Hedge Fund Basics: How to Get Started With Very Little Money

Last Updated on June 1, 2021

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Hedge funds are an interesting investment opportunity, especially for those with big bucks to spend. However, investing in them isn’t as inclusive as stocks, bonds, cryptocurrency, or other investments. Instead, you’ll need hundreds of thousands of dollars to get started investing in hedge funds — and plenty more in case things get rocky. Investing in hedge funds is not the only way to benefit from them. There are ways to get started in hedge funds with very little money.

 

Hedge Funds? What Are Those?

 

Hedge funds are a type of investment where big bucks are pooled together to employ a variety of investment strategies to maximize returns. Managed by a separate entity from the primary investors, hedge funds often utilize aggressive tactics to generate returns in international and domestic markets.

 

Hedge funds are only available to experienced investors with proof of funds. Since there are fewer SEC regulations on hedge funds than others like mutual funds, investors need to have solid experience in the market to join the club.

 

Big Risk, Massive Returns

 

Investors like hedge funds because despite the immense risk the managers often employ aggressive tactics to maximize returns. Though hedge funds may invest in a wide variety of stocks, they can also invest in derivatives like options and futures and can leverage in order to increase investment potential.

 

It’s important to note that to be an investor in hedge funds or to start your own, you’ll need a hefty amount of knowledge in investing that you can’t get from the internet. Experience is key!

 

Got Money? Join the Club!

 

Hedge funds often require investors to have certain qualifications before giving access to the pearly white gates of heavenly returns. First off, investors need to have had an annual income of at least $200,000, or $300,000 with a spouse, for two years before the time of investment. There must also be proof that investors are currently on track to make at least the required amount in the current financial year.

 

Qualifications can sometimes ignore annual income and instead look at net worth. Investors with a net worth of more than $1 million, not counting home equity, can invest in hedge funds. Eligibility can also be earned with a Series 7, 65, or 82 investment license.

 

This makes joining that club especially challenging. Even if you meet the minimum requirement, putting money into hedge funds often requires starting investments around $500,000 or more. This could be particularly discouraging if half of your net worth is being thrown into a risky investment. It’s not for everyone.

 

No Money! What Now?

 

If you’ve got the investment experience but not the money to back it up, starting your own hedge fund might be the better way to get close to those massive returns. A “2-and-20 fee” is the fee structure for hedge fund managers. Investors are usually required to pay a 2 percent asset management fee to cover the costs of managing the hedge fund. If investors send $1 million, this could be a $20,000 payday.

 

The 20 percent comes in after profits roll in. Hedge fund managers usually keep around 20 percent of all profits from the investments, despite whether or not they’ve put money in it themselves. It’s a fair trade for working their tails off.

 

Manage It

 

Managing requires plenty of steps, but if you can get through them, massive returns might be in your future. To legally start your hedge fund, you’ll need to file the Article of Incorporation for the firm. Two separate business entities will need to be formed, one for the fund itself and another for the investment manager. It’ll be set up at a limited partnership (LP) or a limited liability corporation (LLC). For additional questions, seek the secretary of state in the state you are trying to form the hedge fund.

 

Once you’re ready to file, think up a name for the fund. Though you may want to enter something cool, it’s better to be professional for this sort of thing. (Though the temptation is certainly great).

 

You’ll then need to apply for a Federal Employer Identification Number with the IRS on their website. These first steps are quick, easy, and don’t require a lot of dough.

 

Write the Bylaws

 

If you’re good with a pen and paper, you’ll want to get started on the corporate bylaws. Completing documents, registering with the SEC, and registering with the regulatory bodies in the state of incorporation are the necessary next steps. The bylaws will require a fully formed mission statement, compliance manual, ethical code of conduct, manual for supervisor producers, and advisor portfolio management agreement for your investors.

 

So, What Are the Next Steps?

 

Register the company as an investment advisor on the Investment Advisor Registration Depository website. (It’s completely free!)

 

Register the representatives as investment advisors by taking the Financial Industry Regulatory Authority Series 65 exam.

 

Register the hedge fund offering with the SEC.

 

Cross Your T’s and Dot Your I’s

 

Once everything is registered, you’re good to go … until your management reaches $25 million in assets. Once it does, you’ll be required to register with the SEC by completing Form ADV. Until then, you have to look at the individual laws described by your home state.

 

Before you start accepting investments, you’ll want to hire good legal counsel to ensure you don’t fall into any issues during your growth. They may also be a good way to network into the investment business, with special dinners or meet-and-greets with potential investors.

 

Now… Get to It!

 

Once your hedge fund is set up, it’s time to market it to potential investors. Accredited investors have free reign to market their fund to the general public. Once you build up assets, it’s time to start using those assets to create huge returns.