Mar
28
2025

What Is a Synthetic CDO?

By | invest, Investing | Comments Off on What Is a Synthetic CDO?

A synthetic CDO is a type of collateralized debt obligation that invests in non-cash derivatives, such as credit swaps, options, and insurance contracts, without owning the underlying assets.

Synthetic CDOs are a type of collateralized debt obligation; both are considered alternative investments and are high-risk due to their complexity. Unlike regular CDOs, which are pooled investments in traditional types of debt, like loans, mortgages, and bonds, synthetic CDOs are invested in non-cash derivatives, which may have a higher risk of default.

Synthetic CDOs are typically not available to retail investors. They are often viewed as controversial, as many have cited them as a contributor to the 2008 financial crisis and subprime mortgage collapse. Here’s a closer look at how synthetic CDOs work and the risks associated with investing in them.

Key Points

•   A synthetic CDO invests in credit derivatives, like credit swaps, without owning underlying assets.

•   Synthetic CDOs have tranches reflecting different risk levels, with higher ratings indicating lower risk as well as lower returns.

•   Due to their complexity and risk, synthetic CDOs are used mainly by institutional investors.

•   Synthetic CDO instruments are considered high-risk, in part due to market risk and the potential for the underlying assets to default.

•   Synthetic CDOs have been criticized for contributing to the subprime mortgage collapse that led to the 2008 financial crisis.

What Is a Collateralized Debt Obligation (CDO)?

CDO and synthetic CDO are two distinct products. A CDO or collateralized debt obligation is a type of derivative investment, meaning it derives its value from an underlying financial asset or pool of assets. Those assets can include loans, bonds, and other types of debt.

How Does a CDO Work?

Many borrowers may be familiar with the term “collateral”; in finance it refers to the security that lenders typically require in return for offering loan products. With CDOs, the collateral would be the payments from the underlying loans, bonds, and other types of debt.

Because debt payments tend to be predictable, the appeal of CDOs is the potential for cash flow. But the risk in these types of financial assets lies in the potential for default.

CDOs are considered derivatives as their value (and price) derives from the underlying bonds and loans. In essence, a CDO is a bundle of debt that’s sold to investors on the secondary market. Rather than individual investors, CDOs are typically sold to institutional investors, such as insurance companies or investment banks.

Different Categories of CDOs

Collateralized debt obligations are considered a type of alternative asset, in that they’re not part of the world of traditional securities like stocks and bonds.

CDO categories may include:

•   Mortgage-backed securities, which are comprised of mortgage loans

•   Asset-backed securities, which invest in non-mortgage debt, such as credit cards or car loans

•   Collateralized bond obligations, which hold a mix of bonds1

CDOs are assigned a tranche or class which signifies the level of risk and reward. The highest rating is AAA, which signifies the lowest risk but correspondingly, the lowest yields.

CDOs and the Financial Crisis

CDOs contributed to the 2008 financial crisis because many of them concentrated holdings in high-risk assets, namely, subprime mortgages. Banks flocked to CDOs because they offered diversification and generated cash flow, which was used to make new loans.

When the housing bubble burst, however, declining home values led many borrowers to default on their subprime loans. That resulted in a rapid cooling of the CDO market and substantial losses for banks.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

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Understanding Synthetic CDOs

Synthetic investments attempt to generate cash flow without ownership of the underlying assets. What is a synthetic CDO? It’s an investment vehicle that offers investors exposure to non-cash credit derivatives, such as credit swaps, insurance contracts, or options.

Like regular CDOs, synthetic CDOs are assigned tranches relative to the level of risk they present. The higher the credit rating, the lower the risk, but the return profile is also lower.

How a Synthetic CDO Works

How does a synthetic CDO work? It depends on the underlying investments but for simplicity’s sake, let’s consider a typical synthetic CDO that invests in credit default swaps. A credit default swap is a contract in which a buyer pays a premium to the seller, and the seller agrees to pay a lump sum to the buyer if the underlying credit instrument defaults.

In this type of arrangement, the seller of the synthetic CDO assumes a long position, betting that the underlying assets will perform as expected. The buyer assumes a short position, betting that the underlying assets will default. If the asset defaults, the buyer is entitled to a payout from the seller.

Recommended: Stock Market Basics

Investing in Synthetic CDOs

Synthetic CDOs are not designed for the everyday investor. If you’re opening a brokerage account, for example, you won’t find them offered alongside individual stocks or exchange-traded funds (ETFs).

More often, synthetic CDOs are the domain of institutional investors like banks or insurance companies. That’s appropriate, given how complex — and often confusing — these products are.

Individual investors who are interested in diversifying their asset allocation with alternative investments can gain exposure to credit default swaps outside of a synthetic CDO. For example, you might invest in an ETF or mutual fund that holds credit default swaps as an underlying asset.

There are, however, some stipulations. Venturing into this type of alternative investment is generally not recommended for investors who don’t fully understand how they work or the risks involved.

What Are Alternative Investments?

Alternative investments, sometimes called alts, refer to non-traditional assets that fall outside the realm of stocks, bonds, and cash. Alts may include commodities, real estate, private equity, hedge funds, and other instruments like CDOs.

Alts typically have little or no correlation with traditional asset classes. Thus they can be appealing to some investors because they may offer some portfolio diversification, and the potential for higher risk-adjusted returns.

That said, alts tend to be illiquid, not transparent, not well-regulated, and high risk.

Risks of Investing in Synthetic CDOs

Like most types of alternative investments, synthetic CDOs carry elevated levels of risk for investors.

Some of the most significant risks include:

•   Lack of transparency and limited federal regulation

•   Credit risk and the potential for default of underlying assets

•   Liquidity risk and the difficulties in buying and selling synthetic CDO positions

•   Modeling risk, which can result in incorrect assumptions about the value of underlying assets

•   Market risk, or the risk of changes in the value of underlying assets

While the market has changed in the years since the financial crisis, and federal regulations now exist to protect investors from a repeat of those events, the risks of synthetic CDOs and CDOs in general can’t be discounted.

The Takeaway

Synthetic CDOs are a complicated way to build a portfolio. If you’re looking for a way to diversify, you can invest in stocks, ETFs, private credit, commodities, and even IPOs through an online brokerage account.

SoFi does not offer CDO investments at this time, but it does provide access to a range of alternative investment funds. You can choose what to invest in, based on your risk tolerance and goals.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.


Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

What is the main purpose of a synthetic CDO?

The main purpose of a synthetic CDO is to allow investors to gain exposure to an underlying credit asset without owning it. Synthetic CDOs that invest in credit default swaps allow a buyer and seller to take short and long positions respectively to bet on the behavior and performance of an underlying asset.

How do synthetic CDOs differ from traditional CDOs?

Traditional CDOs invest in debt instruments or securities, such as mortgage loans, credit card debt, or auto loans. Synthetic CDOs primarily invest in credit instruments, such as credit default swaps or options.

What are the risks associated with investing in synthetic CDOs?

Synthetic CDOs are subject to credit risk, market risk, and liquidity risk. If the underlying asset doesn’t perform as expected, that can result in losses for the buyer or seller.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/akinbostanci

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Mar
28
2025
Guide to Yankee Certificates of Deposit

Guide to Yankee Certificates of Deposit

By | Growing Wealth, Investing, money | Comments Off on Guide to Yankee Certificates of Deposit

A Yankee certificate of deposit is a special type of CD that’s issued domestically by a branch of a foreign bank.

Yankee CDs, sometimes referred to as YCDs in finance, have several features that set them apart from other types of CDs, including higher minimum deposit requirements, short terms, and a lack of FDIC protection.

For those reasons, it’s helpful to understand how a Yankee certificate of deposit investment works and the potential risks involved.

What Is a Yankee Certificate of Deposit?

To understand what a Yankee certificate of deposit is, it’s helpful to know how a certificate of deposit works in general.

A regular CD is a deposit account that requires investors to lock up their cash for a fixed period of time (typically a few months to a few years), and in exchange pays a higher interest rate than a traditional savings account and as much or more than a high-yield savings account.

CDs purchased at a bank are generally FDIC insured up to $250,000 (CDs bought at a credit union are insured by the National Credit Union Association up to the same amount).

By contrast, a Yankee certificate of deposit is a CD account that’s issued by a branch of a foreign bank in the U.S., to U.S. customers. In general, the term of a Yankee certificate deposit is less than a year, and the minimum deposit required is more in line with a jumbo CD.

So, for example, a Canadian bank that has branches in the U.S. could offer Yankee CDs to U.S. residents. Even though the CDs would be issued by a foreign bank, they would still be subject to U.S. regulation by the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Board. But a Yankee certificate of deposit would not be federally insured.

Foreign banks that operate in the U.S. can issue Yankee CDs in order to generate capital for making loans or investments. These CDs can be purchased at issuance or on the secondary market.

Recommended: What is Liquid Net Worth

How Yankee CDs Work

As noted above, Yankee CDs work much the same as other types of deposit accounts that are CDs. There are some differences, however, with regard to:

•   Minimum deposits

•   Interest rates

•   Maturity terms

•   Investment risk

Minimum Deposits

Though you might be able to invest in a standard CD with $500 or $1,000, a Yankee certificate of deposit investment might require an initial deposit of $1 million or more. Scotiabank, for instance, issues its Yankee CDs in increments of $250,000 while UBS requires a $1 million minimum deposit for Yankee CDs offered through its Stamford, CT, branch.

A CD of this size issued by a U.S. institution could be categorized as a negotiable CD or NCD. NCDs have a face value of $100,000 or more. But Yankee CDs are not negotiable CDs because they are not FDIC insured.

Fixed and Variable Rates

Interest rates for Yankee CDs may be fixed or variable, which is another difference from other CDs which typically offer a fixed rate, making them more predictable instruments for fixed-income investors.

Shorter Terms

Maturity terms for a Yankee certificate of deposit tend to be shorter (one to three years, depending on the issuer), while regular CDs can have terms ranging from 28 days up to 10 years. The investor cannot access their cash until the CD matures, without triggering an early withdrawal penalty.

Potential Risk

Perhaps the biggest difference between Yankee CDs and other types of CDs is the level of risk involved. Generally speaking, CDs are considered to be safe investments since they offer a practically guaranteed rate of return, and deposits are federally insured up to a certain amount. Yankee CDs, on the other hand, carry certain risks including credit risk and the possibility of lower-than-expected returns if you’re choosing a variable-rate option.

Recommended: Average Savings by Age

Why Does a Yankee CD Matter?

Yankee CDs are not something the everyday investor is likely to be concerned with. After all, most people don’t have $1 million or $50 million to invest into a single CD.

If you’re able to invest in a Yankee CD, however, it’s possible that you could earn a higher rate of return for your money. That could be important to you if you’re working on building wealth and want to diversify your portfolio.

Are CDs smart investments? They can be, if you’re comfortable leaving money in a CD account until it reaches maturity. Again, with a Yankee certificate of deposit you may be looking at a one- to three-year wait until the CD matures. So given the higher deposit requirements involved, it’s important to consider how comfortable you are typing up larger amounts for that long, and what kind of return you can expect.

From a banking perspective, Yankee CDs matter because they’re a source of capital for foreign banks, which may need U.S. dollars to cover domestic obligations.

Yankee CDs: Real World Example

Scotiabank is one example of a Canadian bank that offers Yankee CDs to U.S.-based savers. The bank, headquartered in Toronto, offers both floating-rate and fixed- rate Yankee certificates of deposit. The bank’s floating-rate products have maturity terms ranging from two to three years, with minimum deposits of $250,000 and target principal amounts ranging from $50 million to $90 million.

The fixed-rate Yankee CD earns an impressive yield and requires a minimum deposit of $250,000, with a target principal amount of $100 million. The maturity period for this CD is also two years. Scotiabank offers these CDs exclusively to institutional investors who are accredited.

Special Considerations for Yankee CDs

There are two important things to keep in mind with a Yankee certificate of deposit investment. First, investors assume a certain amount of credit risk with these CDs.

The quality of these CDs is determined by the credit rating of the issuing bank. Banks with lower credit ratings may be more likely to default on financial obligations, including the payment of interest to CD holders. Tying up large amounts of money in Yankee certificates of deposit issued by banks with questionable credit ratings could therefore be risky.

Second, it’s important to keep in mind that FDIC protection does not apply to these CDs. Ordinarily, CDs issued at FDIC-insured banks are protected up to $250,000 per depositor, per financial institution, per account ownership type, in the rare event that the bank fails. With Yankee CDs, you don’t have that reassurance that your money is safe should the worst happen.

How to Open a Yankee CD

Opening a Yankee isn’t that different from opening any other type of CD. Here are the main steps involved:

•   Locate banks that offer Yankee CDs in the U.S.

•   Compare the Yankee certificates of deposit available, including the minimum deposit and interest rate.

•   Complete the application to open an account.

•   Make your initial deposit.

As noted, it’s important to choose a financial institution with good credit ratings. So you may want to take the additional step of checking credit ratings to measure the bank’s financial health and strength.

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Alternatives to Yankee CDs

If you’re looking for CD options that may be more accessible than Yankee CDs, there are some other possibilities. You could use any of the following to reach your savings goals:

•   Standard CDs. A standard CD is a regular CD offered by a bank or credit union that pays interest and has a reasonable minimum deposit.

•   Jumbo CDs. Jumbo CDs are similar to standard CDs but have larger minimum deposit requirements. For example, you may need $10,000 or more to open a jumbo CD.

•   No-penalty CDs. A no-penalty CD allows you to withdraw money from your CD before its maturity date without triggering an early withdrawal penalty.

•   Bump up CDs. Raise your rate or bump up CDs allow you to raise your interest rate once or twice during the CD term. This type of CD might be attractive if you expect rates to rise.

•   Add-on CDs. An add-on CD allows you to make additional deposits to your account after your CD has been opened. Ordinarily, CDs don’t allow additional deposits.

You may also consider CD-secured loans if you’re interested in a CD product that can help you build credit. With a CD-secured loan your CD serves as collateral. Your money stays in the CD until maturity, earning interest. Meanwhile, you make payments to the loan which can be reported to the credit bureaus.

Once the CD matures, you can withdraw the principal and interest or roll it into a new CD. You also get the benefit of on-time payment history, which can help to improve your credit score.

The Takeaway

A Yankee certificate of deposit is issued domestically by a branch of a foreign bank to U.S. investors. Yankee CDs are designed to help investors earn a solid return while allowing foreign banks to raise capital via U.S. investors. Due to their high minimum deposit requirements (as much as $1 million or more), these CDs may be better suited to some investors than others; they’re sometimes restricted to institutional investors.

Yankee CDs may offer competitive rates, but they are not federally insured like most U.S.-issued CDs.
If a Yankee CD doesn’t suit your needs, you might want to consider alternatives, such as a regular CD or a high-yield checking account or checking and savings account instead.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.


Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.80% APY on SoFi Checking and Savings.

FAQ

Can you lose money on a certificate of deposit?

Certificates of deposit (CDs) are generally a safe, secure way to save money. It’s possible, however, to lose money with a Yankee CD if the bank that issued it is unable to meet its financial obligations and pay interest to investors as scheduled.

What are the cons of a certificate of deposit?

Certificates of deposit may offer lower rates of return compared to other investments, which means your money might have less potential for growth. With bank CDs, savers may face early withdrawal penalties if they take money from their accounts before the CD matures.

How do I redeem a certificate of deposit?

If your CD is reaching maturity or you need to withdraw money for any other reason, you can visit a branch to redeem your CD or do so online if your bank allows it. You’ll need to specify how much money you want to withdraw and where that money should be sent if you’re redeeming CDs online.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/utah778


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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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3.80% APY
SoFi members with Eligible Direct Deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below).

Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning 3.80% APY, we encourage you to check your APY Details page the day after your Eligible Direct Deposit arrives. If your APY is not showing as 3.80%, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning 3.80% APY from the date you contact SoFi for the rest of the current 30-day Evaluation Period. You will also be eligible for 3.80% APY on future Eligible Direct Deposits, as long as SoFi Bank can validate them.

Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi members with Eligible Direct Deposit are eligible for other SoFi Plus benefits.

As an alternative to Direct Deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Eligible Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving an Eligible Direct Deposit or receipt of $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Eligible Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Eligible Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Eligible Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Eligible Direct Deposit or Qualifying Deposits until SoFi Bank recognizes Eligible Direct Deposit activity or receives $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Eligible Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Eligible Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

Members without either Eligible Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, or who do not enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days, will earn 1.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 1/24/25. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

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2025
Guide to Zero-Coupon Certificates of Deposit (CDs)

Guide to Zero-Coupon Certificates of Deposit (CDs)

By | Growing Wealth, Investing, money | Comments Off on Guide to Zero-Coupon Certificates of Deposit (CDs)

A zero-coupon certificate of deposit or zero-coupon CD is a type of CD that’s purchased at a discount and pays out interest at maturity. Zero-coupon CDs can offer higher yields than standard CDs for investors who have the patience to wait until maturity to collect their original deposit and the interest earned.

Zero-coupon certificates of deposit are similar to bonds in that both are considered lower-risk, fixed-income instruments, but they serve different purposes in a portfolio. Understanding how a zero-coupon CD works can make it easier to decide if it’s a good investment for you.

What Is a Zero-Coupon CD?

To understand zero-coupon CDs, it’s important to know how a regular certificate of deposit works. A CD account, also referred to as a time-deposit or term-deposit account, is designed to hold money for a specified period of time. While the money is in the CD, it earns interest at a rate determined by the CD issuer — and the investor cannot add to the account or withdraw from it without penalty.

CDs are FDIC or NCUA insured when held at a member bank or credit union. That means deposits are insured up to $250,000.

CDs are some of the most common interest-bearing accounts banks offer, along with savings accounts and money market accounts (MMAs).

A zero-coupon certificate of deposit does not pay periodic interest. Instead, the interest is paid out at the end of the CD’s maturity term. This can allow the purchaser of the CD to potentially earn a higher rate of return because zero-coupon CDs are sold at a discount to face value, but the investor is paid the full face value at maturity.

By comparison, traditional certificates of deposit pay interest periodically. For example, you might open a CD at your bank with interest that compounds daily. Other CDs can compound monthly. Either way, you’d receive an interest payment in your CD account for each month that you hold it until it matures.

Once the CD matures, you’ll be able to withdraw the initial amount you deposited along with the compound interest. You could also roll the entire amount into a new CD if you’d prefer.

Remember: Withdrawing money from a CD early can trigger an early withdrawal penalty that’s typically equal to some of the interest earned.

How Do Zero-Coupon CDs Work?

Ordinarily when you buy a CD, you’d deposit an amount equal to or greater than the minimum deposit specified by the bank. You’d then earn interest on that amount for the entirety of the CD’s maturity term.

With zero-coupon CD accounts, though, you’re purchasing the CDs for less than their face value. But at the end of the CD’s term, you’d be paid out the full face value of the CD. The discount — and your interest earned — is the difference between what you pay for the CD and what you collect at maturity. So you can easily see at a glance how much you’ll earn from a zero-coupon CD investment.

In a sense, that’s similar to how the coupon rate of a bond works. A bond’s coupon is the annual interest rate that’s paid out, typically on a semiannual basis. The coupon rate is always tied to a bond’s face value. So a $1,000 bond with a 5.00% interest rate has a 5.00% coupon rate, meaning a $50 annual payout until it matures.

Real World Example of a Zero-Coupon CD

Here’s a simple example of how a zero-coupon CD works. Say your bank offers a zero-coupon certificate of deposit with a face value of $10,000. You have the opportunity to purchase the CD for $8,000, a discount of $2,000. The CD has a maturity term of five years.

You wouldn’t receive any interest payments from the CD until maturity. And since the CD has a set term, you wouldn’t be able to withdraw money from the account early. But assuming your CD is held at an FDIC- or NCUA-member institution, the risk of losing money is very low.

At the end of the five years, the bank pays you the full $10,000 face value of the CD. So you’ve essentially received $400 per year in interest income for the duration of the CD’s maturity term — or 5.00% per year. You can then use that money to purchase another zero-coupon CD or invest it any other way you’d like.

💡 Quick Tip: Typically, checking accounts don’t earn interest. However, some accounts do, and online banks are more likely than brick-and-mortar banks to offer you the best rates.

Tips When Investing in a Zero-Coupon CD

If you’re interested in zero-coupon CDs, there are a few things to consider to make sure they’re a good investment for you. Specifically, it’s important to look at:

•   What the CD is selling for (in other words, how big of a discount you’re getting to its face value)

•   How long you’ll have to hold the CD until it reaches maturity

•   The face value amount of the CD (and what the bank will pay you in full, once it matures)

It’s easy to be tempted by a zero-coupon certificate of deposit that offers a steep discount between the face value and the amount paid out at maturity. But consider what kind of trade-off you might be making in terms of how long you have to hold the CD.

If you don’t have the patience to wait out a longer maturity term, or you need the money in the shorter term, then the prospect of higher returns may hold less sway for you. Also, keep in mind what kind of liquidity you’re looking for. If you think you might need to withdraw savings for any reason before maturity, then a standard CD could be a better fit.

Comparing zero-coupon CD offerings at different banks can help you find one that fits your needs and goals. You may also consider other types of cash equivalents, such as money market funds or short-term government bonds if you’re looking for alternatives to zero-coupon CDs.

Recommended: How to Invest in CDs: A Beginner’s Guide

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Pros of Zero-Coupon CDs

Zero-coupon CDs have some features that could make them more attractive than other types of CDs. The main advantages of investing in zero coupon certificates of deposit include:

•   Higher return potential than regular CDs

•   Guaranteed returns, since you’re unable to withdraw money before maturity

•   Suited for longer-term goals

•   Can be federally insured

Zero-coupon CDs are lower-risk investments, which can make them more appealing than bonds. While bonds are considered lower-risk investments generally, if the bond issuer defaults, then you might walk away from your investment with nothing.

A zero-coupon certificate of deposit, on the other hand, does not carry this same default risk because your money is insured up to $250,000. There is, however, a risk that the CD issuer could “call” the CD before it matures (see more about this in the next section).

Cons of Zero-Coupon CDs

Every investment has features that may be sticking points for investors. If you’re wondering what the downsides of zero-coupon CDs are, here are a few things to consider:

•   No periodic interest payments

•   No liquidity, since you’re required to keep your money in the CD until maturity

•   Some zero-coupon CDs may be callable, which means the issuer can redeem them before maturity, and the investor won’t get the full face value

•   Taxes are due on the interest that accrues annually, even though the interest isn’t paid out until maturity

It may be helpful to talk to your financial advisor or a tax professional about the tax implications of zero-coupon CDs. It’s possible that the added “income” from these CDs that you have to report each year could increase your tax liability.

How to Collect Interest on Zero-Coupon CDs

Since zero-coupon CDs only pay out at interest at the end of the maturity term, all you have to do to collect the interest is wait until the CD matures. You can direct the bank that issued the CD to deposit the principal and interest into a savings account or another bank account. Or you can use the interest and principal to purchase new CDs.

It’s important to ask the bank what options you’ll have for collecting the interest when the CD matures to make sure renewal isn’t automatic. With regular CDs, banks may give you a window leading up to maturity in which you can specify what you’d like to do with the money in your account. If you don’t ask for the money to be out to you it may be rolled over to a new CD instead.

How to Value Zero-Coupon CDs

The face value of a zero-coupon CD is the amount that’s paid to you at maturity. Banks should specify what the face value of the CD is before you purchase it so you understand how much you’re going to get back later.

In terms of whether a specific zero-coupon CD is worth the money, it helps to look at how much of a discount you’re getting and what that equates to in terms of average interest earned during each year of maturity.

Purchasing a $10,000 zero-coupon CD for $8,000, for example, means you’re getting it at 20% below face value. Buying a $5,000 zero-coupon CD for $4,500, on the other hand, means you’re only getting a 10% discount.

Of course, you’ll also want to keep the maturity term in perspective when assessing what a zero-coupon CD is worth to you personally. Getting a 10% discount for a CD with a three-year maturity term, for example, may trump a 20% discount for a five-year CD, especially if you don’t want to tie up your money for that long.

The Takeaway

Investing in zero-coupon CDs could be a good fit if you’re looking for a lower-risk way to save money for a long-term financial goal, and you’d like a higher yield than most other cash equivalents.

Zero-coupon CDs are sold at a discount to face value, and while the investor doesn’t accrue interest payments annually, they get the full face value at maturity — which often adds up to a higher yield than many savings vehicles. And because the difference between the discount and the face value is clear, zero-coupon CDs are predictable investments (e.g. you buy a $5,000 CD for $4,000, but you collect $5,000 at maturity).

As with any investment, it’s important for investors to know the terms before they commit any funds. For example, zero-coupon CDs don’t pay periodic interest, but the account holder is expected to pay taxes on the amount of interest earned each year (even though they don’t collect it until they cash out or roll over the CD).

If you’re eager to earn a higher rate on your savings, you’ve got a lot of options to explore — including a high-yield bank account or a regular CD.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.80% APY on SoFi Checking and Savings.

FAQ

What is a coupon on a CD?

The coupon on a CD is its periodic interest payment. When a CD is zero coupon, that means it doesn’t pay out interest monthly or annually. Instead, the investor gets the full amount of interest earned paid out to them when the CD reaches maturity.

Is a certificate of deposit a zero-coupon bond?

Certificates of deposit and bonds are two different types of savings vehicles. While a CD can be zero-coupon the same way that a bond can, your money is not invested in the same way. CD accounts also don’t carry the same types of default risk that bonds can present.

Are CDs safer than bonds?

CDs can be safer than bonds since CDs don’t carry default risk. A bond is only as good as the entity that issues it. If the issuer defaults, then bond investors can lose money. CDs, on the other hand, are issued by banks and typically covered by FDIC insurance which generally makes them safer investments.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/Joyce Diva


Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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3.80% APY
SoFi members with Eligible Direct Deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below).

Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning 3.80% APY, we encourage you to check your APY Details page the day after your Eligible Direct Deposit arrives. If your APY is not showing as 3.80%, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning 3.80% APY from the date you contact SoFi for the rest of the current 30-day Evaluation Period. You will also be eligible for 3.80% APY on future Eligible Direct Deposits, as long as SoFi Bank can validate them.

Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi members with Eligible Direct Deposit are eligible for other SoFi Plus benefits.

As an alternative to Direct Deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Eligible Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving an Eligible Direct Deposit or receipt of $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Eligible Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Eligible Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Eligible Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Eligible Direct Deposit or Qualifying Deposits until SoFi Bank recognizes Eligible Direct Deposit activity or receives $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Eligible Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Eligible Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

Members without either Eligible Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, or who do not enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days, will earn 1.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 1/24/25. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

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2025

What Is an Interval Fund?

By | invest, Investing, Terminology | Comments Off on What Is an Interval Fund?

Interval funds are closed-end mutual funds that don’t trade publicly on an exchange. These funds are so named because they offer to repurchase a percentage of outstanding shares at periodic intervals.

Investing in interval funds can be attractive since they have the potential to generate higher yields. However, they’re less liquid than other types of funds, owing to the restrictions around when and how you can sell your shares.

Key Points

•   Interval funds are closed-end mutual funds that offer to repurchase a percentage of outstanding shares at periodic intervals.

•   Investing in interval funds can generate higher yields but they are less liquid compared to other funds.

•   Interval funds make periodic repurchase offers to shareholders based on a schedule set in the fund’s prospectus.

•   Interval funds may hold a variety of underlying investments such as private credit, real estate, private equity, venture capital, and infrastructure.

•   Interval funds differ from closed-end funds and mutual funds in terms of trading on an exchange, initial public offering, and liquidity.

How Do Interval Funds Work?

Interval funds are alternative investments that work by making periodic repurchase offers to shareholders according to a schedule set in the fund’s prospectus.

Shareholders are not obligated to accept the offer but if they do, they receive a share price that’s based on net asset value (NAV). Repurchase intervals may occur quarterly, biannually, or annually.

These funds typically rely on an active management strategy, which is designed to produce returns that outpace the market. But because of the types of investments held by interval funds, as well as the fund’s structure, the trade-offs are potentially higher risk and far less liquidity.

💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.

Alternative investments,
now for the rest of us.

Start trading funds that include commodities, private credit, real estate, venture capital, and more.

What Types of Assets Do Interval Funds Hold?

Interval funds may hold a variety of underlying investments that are different from what traditional funds may invest in, which is partly why interval funds are considered a form of alternative investing. An interval fund’s prospectus should include a detailed account of its underlying assets to help investors better understand what they’re investing in.

Recommended: Alternative Investment Guide

Private Credit

Private credit refers to lending that occurs outside the scope of traditional banking. Rather than going through a bank for a loan, businesses gain access to the capital they need through private lending arrangements.

Also referred to as direct lending or private debt, private credit helps to fill a void for businesses that have been unable to secure traditional financing. Private credit can also offer investors an opportunity, as private credit generates returns for investors in the form of interest on the loans.

Real Estate

Real estate can be an attractive investment for investors who are seeking an inflationary hedge with low correlation to the stock market. Interval funds may invest in private real estate investment trusts (REITs), private real estate funds, commercial properties, and land. Some real estate interval funds focus on real estate debt investments.

Private Equity

Private equity refers to investments in companies that are not publicly traded on an exchange. Private equity funds pool capital from multiple investors to purchase companies, overhaul them, and sell them at a profit. This type of investment can prove risky, as there are no guarantees that the company’s value will increase but if it does, the rewards for investors can be great.

Venture Capital

Venture capital is a form of private equity in which investors provide funding to startups and early-stage businesses. In exchange, investors receive an equity stake in the company. Venture capitalists have an opportunity to make their money back once the company goes public by selling their shares.

Infrastructure

Infrastructure interval funds invest in the mechanisms, services, and systems that make everyday life possible. Investments are focused on:

•   Transportation

•   Energy and utilities

•   Housing

•   Healthcare

•   Communications

These types of investments can be attractive as they tend to produce stable cash flow since a significant part of the population relies on them.

How Does the Repurchase Process Work?

An interval fund makes repurchase offers according to the schedule set in the prospectus. Shareholders should be given advance notice of upcoming repurchase offers and the date by which they should accept the offer if they prefer to do so. The fund should also specify the date at which the repurchase will occur.

In terms of the timing, it may look something like this:

•   Once shareholders are notified of an upcoming repurchase offer, they have three to six weeks to respond.

•   After the acceptance deadline passes, there may be a two-week waiting period for the repurchase to occur.

•   Investors who accepted the repurchase offer may have up to a one-week wait to receive proceeds owed to them.

The price shareholders receive is based on the per share NAV at a set date. A typical repurchase offer is 5% to 25% of fund assets. interval funds may collect a redemption fee of up to 2% of repurchase proceedings. This fee is paid to the fund to cover any expenses related to the repurchase.

What’s the Difference Between an Interval Fund and a Closed-End Fund?

Closed-end funds issue a fixed number of shares, with no new shares issued later (even to keep up with demand from investors). An interval fund is categorized as a closed-end fund legally. However, interval funds don’t behave the same way as other closed-end funds. Specifically:

•   There’s typically no initial public offering (IPO)

•   Interval funds do not trade on an exchange

•   Investors can purchase shares at any time

The third point makes interval funds more like open-end funds, but there’s a key difference there as well. Interval funds can hold a much higher percentage of assets in illiquid investments than open-end funds.

What’s the Difference Between an Interval Fund and a Mutual Fund?

Interval funds are different from traditional mutual funds, which are also a type of pooled investment. With a mutual fund, investors can buy shares to gain exposure to a wide variety of underlying assets. The fund may pay out dividends to investors or offer the benefit of long-term capital appreciation.

Investors can buy mutual fund shares at any time, but unlike an interval fund, these shares trade on a stock exchange. The fund’s share price is set at the end of the trading day. Mutual funds can offer greater liquidity to investors since you can buy shares one day and sell them the next day or even the same day.

Interval funds don’t offer that benefit as you must wait until the next repurchase date to sell your shares. An interval fund may also be more expensive to own compared to a mutual fund, as there are often additional costs that apply.

Investor Considerations

If you’re interested in alternative investments and you’re considering interval funds, there are some important things to keep in mind.

•   What is the minimum investment required and can you meet it?

•   How does your risk tolerance align with the risk profile of the fund you’re weighing?

•   What is the schedule for repurchase offers and how does that align with your liquidity needs?

•   How much will you pay to invest in the fund?

•   What is your target range for returns?

Due to their illiquid nature, it may not make sense for the average investor to tie up a large part of their portfolio in interval funds. It’s also important to keep in mind that the minimum investment may be in the five-figure range, which is often well above the minimum needed to trade mutual fund shares.

💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Potential Upside

The potential upside of interval funds is the possibility of earning returns that beat the average return of the stock market. Depending on the fund’s strategy and underlying investments, it’s possible to realize returns that are substantially higher than what you might get with a traditional open-end mutual fund.

Interval funds can add diversification to a portfolio and give you access to illiquid investments that might otherwise be closed off to you. While there are risks involved, interval funds may be less susceptible to market volatility as they have a lower correlation to stocks overall.

Although lack of liquidity may be problematic for some investors, it can benefit others who may be tempted to give in to investing biases. Since you can’t easily sell your shares, interval funds can prevent you from making panic-driven decisions with this segment of your portfolio.

Recommended: Why Portfolio Diversification Matters

Possible Risks

Much of the risk associated with interval funds lies in their underlying investments. If a fund is investing in private credit or venture capital, for example, and the companies the fund backs fail to become profitable, that can directly impact the returns you realize as an investor.

As mentioned, liquidity risk can also be an issue for investors who don’t want to feel locked into their investments. Even if you’re comfortable with only being able to redeem shares at certain times, there’s always market risk which could negatively affect the NAV share price you’re offered.

The Takeaway

Interval funds can be rewarding to investors, but they’re more complex than other types of mutual funds or exchange-traded funds. Weighing the pros and cons is an important step in deciding whether to invest. You may also consider talking it over with a financial advisor before adding interval funds to your portfolio.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

Are interval funds a good investment?

Interval funds may be a good investment for investors who are comfortable with higher risk exposure given the potential to earn higher rewards. The complexity of these alternative investments may make them less suitable for individuals who are just getting started with building a portfolio.

What’s the difference between an interval fund and an ETF?

An exchange-traded fund (ETF) is a type of mutual fund that trades on an exchange like a stock; an interval fund is a closed-end fund that doesn’t trade on an exchange. ETFs can offer exposure to a pool of different investments, including some of the same illiquid investments that an interval fund may hold. But whereas the majority of ETFs are passively managed, most interval funds have an active portfolio manager.

Do interval funds pay dividends?

Interval funds can pay dividends though they’re not required to do so. When collecting dividends from an interval fund or any other type of mutual fund, it’s important to understand how that income will be treated for tax purposes.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/sofirinaja

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Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.


Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.


Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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Mar
28
2025
What is Buying Power? Definition & Formula

Guide to Buying Power

By | Growing Wealth, invest, Investing | Comments Off on Guide to Buying Power

Buying power refers to an investor’s ability or resources on hand to buy securities or investments. Investors who trade securities through an online brokerage account or margin account may see references to buying power or excess equity when reviewing the amount of money they have available to purchase securities.

Put differently, buying power is a determination of an investor’s ability to make trades at any given time. Understanding the differences in what it means to have more or less power to buy stocks, options or crypto can help with shaping investment decisions.

What Is Stock Buying Power?

Buying power, or excess equity, is a measure of how much capital an investor has available to trade stocks, options, and other securities. There are different ways to measure buying power, depending on the type of account an investor has. Completing trades can reduce an investor’s ready capital while selling securities and depositing the cash into their trading account can increase it.

There’s no standard buying power definition; instead, it’s simply a way to gauge an investor’s ability to trade, based on the financial resources they have in their trading account. It can also be thought of, or related to the purchasing power of the dollar.

Buying Power vs Purchasing Power

Buying power, in this sense, is not the same thing as purchasing power, however. Purchasing power refers to the amount of goods or services a given unit of currency can purchase, when factoring in inflation. Often purchasing power comes up during discussions of how inflation may affect a portfolio’s returns.

Buying Power vs Consumer Buying Power

Further, a consumer’s buying power or consumer purchasing power is a measure of how much a consumer has on hand to buy goods or services, not only investments or financial securities. Again, in this sense, the concept is broader and doesn’t relate strictly to investing.

How Does Buying Power Work?

To understand how buying power works, it helps to understand when this term comes into play. The types of accounts that use or reference buying power include:

•   Margin trading accounts

•   Cash brokerage accounts

•   Individual Retirement Accounts (IRAs)

Margin trading involves using leverage, or borrowing cash, from a broker-dealer to purchase securities using the assets in a brokerage account as leverage or collateral.

Margin trading can increase an investor’s buying power above what they’d have in a cash account or IRA account. (Cash accounts and IRAs don’t use margin or leverage.) While trading on margin can enhance risk, it can also double the amount of capital an investor has available to make trades with.

Note, too, that there are distinctions that are important to understand when discussing leverage vs margin.

Pattern day trading can also increase buying power for margin investors who prefer active trading versus a buy-and-hold approach. The Financial Industry Regulatory Authority (FINRA) defines a pattern day trader as any investor who executes four or more day trades within five business days, provided that the number of day trades represents more than 6% of the investor’s total trades in the margin account for that same five-day period.

Buying Power Example

Assume that an investor has $10,000 in cash in a margin account. They want to use that $10,000 to purchase shares of stock. The stock has a 50% initial margin requirement. In that case, the investor’s buying power calculation looks like this:

$10,000 in cash divided by 50% initial margin requirement = $20,000 in margin buying power

Now, assume that same investor has $100,000 in cash instead to purchase stocks with. Using the same initial margin requirement, the calculation looks like this:

$100,000 in cash divided by 50% initial margin requirement = $200,000 in margin buying power

It’s important to remember that the value of the stocks the investor owns can determine the value of their margin account. When the value of the account increases, that can lead to more gains for the investor but it can also increase their odds of a margin call.

How To Calculate Buying Power

The method of calculating buying power depends on the kind of account involved. With a brokerage account or IRA, this calculation is simple. An investor would simply add up the amount of cash they have available to trade. So if someone has $20,000 in cash in their brokerage account they’d have $20,000 in buying power.

With margin accounts, buying power is typically double the amount of equity they have in their accounts. So an investor who has $25,000 in a margin account would have $50,000 of stock buying power in that instance.

With pattern day trading, the buying power is four times the amount of equity. So, if an investor has $50,000 in cash or equity with which to trade, they could have up to $200,000 in buying power using pattern day trading rules. It’s important to note that if an investor exceeds their day trading margin limits, their brokerage may issue a margin call.

Margin Calls

A margin call can happen if the value of securities in a margin account drops below a set level, as determined by the brokerage. When that occurs, the investor may need to deposit cash or other securities in their account or sell securities to make up a shortfall. The more leverage a brokerage allows, the more difficult it can be for an investor to fill the gap when there’s a margin call.

What Happens if You Don’t Have Enough Buying Power?

If you lack buying power as an investor, you simply won’t be able to place trades on your chosen platform. If you try to execute a trade and lack the buying power, the trade will simply not execute. The specifics may depend on your chosen exchange or platform, of course, but generally speaking, a lack of buying power means that you lack the ability to buy.

Where to Find Your Buying Power

Where you can find your buying power will depend on the specific platform or exchange you’re using, but typically, you’ll be able to find it somewhere in your account information or balances. For instance, if you’re investing with SoFi, you can find your buying power displayed in your account near its overall performance in the performance section of your Active Invest account.

How To Use Buying Power

If you’re interested in trading stocks, options, or other securities, having more buying power can work in your favor. Trading on margin can allow you to invest larger amounts of money and it has the potential to magnify your investment returns.

Say you have only $5,000 to invest. You open a margin account and your brokerage allows an additional $5,000 in buying power for a combined total of $10,000. You use this $10,000 to purchase 500 shares of stock which are trading at $20 each.

The stock’s price doubles to $40 per share. Now your shares are worth $20,000. You decide to sell, paying back the $5,000 margin loan to your broker. You also pay $500 in interest for the loan. That leaves you with $14,500 in profit.

Now, say you used $5,000 to buy 250 shares of that same stock. Once the stock’s price doubles to $40, you sell them and rake in a $10,000 profit. You’re still coming out ahead but trading on margin would have given you more buying power and thus more profits.

When using buying power to your advantage, you do have to consider the risks as well. Just as margin trading can increase your profits, it can also increase losses if the securities you purchase decline in value. In the event of a margin call, you’d have to liquidate some of your holdings or deposit extra cash to cover the difference.

Investing With SoFi

As noted, an investor’s buying power refers to how much they have at their disposal to purchase various investments and securities. Understanding how buying power works matters, especially if you’re a day trader or you’re trading on margin. And even if you’re a beginning investor, it’s still important to know what this means when it comes to your first brokerage account or IRA.

If you feel like you still need some guidance in calibrating your investment strategy, or furthering your understanding of buying power, it may be beneficial to speak with a financial professional.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What is buying power in simple terms?

Buying power, as it relates to investing, refers to how much an investor has to spend on investments, and can include cash in their account, as well as margin.

Why is buying power important?

Buying power gives an investor an idea of what they have to work with, and how they can leverage their assets and holdings to reach their financial goals. Understanding buying power may be particularly important for day traders or margin traders.

What is buying power vs cash?

Cash could refer to the investments you can afford to make with your wholly-owned assets, whereas buying power can also incorporate what you can borrow (margin) to purchase investments.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/solidcolours

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