. 

This resulted in a loss of net worth for many individuals, impacting their ability to meet the million-dollar qualification for accredited investors.

To address these issues, the government enacted Dodd-Frank, a set of financial regulations aimed at preventing another economic crisis. This legislation was a response to the events leading up to and including the 2008 financial crisis.

Transformative Changes Under Dodd-Frank

Under Dodd-Frank, there's a significant change regarding the use of homes to qualify as an accredited investor. Now, your home cannot be considered part of your net worth for qualification. The focus is on investable assets, meaning you must have a million dollars available for active investments, which could include stocks, investment products, or cash. However, your primary residence doesn't count towards this million-dollar requirement.

This classification of sophisticated investors, known as accredited investors, has led to the creation of a separate market from the public markets. The rules governing this private market are strict, especially regarding solicitation. Essentially, you can't openly talk about or promote these private opportunities unless you have direct knowledge that the individuals are accredited investors. The laws are stringent to prevent any violations.

As a result, these private markets have become somewhat secretive. While we're aware that they exist, the strict regulations mean that we don't really see or know much about what happens in these markets. The secrecy is intentional, as discussing or sharing information about these private investments is against the law. So, the secret investments of the one percent involve direct ownership and participation in private opportunities.

How Non-Accredited Investors Can Navigate the World of Wealth Creation

The communication and engagement in these private investments happen among the rich, mainly because they are accredited investors. It's not that they necessarily don't want to talk about it; they can't due to strict regulations. However, the concept is quite straightforward. Even individuals like myself participate in this.

People, including non-accredited investors, can come together to invest collectively. For instance, a group of private individuals may pool their money to buy assets that everyone can participate in. This practice occurs on a massive scale, especially with the introduction of fund structures that have changed the financial landscape of the United States. Funds pool together accredited investors for various private investments, such as private equity and hedge funds.

Does this mean that non-accredited investors can never invest like the one percent? Not at all. It means that certain types of investments might not be offered to them through formal funds. However, this doesn't stop individuals from directly purchasing assets. You can gather family and friends, create an LLC, and jointly acquire an asset. Starting small and directly participating in private investments, as we did when we began, requires more effort, but it's certainly possible.

It's crucial to keep an eye on what's happening in the private markets, observing the strategies and investments of the rich or the one percent. Understanding what these funds are participating in, the data they analyze, and the strategies they employ can provide insights for others to follow suit.

As for accredited investor status, what are your thoughts? Do you believe the government should impose regulations and constraints on individuals' investment choices? And for both accredited and non-accredited investors, what questions do you have about investing?

 

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