The passage of the 2012 Jumpstart Our Business Startups Act has made crowdfunding a hot topic, particularly among investors. Over the last few years, entirely new asset classes have been created, and certain barriers to investing have been removed entirely. Incorporating crowdfunded investments into a portfolio is now easier than ever, and investors are positioned to benefit.  

Who Can Invest Through Crowdfunding?

Until recently, crowdfunding as an investment tool was only an option for accredited investors. Under Rule 501 of Regulation D, this meant participation was limited to individuals earning $200,000 or more annually or those with a net worth of at least $1 million. For married couples, the minimum income threshold is set at $300,000.  

The accredited investor rule was rewritten at the end of October when the Securities and Exchange Commission (SEC) finalized Title III guidelines of the JOBS Act. Now, anyone can invest through crowdfunding platforms without restriction on income or net worth. 

Crowdfunding Investment Options

The first step in building a portfolio with crowdfunded investments is weighing the different options that are available. Specifically, there are three distinct sectors where investors can park their money.

Start-up funding

Crowdfunding represents a new avenue for start-ups who need to raise capital. The JOBS Act made it possible for startups to raise up to one million per year through equity financing without having to register securities with the SEC.

Investors who contribute to a start-up’s crowdfunding campaign receive an equity share in the company in exchange for funding. Assuming the company flourishes, investors would be able to sell their shares for a profit at some point in the future.

Real estate crowdfunding

In addition to start-up funding, crowdfunding has also trickled into the real estate market. Real estate crowdfunding has become a $2.5 billion industry, according to Massolution and it’s on track to continue a steady rate of growth. 

There are two avenues available for investors seeking to crowdfund real estate deals. The first involves making an investment in a mortgage loan that’s secured by a residential or commercial property. As the loan is paid each month, investors earn steady returns in the form of interest.

The second option is equity investing. Investors own a share in the property and instead of receiving interest payments, and returns come from the rental income it generates. Equity investing is the riskier of the two, but there’s more potential for higher returns. (For more, see: Real Estate Crowdfunding: A New Path for Investors.)

Peer to peer lending

Peer to peer lenders have reshaped the way individuals and businesses borrow money. Instead of going through a bank, borrowers appeal to investors to get a loan. Similar to debt investments in the real estate crowdfunding sector, investors earn a share of the interest on the loan as it’s repaid.

Pros and Cons

Crowdfunding as an investment tool can offer significant rewards but like anything else, there’s a certain amount of risk involved. Weighing the pros and cons is a must when evaluating any crowdfunded investment opportunity.

Advantages

Regarding the benefits, one of the most appealing features is the fact that crowdfunding doesn’t require a huge initial investment. With real estate and venture crowdfunding, for instance, it may be possible to invest with as little as $1,000. Peer-to-peer lenders like Prosper allow you to get started with as little as $25. Compared to mutual funds, some of which may require a minimum investment of $10,000, crowdfunding is a more attractive alternative for smaller investors.

Crowdfunding is also a comparatively accessible way to invest. With real estate crowdfunding, for example, the only way to get in on private deals before the JOBS Act was to know someone connected to the investment. Crowdfunding platforms have broadened the horizon for investors who were previously shut out of investing in real estate. (See also: 5 Simple Ways to Invest in Real Estate.)

Another positive aspect of crowdfunded investments is their level of transparency. When investing in mutual funds, for instance, it can be difficult to pinpoint exactly which assets are included in the fund. Crowdfunding platforms, on the other hand, are built with transparency in mind, so investors know beforehand what they’re putting their money into. 

Disadvantages

Crowdfunding is not the best choice for investors who are seeking quick returns. With an equity investment in a start-up, for example, investors may be waiting years for the company to grow in value.

The other issue with crowdfunding is that it can entail more risk than other investments. If the start-up you invest in never takes off or the individual you've loaned money to through a P2P platform doesn't pay it back, your investment could end up being worthless in the long run.

Choosing a Crowdfunding Platform

New crowdfunding platforms are entering the market all the time, but they’re not created equally. Before committing to a particular company, investors must perform the appropriate due diligence on any platforms they’re considering.

There are several things investors should be concerned with when comparing crowdfunding sites, starting with the fees. Pay close attention to what each platform charges in terms of upfront and ongoing fees and how the cost impacts your anticipated returns.

It’s also a wise move to research the platform’s reputation. Investors should be targeting crowdfunding sites that have an established presence in their particular niche. Taking a look at the platform’s historical track record regarding investment performance can indicate how successful the company is overall and speak volumes about its management. 

The Bottom Line

For those who are willing to take the leap, crowdfunding represents a unique opportunity to potentially reap some big rewards while injecting their portfolios with a new level of diversity. The key lies in knowing which crowdfunding path is best for filling portfolio gaps and how to thoroughly vet investment opportunities before making a commitment.

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