Are You a Qualified Investor?

There's an interesting term in the financial world: "qualified investor." I bet it doesn't mean what you think it means. Here's one definition from Chris Lott at www.invest-faq.com:

For an individual to be considered a qualified investor (also termed an accredited investor), that person must either have a net worth of about a million bucks or have an annual income in excess of $200,000. Companies who wish to raise capital from individuals without issuing registered securities are forced to limit their search to people who fall on the happy side of these thresholds.

The term exists because only specific kinds of investors are permitted to invest in certain classes of investments, such as hedge funds. The reasoning is that it would be dangerous to let unsophisticated investors participate in less regulated (and often riskier) investments. The investors should know what they're doing. How do you measure such sophistication? By the level of wealth, apparently.

Other kinds of qualifications
I think basing the matter almost entirely on wealth is silly. We've surely witnessed enough wealthy people make stupid financial moves. And then there are people who start out with next to nothing and do terrifically well. These people may have been qualified to invest long before they made their first million.

Some Foolish criteria
So how might we define "qualified investor" for the purposes of determining who should invest in the stock market? Here are some possibilities.

A qualified investor should:

  • Not be saddled with loads of high-interest debt, such as from credit cards. (We can help you dig out, if you are.)
  • Have the time and interest to study investing and get better and better at it.
  • Know what to expect and know how the stock market has performed, on average, over the long haul. (Over the past century, the average annual return has been around 10%.)
  • Have a long time horizon (at least five years, and ideally 10 or more) and be prepared to be patient.
  • Understand terms such as "margin of safety," "intrinsic value," "market capitalization," "return on equity," and so on. (We can help you there, too. You'll find many educational articles in our tour of Fooldom.)
  • Be prepared to keep up with each of his or her holdings, ideally at least quarterly. This means reading annual and quarterly reports and news stories.

Our "13 Steps to Investing Foolishly" offers more insight into what's needed to be successful in stocks.

If you're still not qualified
If the list above is too intimidating, or you just find studying stocks to be boring, that's OK. You can still do really well with stocks just by sticking with a simple index fund, such as the Vanguard 500 Index (FUND: VFINX  ) . Plunk your money into it and you'll instantly be diversified across 500 companies. Your returns will closely track the overall return of the S&P 500 and even the entire U.S. stock market. Not bad, eh?

If you want to aim higher than these average results, seek out above-average mutual funds. There are some excellent ones out there -- ones with solid, long-term track records, attractive prospects, and managers whose philosophies you'll respect. We'd love to introduce you to many of them through our Motley Fool Champion Funds newsletter. Try it for free and see which funds our analyst, Shannon Zimmerman, recommends. Together, his picks have roughly doubled the market's return, gaining an average of 21% vs. 10% for the market in the same time period. Out of about 34 picks, only one was underwater last time I checked, and by just 1 percentage point.

One of his recent picks, a mid-cap, value-oriented fund, rose some 5% in just a few months after being recommended. As of the fund's last report, its top holdings included Cemex (NYSE: CX  ) , Capital One Financial (NYSE: COF  ) , Countrywide Financial (NYSE: CFC  ) , Centex (NYSE: CTX  ) , NVR (AMEX: NVR  ) , and Fannie Mae (NYSE: FNM  ) . To see what fund this is, take advantage of a free trial of the newsletter.

Learn much more about how mutual funds can serve you, whether you're a qualified or unqualified investor, in these Zimmerman articles:

SelenaMaranjian'sfavorite discussion boards include Book Club, Eclectic Library, and Card & Board Games. She owns shares of no stocks or funds mentioned in this article.Formore about Selena, viewher bio and her profile. You might also be interested in these books she has written or co-written:The Motley Fool Money GuideandThe Motley Fool Investment Guide for Teens. The Motley Fool is Fools writing for Fools.Fannie Mae is a Motley Fool Inside Value recommendation.


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