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When it comes to the stock market, things can change—rapidly. Numerous factors impacting the value of individual stocks and the market as a whole can translate into being up one day, down the next. And try as they might, it can be near impossible for analysts to predict how the stock market will fare.

While the markets can be unpredictable, fluctuation is a sign that the stock market is working normally. As an investor, it’s important to get comfortable with the market’s volatility. Understanding how risk plays a role in investing can help inform the investing decisions you make for yourself.

What Is Investment Risk?

All investments come with risk. Unlike when you store your money in a savings account, investing has no guarantees that you’ll earn a return. When you invest, experiencing a financial loss is a possibility.

Different types of investments come with different levels of risk. Typically, as the risk increases, so do the potential returns. Understanding the types of risks associated with investing can be the key to informing your risk tolerance.

Types of Investment Risk

Just as there are a variety of investment vehicles, there are a number of different types of risk involved in investing. Here are a few common kinds:

Market Risk

Sometimes global economic trends, like a recession, or current events, like a natural disaster or political turmoil, can impact how the markets perform. Market risk refers to the potential for an investor to experience losses due to factors that are influencing the financial markets as a whole.

This type of risk is often referred to as systematic risk. The four most common types of market risk include interest rate, equity, commodity, and currency risk.

Interest rate risk reflects the market fluctuations that might occur after a change in interest rates is announced. Fixed-income investments, like bonds, are the investments that are most likely to be influenced by interest rate risk.

Equity risk refers specifically to the risk investors face from market volatility—the possibility that the value of shares will decrease.

Commodity risk comes from price fluctuations in commodities (raw materials) that impacts the users and producers of those same materials.

Currency risk is also known as exchange-rate risk. It stems from the price differences when comparing one currency to another. This type of risk is most relevant to investors who have assets in a foreign country or companies who have a lot of activities abroad.

Inflation Risk

Inflation measures the increase of the cost of goods over a set period of time and a rise in inflation means consumers have less purchasing power. Inflation risk is a concern for investors that have money saved in accounts with fixed interest rates, because the rate of inflation may outpace the fixed interest rate being earned.

Business Risk

When you buy a stock, you’re essentially buying a small share of the company. In order to make a possible return on your investment, the company you’ve invested in needs to remain in business. If a company goes out of business, common stockholders are likely the last to get paid, if at all.

Liquidity Risk

This type of risk reflects the concern that investors won’t find a market for their holdings when they ultimately do decide to sell their investments. This could prevent investors from buying and selling assets as desired; they may have to sell for a lower price, if they are able to sell at all.

This risk could also apply to investments with strict term limits like a certificate of deposit (CD). Account holders would typically face a penalty from withdrawing or liquidating this account before the specified time.

Horizon Risk

In investing, a time horizon is the amount of time you have until a specific financial goal.

A lengthy time horizon could potentially allow you to take on riskier investments, since if you do suffer a loss, your investments will have more time to rebound.

Horizon risk occurs when the time horizon of an investment is unexpectedly shortened—like, say, by an unexpected, expensive medical emergency.

On the other side of the spectrum, investors in or nearing retirement could face the risk of outliving their savings. This is referred to as longevity risk.

Concentration Risk

This type of risk can occur when an investor is invested in a limited number of assets or owns assets only in one category or asset class. If that one category experiences losses, so will a concentrated investment portfolio.

The Investment Risk Pyramid

Remember the food pyramid? Before MyPlate , the food pyramid was the gold standard of nutrition in the U.S. It recommended a hearty foundation of grains, followed by a smaller layer of fruits and veggies, followed by an even smaller layer of dairy, meats, beans, eggs, and nuts. At the very top, making up the smallest portion of the pyramid were fats, oils, and sweets.

The investment risk pyramid takes a similar approach, and could prove helpful if you’re looking for guidance as you’re evaluating the risks associated with different types of investments.

It may help you understand which investments pose the greatest risk, and can assist you in creating a portfolio that falls in line with your personal risk tolerance.

At the base of the pyramid are lower risk investments that have the potential to earn foreseeable returns. These investments create the foundation of a financial portfolio. Low risk investments typically include things like government bonds, CDs, money market accounts, and savings accounts.

In the middle of the pyramid are investments with moderate risk. These investments will be a little riskier than the base of the pyramid, but will hopefully lead to capital appreciation. Investments like high-income government bonds, real estate, equity mutual funds, and large and small cap stocks would fall into this category.

The riskiest investments are at the peak of the pyramid. Just like sweets, fats, and oils should make up a limited portion of your diet, these investments are generally recommended to only make up a relatively small portion of your overall investment portfolio.

Since these investments are so risky, some guidelines suggest only investing money that, if lost, won’t cause serious issues in your day-to-day life.

As you continue building your investment portfolio, it’s helpful to know that although the investment risk pyramid can be a useful tool, it’s just a guideline. Just as everyone’s dietary and nutritional needs are different, so are individual investment portfolios.Take it with a grain of salt.

Managing Risk

Here’s the thing about investing—risk is an unavoidable reality. While you won’t be able to eliminate risk completely, there are strategies to help you manage the investment risks your portfolio is subject to.

Understanding Your Financial Goals and Risk Tolerance

The first step in managing risk will be determining your risk tolerance—how much risk you are willing to take on as an investor. Your financial goals could help inform your risk tolerance. Consider asking yourself what you want to use your money for and then figuring out the timeline for when you’ll need it.

The amount of time you have to invest will likely influence the type of investments you make with your money.

For example, if you are saving for retirement in 40 years, you may be able to take on more risk than someone who plans to retire, in say, 10 years.

Try as we might, we can’t plan for everything and life can change quickly. As it does, it can be helpful to re-check your financial goals and re-assess your risk tolerance to see if any changes are necessary.

For example, if you’ve recently had a child, you may want to integrate a college fund into your financial plan. Or perhaps you and your partner have decided you want to upgrade to a bigger house before growing your family.

Diversifying Your Portfolio

With a diversified portfolio, your money isn’t concentrated into one specific area. Instead, it’s spread across different asset classes—like stocks, bonds, and real estate—the money isn’t concentrated in one specific area within each asset class.

While it can be tempting to concentrate your investments into areas you are most familiar with, limiting yourself to only a few industries or types of investments can be the financial equivalent of putting all of your eggs in one basket.

A diversified portfolio can provide some insulation to risk. If your portfolio is highly concentrated in one area and that sector takes a dip, it’s likely your portfolio will be impacted.

But if your portfolio is balanced across varied assets and classes, the impact of one underperforming section won’t be felt as dramatically. While a diversified portfolio won’t eliminate risk, it could help make your portfolio a little less vulnerable.

You could choose to diversify your portfolio through a series of thoughtful investments. As an alternative, you could also choose to invest in mutual funds or ETFs—exchange-traded funds.

When you buy shares in a mutual fund, you are automatically invested in each company that is included in the fund, which provides instant diversification. ETFs, on the other hand, bundle a group of securities together in one neat package and they can be a low-cost way to diversify your portfolio.

Monitoring Your Investments

It can be tempting to set it and forget it when it comes to investments. But keeping an eye on your portfolio is another step that could potentially help you manage risk. You won’t know there is an issue unless you monitor progress.

As the market fluctuates, your portfolio likely will, too. Consider setting a recurring time to monitor your holdings. It doesn’t have to be every day, but once a week or even once a month could be a good idea.

How have the assets been performing? Is your portfolio still in line with your current risk preferences? If not, consider taking the time to make adjustments so you’re comfortable with where your investments stand.

Regularly checking in with your investments will also allow you to monitor your progress and see if you’re still on track with your goals.

Asking for Help

Investing can be confusing. Sometimes all it takes a second set of (experienced) eyes to provide a bit of clarity. Don’t feel like you have to build your investment portfolio in a vacuum.

Consider speaking with a financial advisor who can assist you in creating a personalized financial plan that is designed to help you achieve your specific goals.

Know that financial advisors often charge fees for their services, but they can often provide valuable insight and advice. SoFi members have access to one-on-one advice with certified financial professionals, at absolutely no cost.

Becoming an Investor

Now that you understand how risk impacts investments and some of the ways to manage risk, you might be ready to build your investment portfolio. Investing can be a good way to grow your wealth in the long term. And the good news is it’s never too early or too late.

If you’re ready to get started, consider an account with SoFi Invest®, which offers a variety of options so you can invest in line with your personal risk preferences and financial goals.

For those that like to be in the driver’s seat—there’s active investing. You can buy and sell stocks, creating a completely personalized portfolio without any fees.

Investors who prefer to take a less intensive approach can opt for an automated account. You won’t have to worry about tracking individual stock prices and making timely trades. The account will do most of the work for you, automatically rebalancing to stay in line with your specified risk preference.

And SoFi offers a range of exchange-traded funds. SoFi offers four different types of ETFs that are intelligently weighted and are automatically rebalanced, so they’re always at the forefront of growing industry.

Ready to start managing your investment risks? Learn more about ETF investing and how they can help you make the most of your investments.

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

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, LLC and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“SoFi Securities”).
Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
Advisory services are offered through SoFi Wealth LLC, an SEC-registered investment adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .

SOIN19143

The big ol’ world of investing can feel overwhelming to navigate. There are stocks, bonds, commodities, mutual funds, and exchange-traded funds, to name a few.

With so many choices, it can be hard to nail down just where to start.

The confusion is especially real for investors who are just getting into the game, whether it’s because they are young, earning more for the first time, or are finally ready to invest after paying down student loans.

One investment type that has gained in popularity with all types of investors, both new and seasoned, is the exchange-traded fund. This investment type is more commonly referred to by its acronym, “ETF.”

How do ETFs work? An ETF is an investment fund that you can buy and sell like a stock, but that potentially bundles together some other investment types, such as bonds.

In this way, they are similar to mutual funds, though ETFs are structured to give them some tactical advantages over mutual funds.

To understand the benefits of the ETF, it helps to first know what an ETF is and how ETFs work. With some ETF basics down, you can decide whether it’s the right choice for your investment portfolio.

What is an ETF?

An ETF is an investment fund that pools together different assets, such as stocks, bonds, commodities, or currencies, and then divides its ownership up into shares.

This means that with just a few clicks, it is possible to buy one fund that provides exposure to hundreds or thousands of investment securities. ETFs are often heralded for helping investors gain diversified exposure to the market for a relatively low cost.

This is important to understand—the ETF is simply the suitcase that packs investments together. When you invest in an ETF, you are exposed to the underlying investment. For example, if you are invested in a stock ETF, you are invested in stocks. If you are invested in a bond ETF, you are invested in bonds.

ETFs were created to try and improve upon the mutual fund. Unlike a mutual fund, which only trades once a day, an ETF is structured so that it trades like a stock, on an exchange (such as the New York Stock Exchange), during normal market hours.

While the market is open, it is possible to buy or sell an ETF nearly instantaneously—and see an ETF’s value in real-time. A mutual fund only provides its value at the end of the trading day.

Most ETFs track a particular index that measures some segment of the market. For example, there are multiple ETFs that track the S&P 500 index. The S&P 500 index is a measure of the stock performance of 500 leading companies in the United States.

Therefore, if you were to purchase one share of an S&P 500 index fund, you would be invested in all 500 companies in that index, in their proportional weights.

This means that most ETFs are passive, which means to track an index. Again, their aim is to provide an investor exposure to some particular segment of the market in an attempt to return the average for that market. If there’s a type of investment that you want broad, diversified exposure to, there’s probably an ETF for it.

Though less popular, there are also actively-managed ETFs, where there’s a person or group that is making decisions about what securities to buy and sell within the fund. Generally, these will charge a higher fee than index ETFs, which are simply designed to track an index or segment of the market.

How Do ETFs Work?

To answer the question, “How do ETFs work?” it helps to start by thinking about how a mutual fund works, because mutual funds are slightly more intuitive.

Investors in mutual funds buy their shares from, and sell their shares to, the mutual funds themselves. Mutual funds price their shares each business day, usually after the trading day is closed.

To calculate the value of one share, the fund first calculates its total assets (minus its liabilities) to obtain the Net Asset Value (NAV) of its holdings. Then, the NAV is divided by the total number of shareholders.

Because ETFs trade on a continual basis, this pricing methodology wouldn’t be fast enough. ETF sponsors need to create and redeem shares throughout the day. Therefore, ETFs require market arbitrage to keep their prices accurate. How exactly does that work? Let’s take a look.

First, remember that an ETF trades like a stock. For this to happen, ETF sponsors generally have a relationships with one or more “authorized participants”—typically large broker-dealers. Generally, ETFs only work with authorized participants to purchase and redeem shares.

They are able to make fast exchanges with ETF sponsors when they need either large blocks of the underlying securities, called “creation blocks,” or when they are attempting to trade out the ETF fund shares themselves.

But this is only part of the story. ETF prices are constantly fluctuating with the buying and selling of that ETF. That’s the power of supply and demand at work.

Meanwhile, the same thing is happening with the underlying stocks held within the fund. Because of this, the price (also known as the market value) of the ETF can deviate from the price of its underlying assets (the Net Asset Value, or NAV).

This creates an opportunity for arbitrage, where a trader could potentially take advantage of the discrepancy between the NAV and the market value.

When these traders act in a way to take advantage of the discrepancy, it helps to close the gap, and push the two values closer. By publishing the NAV and allowing traders to act on the information, the market price of an ETF often stays near that of the NAV.

Benefits of Using ETFs

ETFs are gaining popularity as a tool for short and long-term investors alike—they make it easy to get started. Some investors may opt to take the DIY approach, and others will prefer to have someone help manage their ETF strategy. Either way, ETFs offer some benefits to the investors that choose to use them.

Tax Benefits

ETFs are often considered more tax efficient than a mutual fund. When shares of a mutual fund are redeemed, it is possible that capital gains taxes are passed through to investors.

Because ETFs generally “redeem” shares through an in-kind trade with an active participant, minimal capital gains taxes are triggered. ETFs typically pass through less capital gains costs than comparable mutual funds.

Talk to a tax professional to learn more about the potential tax benefits of an ETF.

Low-Cost

ETFs and mutual funds charge what is called an “expense ratio,” which is an annual fee charged for upkeep in the fund. While both index mutual funds and ETFs are considered cost-effective ways to invest in the market, ETFs usually eke out some costs savings over index mutual funds.

Expense ratios aren’t the only fees charged by both ETFs and mutual funds, though. Because an ETF trades like a stock, there is often a transaction/trading fee to buy in and out of the fund.

Some mutual funds may have front-end load fees or back-end load fees that work in a similar manner, though you’d generally only see these fees on actively-managed mutual funds. Either way, make sure that you are looking at all of the fees involved in buying or selling any investment, not just the expense ratio.

Easy Diversification

Ever heard of the investing adage, “don’t put all your eggs in one basket?” That’s the idea behind diversifying your investments. Owning just one bond or one stock, or even a handful of bonds or stocks, can be considered risky.

By owning hundreds of investments all within one single investment, you minimize the risk of any one investment (such as a stock) doing poorly and tanking your portfolio along with it.

For example, if you were to buy an S&P 500 index ETF, you’re not just investing in one fund, but you’re investing in the 500 leading companies in the United States, achieving near-instant diversification. And by using an ETF, you get access to this diversification at a fairly low cost.

Investing in ETFs

There is no one way to use ETFs to invest. Some investors may be interested in the short-term moves of the market and use ETFs to place bets for or against those moves. Other investors may use ETFs to achieve broad, cheap exposure to the market in a long-term, buy-and-hold strategy.

For those interested in the latter, long-term strategy—which is likely most people—it is possible to buy a portfolio of ETFs through your brokerage firm of choice. This strategy will require you to choose investments that match up with your long-term goals and risk tolerance.

Investors who are interested in utilizing an ETF strategy but aren’t interested in the DIY approach may prefer to have the help of a professional.

Not only can the right professional help guide you into the right portfolio strategy for you, but they are there to help you manage your ETF strategy over the long-term. A professional can help you rebalance your portfolio and manage your investments from a tax standpoint.

If you want to invest in low-cost, diversified ETFs and have the support of investment professionals, check out SoFi Invest®.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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.


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

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, LLC and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Advisory services are offered through SoFi Wealth LLC, an SEC-registered investment adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .

SOIN19045

When it comes to investing, there’s an old adage, “Don’t put all your eggs in one basket.” (Who carries their eggs in a basket anymore?) This is generally referred to as portfolio diversification.

The idea does make sense. Buying only one or two similar stocks might feel risky (and may be risky), no matter how profitable the companies currently are.

But did you know that diversification goes beyond the stock portfolio? For many investors, diversification might mean investing in other asset classes that don’t perform like stocks.

In fact, instead of considering which stock to buy, it may be more important to decide if it’s appropriate to own stocks in the first place. And, if it is appropriate, an investor may also want to ask: what proportion of a portfolio should be stocks?

Another way to describe the mix of stocks, bonds, cash, and other asset types in a portfolio? Asset allocation, or quite literally, the amount of money that is allocated to each of the different asset classes.

So what is asset allocation? Although it sounds like investing jargon, asset allocation is one of the more important investing concepts to understand. And although there is not a universal consensus about the right allocation mix for each investor, this big-picture decision could drive a majority of returns over time.

What Does Asset Allocation Mean?

Asset allocation is the investment strategy of balancing risk and reward by divvying up a portfolio into different asset types.

Generally, asset allocation is determined by looking at goals, risk tolerance, the investing timeline for the investor’s money, and comparing that to what the different asset classes have done over history. That way, an investor can determine what mix of assets is a good fit for what an investor is trying to accomplish.

Each asset class will have its own path of performance over time. The goal of diversification is to invest in such a way that not all investments perform the same or even similarly during different periods over the course of an investment journey.

For example, some investors may find it helpful to make investments beyond stocks during a stock market crash, which could have a sweeping and dramatic impact on all stock prices. Historically, bonds have performed well during stock market crashes, and aren’t considered to be correlated to stock market prices.

Therefore, bonds can act as a portfolio hedge during those stock market downturns. Another way to think about diversification? Stocks zig while bonds zag—or at least they have historically.

Using Modern Portfolio Theory

For all the statistics buffs out there, it may help to think of asset allocation in terms of Modern Portfolio Theory (MPT) . MPT assumes that investors are risk averse, and builds portfolios with the lowest level of risk given the desired level of return.

It does this by analyzing the historical return of each asset class, the variability of that return (called the variance), and the degree to which the price level of different asset classes experiences volatility at the same time (the correlation).

Within portfolios, volatility and risk are often measured by their standard deviation (which happens to be the square root of the variance).

For example, if there were two portfolios and both have the same expected rate of return, but one has a lower standard deviation, the investor may want to choose that one.

Managing Risk by Asset Class

Whether the goal is to try to minimize risk, maximize potential returns, or some combination of the two, a good place for an investor to start is to study the risk and return characteristics of the various asset classes, such as stocks, bonds, cash or money market funds, real estate, private equity, investment partnerships, and natural resources, like gold. Much of the time, the discussion about risk and reward of the different asset classes is focused only on the tradeoff between stocks and bonds.

Common stocks, also known as equities, historically fall on the higher risk and higher reward end of the spectrum. Bonds are often considered to be lower in risk but also lower in reward.

Cash and cash equivalents (like money market funds) are typically considered to be the safest options, in the sense that cash experiences little price volatility. But be aware: The value of cash is eroded by inflation over time, which means potentially losing purchasing power.

Not all stocks or bonds are the same. Categories within each of the asset classes may carry different risk and reward characteristics. For example, small cap stocks are typically considered to be riskier but may come with higher returns than large cap stocks (also known as big cap stocks), which are generally more established. This is because small cap stops have the ability to grow into large cap stocks, whereas large cap stocks may not experience as much volatility—in either direction.

That said, the difference between the two is somewhat subjective, and small cap stocks can be established (in other words, they’re not just start-ups), while large cap stocks can crash as well (think Enron). Within the category of bonds, for example, junk bonds may be riskier while U.S. Treasury bonds are considered a safer option.

Determining Asset Allocation

After learning what to expect from the different asset classes, a good next step is to think about goals, risk tolerance, and investing time horizon—for each pool of money to be invested. For example, an investor may want to invest retirement money differently than emergency money.

A couple questions an investor might begin by asking: What is their goal with this money? When will they need to use this money? The latter is the idea behind investing time horizon.

To determine an appropriate asset allocation, an investor may want to conceptualize how long this money needs to last or what amount is needed for a set goal. Last, they might consider asking: How much risk (volatility) are they comfortable with?

Recommended: age-based rule of thumb is to start with 100, subtract age, and the resulting number is the percentage to invest in stocks. (Or, simply invest current age in bonds, and the rest is allocated to the stock market.) So, for example, if someone is 30 years old, then this rule would have them invest in a portfolio of 70% stocks and 30% bonds.