Investing Archives | Page 61 of 191

May

2024

How taxes and fees impact return on investment

Taxes, Fees, Commissions, and Your Investments

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

Earning returns can be exhilarating. But it’s important to remember that they don’t necessarily represent the money that goes in the bank. Commissions, taxes, and other fees impact the returns any investor makes on their investment.

Just how big a bite these investment expenses take out of an investor’s assets isn’t always instantly clear. But by understanding the fees they pay, and the taxes they’re likely to owe, investors can better plan for the money they’ll actually receive from their investments. And they can also take concrete steps to minimize the effects of fees and taxes.

Key Points

• Taxes, fees, and commissions significantly reduce the actual returns from investments.

• Understanding and planning for these costs can help investors manage their net earnings more effectively.

• Mutual funds and advisors charge various fees, which can diminish investment gains.

• Income tax and capital gains tax are the primary taxes affecting investment profits, with different rates applied based on the investment duration and investor’s income.

• Employing strategies like investing through tax-advantaged accounts can minimize the tax impact on returns.

Investment Expenses 101

There are a few different types of investment expenses an investor may come across as they buy and sell assets. Here are the most common ones.

Fund Fees

Mutual funds are a very popular way for investors to get into the market. They’re the vehicles that most 401(k), 403(b), and IRAs offer investors to save for retirement. But these funds charge fees, starting with a management fee, which pays the fund’s staff to buy and trade investments.

Investors pay this fee as a portion of their assets, whether the investments go up or down. (With employer-sponsored retirement accounts, the employer may cover the fees as long as the account holder is employed by the company.) Management fees vary widely, with some index funds charging as little as .10% of an investor’s assets. But other mutual funds may charge more than 2%.

In addition to the management fee, the fund may also charge for advertising and promotion expenses, known as the 12b-1 fee. Plus, mutual fund investors may have to pay sales charges, especially if they buy funds through a financial planner, or an investment advisor. While the maximum legal sales charge for a mutual fund is 8.5%, the common range is between 3% and 6%.

One way to understand how much of a bite these mutual fund fees take out of an investment on an annual basis is to look at the expense ratio.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Advisor Fees

Investors may also face fees when they hire a professional to help manage their money. Some advisors charge a percentage of invested assets per year. More recently, some advisors have simplified the cost by simply charging an hourly fee.

Broker Fees and Commissions

Even investors who want to manage their own portfolios typically pay a broker for their services in the form of fees and commissions. These fees and commissions may be based on a percentage of the transaction’s value, or they may be rolled into a flat fee. Another factor that may influence the fee: whether an investor uses a full-service broker or a discount broker.

How to Minimize the Cost of Investing

No matter how an investor approaches the market, they can expect to pay some fees. It’s up to each individual to decide whether or not those fees are worth it. For some, paying a professional for hands-on advice is worth the extra annual 1% fee (or more) of their invested assets. For others, minimizing costs may be a priority. Among many options, there are a few investing opportunities that stand out as relatively low-cost.

Index Funds

When investing in mutual funds, one type of fund has established itself as the least expensive in terms of fees: Index funds. That’s because these funds track an index instead of paying analysts and managers to research and trade securities. When it comes to index funds vs. managed funds, proponents typically cite the lower fees.

Automated Investing Platforms

People seeking investing advice or guidance who don’t want to pay typical fees might want to explore automated investing platforms, also known as “robo-advisors.” Some of these platforms charge annual advisory fees as low as .25%. That said, these platforms often use mutual funds, which charge their own fees on top of the platform fees.

Discount Brokerage

Investors who manage their own portfolio may opt for a discount or online brokerage. These brokers tend to charge flat fees per trade as low as $5, with account maintenance fees also often as low as $0 to $50 per account.

How Taxes Eat into Investing Profits

There are typically two kinds of taxes that investors have to worry about. The first is income tax, and the second is capital gains tax. In general, income taxes apply to investment earnings in the form of interest payments, dividends, or bond yields. Capital gains, on the other hand, apply to the returns an investor realizes when they sell a stock, bond, or other investment. (The exception: The IRS taxes short-term investments, which an investor has held for less than a year, at that investor’s marginal income tax rate.)

By and large, capital gains tax rates are lower than income tax rates. Income tax rates for high-earners can be as high as 37%, plus a 3.8% net investment income tax (NIIT). That means the taxes on those quick gains can be as high as 40.8%—and that’s not including any state or local taxes.

The taxes on long-term capital gains are lower across the board. For tax year 2023, for investors who are married filing jointly and earning less than $89,250, the capital gains tax rate is 0%. It goes up depending on income, with couples making between $89,250 and $553,850 paying 15%, and those with income above that level paying 20%.

For tax year 2024, those who are married and filing jointly with taxable income up to $94,050 have a capital gains tax rate of 0%. Couples making between $94,050 and $583,750 have a rate of 15%, and those with income above that have a tax rate of 20%.

💡 Quick Tip: Automated investing can be a smart choice for those who want to invest but may not have the knowledge or time to do so. An automated investing platform can offer portfolio options that may suit your risk tolerance and goals (but investors have little or no say over the individual securities in the portfolio).

Strategies to Minimize Taxes

There are a few ways an investor can minimize the impact of taxes on their investments. One popular way to take advantage of the tax code is by investing through a retirement plan, such as a 401(k), 403(b), or IRA. All of these plans encourage people to save for retirement by offering attractive tax breaks.

For tax-deferred accounts like a 401(k) or traditional IRA, the tax break comes on the front end. Retirees will have to pay income taxes on their withdrawals in retirement. On the other hand, retirement accounts like a Roth 401(k) or Roth IRA are funded with after-tax dollars, and money is not taxed upon withdrawal in retirement.

Another approach some investors may want to consider is tax-loss harvesting. This strategy allows investors to take advantage of investments that lost money by selling them and taking a capital loss (as opposed to a capital gain). That capital loss can help investors reduce their annual tax bill. It may be used to offset as much as $3,000 in non-investment income.

The Takeaway

Fees and taxes typically do have an impact on an investor’s returns on investments. How much they eat into profit varies, and is largely dependent on what the investments are, how they are being managed, and how long an investor has had them. Other factors include the investor’s income level, and whether they’ve also lost money on other investments.

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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.

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.

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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May

2024

What Is the Rule of 55? How It Works for Early Retirement

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

The rule of 55 is a provision in the Internal Revenue Code that allows workers to withdraw money from their employer-sponsored retirement plan without a penalty once they reach age 55. Distributions are still taxable as income but there’s no additional 10% early withdrawal penalty.

The IRS rule of 55 applies to 401(k) and 403(b) plans. If you have either of these types of retirement accounts through your employer, it’s important to understand how this rule works when taking retirement plan distributions.

Key Points

• The rule of 55 allows penalty-free withdrawals from employer-sponsored retirement plans for individuals aged 55 or older.

• This rule applies to 401(k) and 403(b) plans, allowing early access to retirement funds without the usual 10% penalty.

• To qualify, individuals must have separated from their employer at age 55 or older and leave the funds in the employer’s plan.

• The rule of 55 does not apply to IRAs, and certain conditions and restrictions may vary depending on the specific retirement plan.

• While the rule of 55 can be beneficial for early retirees, it’s important to consider tax implications and other factors before utilizing it.

What Is the Rule of 55?

The rule of 55 is an exception to standard IRS withdrawal rules for qualified workplace plans, including 401(k) and 403(b) plans. Normally, you can’t withdraw money from these plans before age 59 ½ without paying a 10% early withdrawal penalty. This penalty is only waived for certain allowed exceptions, of which the rule of 55 is one.

Specifically, the rule of 55 applies to “distributions made to you after you separated from service with your employer after attainment of age 55,” per the IRS. It doesn’t matter whether you quit, get laid off or retired — you can still withdraw money from your retirement plan penalty-free. If you’re a qualified public safety employee, this exception kicks in at age 50 instead of 55.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

How Does the Rule of 55 Work?

The rule of 55 for 401(k) and 403(b) plans allows workers to access money in their retirement plans without a 10% early withdrawal penalty. This rule applies to current workplace retirement plans only.

You can’t use the rule of 55 to take money from a 401(k) or 401(b) you had with a previous employer penalty-free unless you first roll over those account balances into your current plan before separating from service.

This rule doesn’t apply to individual retirement accounts (IRA) either. So, you can’t use the rule of 55 to tap into an IRA before age 59 ½ without a tax penalty. There are, however, some exclusions that might allow you to do so. For example, you could take money penalty-free from an IRA if you’re using it for the purchase of a first home.

¹Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

Rule of 55 Requirements

To qualify for a rule of 55 401(k) or 403(b) withdrawal, you’ll need to:

• Be age 55 or older

• Separate from your employer at age 55 or older

• Leave the money in your employer’s plan (rule of 55 benefits are lost if you roll funds over to an IRA)

You also need to have a 401(k) or 403(b) plan that allows for rule of 55 withdrawals. If your plan doesn’t permit early withdrawals before age 59 ½ , then you won’t be able to take advantage of this rule.

Also keep in mind that IRS rules require a 20% tax withholding on early withdrawals from a 401(k) or similar plan. This applies even if you plan to roll the money over later to another qualified plan or IRA. So you’ll need to consider how that withholding will affect what you receive from the plan and how much you may still owe in taxes on your 401(k) later when reporting the distribution on your return.

Example of the Rule of 55

Here’s how the rule of 55 works. Say you lose your job or decide to retire early at age 55, and you need money to help pay your bills and cover lifestyle expenses. Under the rule of 55, you can take distributions from the 401(k) or 403(b) plan you were contributing to up until the time you left your job. You will not be charged the typical 10% early withdrawal penalty in this instance.

Also worth noting: If you decide to go back to work a year or two later at age 56 or 57, say, you can still continue to take distributions from that same 401(k) or 403(b) plan, as long as you have not rolled it over into another employer-sponsored plan or IRA.

Should You Use the Rule of 55?

The IRS rule of 55 is designed to benefit people who may need or want to withdraw money from their retirement plan early for a variety of reasons. For example, you might consider using this rule if you:

• Decide to retire early and need your 401(k) to close the income gap until you’re eligible for Social Security benefits

• Are taking time away from work to act as a caregiver for a spouse or family member and need money from your retirement plan to cover basic living expenses

• Want to take some of the money in your 401(k) early to help minimize required minimum distributions (RMDs) later

In those scenarios, it could make sense to apply the rule of 55 in order to access your retirement savings penalty-free. On the other hand, there are some situations where you may be better off letting the money in your employer’s plan continue to grow.

For instance, if your employer’s plan requires you to take a lump sum payment, this could push you into a substantially higher tax bracket. Having to pay taxes on all of the money at once could diminish your account balance more so than spreading out distributions — and the associated tax liability — over a longer period of time.

You may also reconsider taking money from your 401(k) early if you still plan to work in some capacity. If you have income from a new full-time job or part-time job, for instance, you may not need to withdraw funds from your 401(k) at all. But if you change your mind later and decide to return to work, you can continue to take withdrawals from the same retirement plan penalty-free.

Other Ways to Withdraw From a 401(k) Penalty-Free

Aside from the rule of 55, there are other exceptions that could allow you to take money from your 401(k) penalty-free. The IRS allows you to do so if you:

• Reach age 59 ½

• Pass away (for distributions made to your plan beneficiary)

• Become totally and permanently disabled

• Need the money to pay for unreimbursed medical expenses exceeding 10% of your adjusted gross income (AGI)

• Need the money to pay health insurance premiums while unemployed

• Are a qualified reservist called to active duty

You can also avoid the 10% early withdrawal penalty by taking a series of substantially equal periodic payments. This IRS rule allows you to sidestep the penalty if you agree to take a series of equal payments based on your life expectancy. You must separate from service with the employer that maintains your 401(k) in order to be eligible under this rule. Additionally, you must commit to taking the payment amount that’s required by the IRS for a minimum of five years or until you reach age 59 ½, whichever occurs first.

A 401(k) loan might be another option for withdrawing money from your retirement account without a tax penalty. You might consider this if you’re not planning to retire but need to take money from your retirement plan.

With a 401(k) loan, you’ll have to pay the money back with interest. Your employer may stop you from making new contributions to the plan until the loan is repaid, generally over a five-year term. If you leave your job where you have your 401(k) before the loan is repaid, any remaining amount becomes payable in full. If you can’t pay the loan off, the whole amount is treated as a taxable distribution and the 10% early withdrawal penalty also may apply if you’re under age 59 ½.

The Takeaway

Early retirement may be one of your financial goals, and achieving it requires some planning. Maxing out your 401(k) or 403(b) can help you save the money you’ll need to retire early, and you may be able to access the funds early with the rule of 55.

You may also consider investing in an IRA or a taxable brokerage account to save for retirement. A brokerage account doesn’t have age restrictions, so there are no penalties for early withdrawals before age 59 ½. You’ll have to pay capital gains tax on any profits realized from selling investments, but you can allow the balances in your 401(k) or IRA to continue to grow on a tax-advantaged basis.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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FAQ

Can I use the rule of 55 if I get another job?

Yes, you can use the rule of 55 to keep withdrawing from your 401(k) if you get another job. As long as it’s the same 401(k) you were contributing to when you left your job and you haven’t rolled it over into an IRA or another plan, you can still continue to take distributions from it whether you get a full-time or part-time job.

How do I know if I qualify for Rule of 55?

First, find out if your employer allows for the rule 55 withdrawals. Check with your HR or benefits department. If they do, and you are 55 or older (or age 50 or older if you are a public safety worker), you should qualify for the rule of 55 and be able to take distributions from your most recent employer’s plan. You cannot take penalty-free distributions from 401(k) plans with previous employers.

How do I claim the rule of 55?

To start taking rule of 55 withdrawals, typically all you need to do is reach out to your plan’s administrator and prove that you qualify — meaning that you are age 55 or older and that you’re leaving your job.

What is the rule of 55 lump sum?

Some 401(k) plans may require you to take a lump sum payment if you are using the rule of 55. That could create a big tax liability since you will need to pay income tax on the money you withdraw. In this case you might want to explore other alternatives to the rule of 55. It may also be helpful to speak with a tax professional.

Photo credit: iStock/bagi1998

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

May

2024

REITs vs. REIT ETFs: What’s the Difference?

By Rebecca Lake | invest, Investing, Terminology | Comments Off

Both real estate investment trusts (REITs) and exchange-traded funds (ETFs) that invest in REITs offer some benefits of real estate investing, without having to own any properties directly. The main differences between a real estate ETF vs. REIT lie in how they’re structured, dividend payouts, taxes, and the fees investors might pay to own them.

Also, REITs are considered alternative investments, which means they tend not to move in sync with traditional investments like stocks and bonds.

Key Points

• REITs and REIT ETFs offer benefits of real estate investing without direct property ownership.

• Differences between REITs and REIT ETFs include structure, dividend payouts, taxes, and fees.

• REITs are considered alternative investments and may not move in sync with traditional investments.

• REITs generate income through rents, while REIT ETFs own a collection of REIT investments.

• Investors can buy and sell shares of REIT ETFs on stock exchanges, while REITs can be publicly traded, non-traded, or private.

Overview of REITs

A real estate investment trust is a legal entity that owns and operates income-producing properties. REITs can hold a single property type or multiple property types, including:

• Hotels and resorts

• Self-storage facilities

• Warehouses

• Retail space, including shopping centers

• Apartment buildings or multi-family homes

• On-campus housing

• Assisted living facilities

REITs that own and manage properties typically generate most, if not all, of their income through rents. Some REITs may also invest in mortgages and mortgage-backed securities. REITs that invest in mortgages can collect interest on those loans.

There are two conditions to qualify for a REIT. A company must:

• Derive the bulk of its income and assets from real estate-related activities

• Pay out at least 90% of dividends to shareholders

Companies that meet these conditions can deduct all of the dividends paid to shareholders from corporate taxable income.

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What Is a REIT ETF?

An exchange-traded fund or ETF is a pooled investment vehicle that shares some of the features of a mutual fund but trades on an exchange like a stock. A REIT ETF is an exchange-traded fund that owns a basket or collection of REIT investments.

While REITs own properties, REIT ETFs do not. REIT ETFs have a fund manager who oversees the selection of securities held in the fund. The fund manager also decides when to sell off fund assets, if necessary.

A REIT ETF may be actively or passively managed. Actively managed ETFs often pursue investment strategies that are designed to beat the market. Passively managed ETFs, on the other hand, aim to mimic the performance of an underlying market benchmark or index.

Recommended: What Is a Dividend?

How REIT ETFs Work

REIT ETFs work by allowing investors to gain exposure to a variety of real estate assets in a single investment vehicle. For example, a REIT may hold:

• Stocks issued by REITs

• Other real estate stocks

• Real estate derivatives, such as options, futures, or swaps

Investors can buy shares of a REIT ETF on a stock exchange and sell them the same way. Like other ETFs, REIT ETFs charge an expense ratio that reflects the cost of owning the fund annually. Expense ratios for a REIT ETF, as well as performance, can vary from one fund to the next.

REIT ETFs pay dividends to investors, which may be qualified or non-qualified. The fund may give investors the option to reinvest dividends vs. collecting them as passive income. Reinvesting dividends can allow you to purchase additional shares of a fund, without having to put up any money out of pocket.

A REIT ETF might track the performance of the MSCI US Investable Market Real Estate 25/50 Index, which offers investors access to multiple REIT property sectors, including:

• Data centers

• Health care

• Hotels and resorts

• Office space

• Industrial

• Real estate

• Retail

• Telecom

What’s the Difference between REITs and REIT ETFs?

REITs and REIT ETFs both offer opportunities to invest in real estate, without requiring investors to be hands-on in managing property. There are, however, some key differences to know when considering whether to invest in a REIT vs. REIT ETF.

Structure

REITs are most often structured as corporations, though they can also be established as partnerships or limited liability companies (LLCs). The Internal Revenue Service (IRS) requires REITs to have a board of directors or trustees who oversee the company’s management. As mentioned, REITs must pay out 90% of dividends to shareholders to deduct those payments from their corporate taxable income.

A REIT may be categorized in one of three ways, depending on what it invests in.

• Equity REITs own properties that generate rental income.

• Mortgage REITs focus on mortgages and mortgage-backed securities.

• Hybrid REITs hold both properties and mortgage investments.

REIT ETFs are structured similarly to mutual funds, in that they hold multiple securities and allow investors to pool funds together to invest in them. The fund manager decides which investments to include and how many securities to invest in overall.

Both REITs and REIT ETFs are structured to pay out dividends to shareholders. And both can generate those dividends through rental income, mortgage interest, or a combination of the two. The difference is that structurally, a REIT ETF is a step removed since it doesn’t own property directly.

Investment Style

REITs and REIT ETFs can take different approaches concerning their investment style. When comparing a REIT vs. REIT ETF, it’s helpful to consider the underlying investments, fund objectives, and management style.

An actively managed REIT, for example, may generate a very different return profile than a passively managed REIT ETF. Active management can potentially result in better returns if the REIT or REIT ETF can beat the market. However, they can also present more risk to investors.

Passive management, on the other hand, typically entails less risk to investors as the goal is to match the performance of an index or market benchmark rather than exceed it. Fees may be lower as well if there are fewer costs incurred to buy and sell securities within the fund.

How They’re Traded

Individual REITs can be publicly traded, public but non-traded, or private. Publicly traded REITs are bought and sold on stock market exchanges and are regulated by the Securities and Exchange Commission. Public non-traded REITs are also subject to SEC regulation but they don’t trade on exchanges.

Private REITs, meanwhile, are not required to register with the SEC, nor are they traded on exchanges. These types of REITs are most often traded by institutional or accredited investors and may require higher buy-ins.

REIT ETFs trade on an exchange like a stock. You can buy shares of a REIT or REIT ETF through your brokerage account. If you decide you’re no longer interested in owning those shares you can sell them on an exchange. Unlike traditional mutual funds, share prices for REIT ETFs can fluctuate continuously throughout the day.

The Takeaway

Real estate can be an addition to a portfolio for investors who are interested in alternative investments. Whether it makes sense to choose a real estate ETF vs. REIT, or vice versa, can depend on your short and long-term financial goals, as well as your preferred investment style.

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FAQ

Do REIT ETFs pay dividends?

REIT ETFs pay dividends to investors. When considering a REIT ETF for dividends, it’s important to assess whether they’re qualified or non-qualified, as that can have implications for the tax treatment of that income.

What are the risks of investing in REITs?

REITs are not risk-free investments, and their performance can be affected by a variety of factors, including interest rates, shifts in property values, and limited liquidity. In some cases, the dividend payout from a REIT can provide steady returns, but this is not always the case, as real estate conditions can fluctuate.

Do REITs have fees?

REITs can charge a variety of fees, which may include upfront commissions, sales loads, and annual management fees. REIT ETFs, meanwhile, charge expense ratios and you may pay a commission to buy or sell them, depending on which brokerage you choose. Evaluating the fees for a REIT or REIT ETF can help you better understand how much of your returns you’ll get to keep in exchange for owning the investment.

Photo credit: iStock/Maks_Lab

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May

2024

What Are Commodities? How Do They Fit Into the Stock Market?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Commodities are the raw materials that are the building blocks of most types of production, whether for commercial, military, or industrial goods. Different types of grain, livestock, metals, and energy sources (such as crude oil) are some of the most common commodities.

Although commodities may offer some advantages to investors, commodities are considered a high-risk market, as prices can fluctuate based on numerous factors that are hard to anticipate: e.g. weather events; regional political changes; supply chain issues, and more.

Nonetheless, investing in commodities can be useful for diversification because commodities tend to have a low correlation with traditional asset classes like stocks and bonds. Commodities are considered alternative investments, and thus they may be better suited to some investors than others.

Key Points

• Commodities are raw materials used in production, including grain, livestock, metals, and energy sources like crude oil.

• Investing in commodities can offer diversification as they have a low correlation with traditional assets.

• Commodities can be traded on commodities exchanges through futures contracts or through investment vehicles like mutual funds and ETFs.

• Commodities prices are influenced by factors like supply and demand, weather events, and geopolitical changes.

• Commodities trading carries risks due to price volatility and external factors, making it important to consider personal risk tolerance.

What Is a Commodity?

A commodity is a raw material that can be bought, sold, or traded according to its value in producing other types of goods. Some commodities, like sugar or beef, may be consumed directly.

Understanding Commodities

Many of the things you use or consume in everyday life start off in commodity form. For example, the gas you put in your car is created by refining crude oil.

The hallmark of a commodity is that a unit of one type of commodity rarely differs substantially from another unit of that commodity. Thus one bushel of corn is equivalent to any other bushel of corn. One bar of gold is interchangeable with any other bar of gold.

This is quite different from traditional investments like stocks and bonds, where the quality of one stock can vary widely from another; or where one bond may get a triple-A rating and another is rated as junk.

Another difference is that the market forces that impact the movement of stocks or bonds often don’t apply to commodities, which are driven by supply and demand. So an inflationary period could hurt the performance of stocks or bonds, but might benefit commodities when the prices of certain goods rise.

This is one reason why commodities are considered alternative investments, which are not correlated with the movements of more traditional assets and thus can offer investors some diversification.

Trading Commodities

While stocks are traded on a stock exchange, such as the New York Stock Exchange (NYSE) or Nasdaq, commodities and commodities futures are traded on a commodities exchange, such as the New York Mercantile Exchange (NYME) or the Chicago Mercantile Exchange (CME).

The Chicago Board of Trade has established standards of measurement and grades of quality for different types of commodities that facilitate commodities trading. For example, there are 5,000 bushels of #2 yellow corn per corn contract, and corn can be traded on the spot or cash market, or the futures market.

💡 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.

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Commodity Types and Examples

Broadly speaking, commodities can be divided into one of two categories: hard or soft.

• Hard commodities generally must be mined or otherwise extracted from the earth.

• Soft commodities are sourced naturally either through agriculture or cultivation.

Hard and soft commodities can serve different purposes in the global economy and supply chain. Within these broader categories, you can further distinguish specific types of commodities from one another.

	Types of Commodities	Examples
Hard	• Energy • Precious Metals • Industrial Metals	• Aluminum Copper • Crude Oil • Diesel • Gold • Lead • Natural Gas • Nickel • Palladium • Platinum • Silver • Tin • Zinc
Soft	• Agricultural Products • Livestock	• Cattle • Coffee • Corn • Cotton • Orange juice • Palm Oil • Pork • Soybeans • Sugar • Tea • Wheat

Types of Commodities

Examples

Hard

• Energy

• Precious Metals

• Industrial Metals

• Aluminum Copper

• Crude Oil

• Diesel

• Gold

• Lead

• Natural Gas

• Nickel

• Palladium

• Platinum

• Silver

• Tin

• Zinc

Soft

• Agricultural Products

• Livestock

• Cattle

• Coffee

• Corn

• Cotton

• Orange juice

• Palm Oil

• Pork

• Soybeans

• Sugar

• Tea

• Wheat

Hard and soft commodities may be traded globally but have a smaller geographic footprint in terms of where they’re sourced from.

For example, nearly 100 countries around the world produce crude oil, but five countries are responsible for 52% of the supply. China, meanwhile, is the world’s largest producer of wheat, generating around 17% of total production.

How Are Commodities Traded on the Stock Market?

Commodities are most often traded on an exchange using futures contracts. A commodity futures contract is an agreement to either buy or sell a specified quantity of a commodity at some future date at a predetermined price. It’s important to note that commodities futures are not regulated by the Securities and Exchange Commission.
Futures are not the only way to trade commodities, however. Investors may also choose to pursue:

• Direct investment via cash (on the spot market)

• Mutual funds

• Exchange-traded funds (ETFs)

• Exchange-traded notes (ETNs)

• Commodity-linked stocks and bonds

Of these options, direct investment tends to prove the most difficult for individual investors. Trading commodities through direct investment requires the exchange of physical goods. However, physically holding one ton of wheat or 1,000 head of cattle isn’t a realistic expectation for most commodities traders.

Mutual funds and ETFs can offer an easier access point to the commodities market while allowing investors to diversify. Rather than tying up investment dollars in a single commodity, an investor may diversify across several different types of commodities within a single fund or ETF.

Regardless of how someone invests in commodities, there are real risks to weigh. Commodities can be highly volatile as there are a variety of outside factors that can influence the direction in which prices move.

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What Determines Commodities Prices?

Supply and demand play an integral role in determining how commodities are valued. When supply exceeds demand, e.g. if there were a drop-off in the demand for copper, the price of that commodity would also likely drop. But if a new technology like AI emerges, creating demand for precious metals, that could drive some commodities prices up.

Global events, such as widespread flooding or war can also trigger fluctuations in commodity prices.

Volatility in commodities pricing can have far-reaching effects on the global economy. Research from the International Monetary Fund (IMF) suggests that swings in commodity prices, meaning what a country pays for its imported commodities vs. what it collects for exported ones, have the potential to hinder long-term economic growth, particularly for those countries that are significant exporters.5

The IMF also determined that instability in commodity prices may also increase volatility in domestic inflation. Rising prices for basic domestic goods, such as food or energy, can be especially burdensome in countries that have developing economies.

The Takeaway

What are commodities? Commodities are all around you, from the clothes you wear to the foods you eat, to the technology you use at home and at work.

Within the financial markets, commodities play an important role in price regulation for consumer goods. As an investor, commodities trading can open up new avenues to diversification, though it’s wise to consider how these investments align with your personal risk tolerance.

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

FAQ

What Is a Commodity vs. a Stock?

A commodity is a raw material that’s used to create something else, such as crude oil that’s refined into gasoline or wheat that’s used to produce bread. Whereas a stock represents an ownership share in a company.

Are commodities riskier than stocks?

Commodities can be riskier than stocks because they’re often speculative in nature and their pricing can be highly volatile. Some types of commodities may prove more stable than others, though it’s important to consider how supply and demand may affect pricing.

What is the safest commodity to invest in?

There are no “safe” investments, and there is always the risk of loss when investing. With commodities, choosing one that is more insulated from fluctuations in pricing can be beneficial, but this can be difficult to predict. Gold and some precious metals may fare well when inflation rises, or there’s increased uncertainty in the markets about interest rates. Again there are no guarantees.

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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.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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May

2024

Private Credit vs. Private Equity: What’s the Difference?

By Rebecca Lake | Family Finances, invest, Investing | Comments Off

Private credit and private equity investments offer investors opportunities to build their portfolios in substantially different ways. With private credit, investors make loans to businesses and earn returns through interest. Private equity represents an ownership stake in a private company or a public company that is not traded on a stock exchange.

Each one serves a different purpose, which can be important for investors to understand.

Key Points

• Private credit and private equity are alternative investments that offer different ways to build portfolios.

• Private credit involves making loans to businesses and earning returns through interest, while private equity represents ownership stakes in private or delisted public companies.

• Private credit investors include institutional investors, high-net-worth individuals, and family offices, while private equity investments are often made by private banks or high-net-worth individuals.

• Private credit generates returns through interest, while private equity aims to generate returns through the sale of a company or going public.

• Private credit carries liquidity risk, while private equity investments can be affected by the company’s performance and potential bankruptcy.

What Does Private Credit and Private Equity Mean?

Private equity and private credit are two types of alternative investments to the stocks, bonds, and mutual funds that often make up investor portfolios. Alternative investments in general, and private equity or credit in particular, can be attractive to investors because they can offer higher return potential.

However, investors may also face more risk.

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Private Credit Definition

Private credit is an investment in businesses. Specifically, an investor or group of investors extends loans to private companies and delisted public companies that need capital. Investors collect interest on the loan as it’s repaid. Other terms used to describe private credit include direct lending, alternative lending, private debt, or non-bank lending.

Who invests in private credit? The list can include:

• Institutional investors

• High-net-worth individuals

• Family offices or private banks

Retail investors may pursue private credit opportunities but they tend to represent a fairly small segment of the market overall. Private credit investment is expected to exceed $3.5 trillion globally by 2028.

Private Equity Definition

Private equity is an investment in a private or delisted public company in exchange for an ownership share. This type of investment generates returns when the company is sold, or in the case of a private company, goes public.

Similar to private credit, private equity investments are often the domain of private banks, or high-net-worth individuals. Private equity firms can act as a bridge between investors and companies that are seeking capital. Minimum investments may be much higher than the typical mutual fund buy-in, with investors required to bring $1 million or more to the table.

Private equity is often a long-term investment as you wait for the company to reach a point where it makes sense financially to sell or go public. One difference to note between private equity and venture capital lies in the types of companies investors target. Private equity is usually focused on established businesses while venture capital more often funds startups.

What Are the Differences Between Private Credit and Private Equity?

Private credit and private equity both allow for investment in businesses, but they don’t work the same way. Here’s a closer look at how they compare.

Investment Returns

Private credit generates returns for investors via interest, whereas private equity’s goal is to generate returns for investors after selling a company (or stake in a company) after the company has grown and appreciated, though that’s not always the case.

With private credit, returns may be more predictable as investors may be able to make a rough calculation of their potential returns. Private equity returns are less predictable, as it may be difficult to gauge how much the company will eventually sell for. But there’s always room for private equity returns to outstrip private credit if the company’s performance exceeds expectations. However, it’s important to remember that higher returns are not guaranteed.

Risk

Investing in private credit carries liquidity risk, in that investors may be waiting several years to recover their original principal. That risk can compound for investors who tie up large amounts of capital in one or two sectors of the market. Likewise, changing economic conditions could diminish returns.

If the economy slows and a company isn’t able to maintain the same level of revenue, that could make it difficult for it to meet its financial obligations. In a worst-case scenario, the company could go bankrupt. Private credit investors would then have to wait for the bankruptcy proceedings to be completed to find out how much of their original investment they’ll recover. And of course, any future interest they were expecting would be out the window.

With private equity investments, perhaps the biggest risk to investors is also that the company closes shop or goes bankrupt before it can be sold but for a different reason. In a bankruptcy filing, the company’s creditors (including private credit investors) would have the first claim on assets. If nothing remains after creditors have been repaid, private equity investors may walk away with nothing.

The nature of the company itself can add to your risk if there’s a lack of transparency around operations or financials. Privately-owned companies aren’t subject to the same federal regulation or scrutiny as publicly-traded ones so it’s important to do thorough research on any business you’re thinking of backing.

Ownership

A private credit investment doesn’t offer any kind of ownership to investors. You’re not buying part of the company; you’re simply funding it with your own money.

Private equity, on the other hand, does extend ownership to investors. The size of your ownership stake can depend on the size of your investment.

Investor Considerations When Choosing Between Private Credit and Private Equity

If you’re interested in private equity or private credit, there are some things you may want to weigh before dividing in. Here are some of the most important considerations for adding either of these investments to your portfolio.

• Can you invest? As mentioned, private credit and equity are often limited to accredited investors. If you don’t meet the accredited investor standard, which is defined by income and net worth, these investments may not be open to you.

• How much can you invest? If you are an accredited investor, the next thing to consider is how much of your portfolio you’re comfortable allocating to private credit or equity.

• What’s your preferred holding period? When evaluating private credit and private equity, think about how long it will take you to realize returns and recover your initial investment.

• Is predictability or the potential for higher returns more important? As mentioned, private credit returns are typically easy to estimate if you know the interest rate you’re earning. However, returns may be lower than what you could get with private equity, assuming the company performs well.

Here’s one more question to ask: how can I invest in private equity?

These investments may not be available in a standard brokerage account. If you’re looking for private credit opportunities you may need to go to a private bank that offers them. When private equity is the preferred option, a private equity firm is usually the connecting piece for those investments.

When comparing either one, remember to consider the minimum initial investment required as well as any fees you might pay.

The Takeaway

Private credit and private equity can diversify a portfolio and help you build wealth, though not in the same way. Comparing the pros and cons, assessing your personal tolerance for risk and ability to invest in either can help you decide if alternative investments might be right for you.

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

FAQ

Why do investors like private credit?

Private credit can offer some unique advantages to investors, starting with predictable returns and steady income. The market for private credit continues to grow, meaning there are more opportunities for investors to add these types of investments to their portfolios. Compared to private equity, private credit carries a lower degree of risk.

How much money do you need for private equity?

The minimum investment required for private equity can vary, but it’s not uncommon for investors to need $100,000 or more to get started. In some instances, private equity investment minimums may surpass $1 million, $5 million, or even $10 million.

Can anyone invest in private credit or private equity?

Typically, no. Private credit and private equity investments most often involve accredited investors or legal entities, such as a family office. It’s possible to find private credit and private equity investments for retail investors, however, you may need to meet the SEC’s definition of accredited to be eligible.

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REITs vs. REIT ETFs: What’s the Difference?

Overview of REITs

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What Is a REIT ETF?

How REIT ETFs Work

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Structure

Investment Style

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FAQ

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What are the risks of investing in REITs?

Do REITs have fees?

What Are Commodities? How Do They Fit Into the Stock Market?

What Is a Commodity?

Understanding Commodities

Trading Commodities

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Commodity Types and Examples

How Are Commodities Traded on the Stock Market?

What Determines Commodities Prices?

The Takeaway

FAQ

What Is a Commodity vs. a Stock?

Are commodities riskier than stocks?

What is the safest commodity to invest in?

Private Credit vs. Private Equity: What’s the Difference?

What Does Private Credit and Private Equity Mean?

Alternative investments, now for the rest of us.

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

Private Credit Definition

Private Equity Definition

What Are the Differences Between Private Credit and Private Equity?

Investment Returns

Risk

Ownership

Investor Considerations When Choosing Between Private Credit and Private Equity

The Takeaway

FAQ

Why do investors like private credit?

How much money do you need for private equity?

Can anyone invest in private credit or private equity?

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