Investing Archives | Page 8 of 191

Dec

2024

What Does DD Mean in Stocks?

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

DD is a term in stock investing that stands for “due diligence.” It’s the process of researching and evaluating stocks before deciding to buy or sell. Due diligence gives investors a comprehensive understanding of a stock so they can make an informed decision about a trade. Although due diligence is not required, it is highly recommended.

Key Points

• “DD” means “due diligence,” which is to conduct thorough research on a company’s fundamentals, including market cap, revenue, profit, and industry position, to make informed investment decisions.

• Due diligence means to analyze financial statements to understand a company’s financial health, profitability, and stability, identifying potential risks and opportunities.

• Due diligence includes following company news to stay updated on developments, management decisions, and industry trends, aiding in risk assessment and decision-making.

• Investors conducting due diligence may use analyst reports for insights into complex financial data and market trends, enhancing understanding and investment decisions.

• It can also include evaluating management and ownership to assess leadership stability and commitment, crucial for long-term investment success.

DD Stock Meaning

Due diligence includes looking at a company’s financial records, comparing it to competitors, considering broader market conditions, and may include factoring in ESG metrics and more. Both quantitative and qualitative analysis is used to evaluate stocks.

Most of the information used for due diligence can be found on company websites, quarterly and annual reports, financial statements, and even on stock brokerage sites and trading apps.

To “DD” a stock means to do research and analysis on the company’s fundamentals before deciding whether to buy stocks. Due diligence can be carried out by individuals, companies, and institutional investors. If an investor buys a stock without doing any research into it, they put themselves at much greater risk of losses.

The process of due diligence has been around for ages, but the term DD has become particularly popular since the rise of meme stocks and trading lingo conceived in forums like the WallStreetBets subreddit.

Even if someone on social media or a professional trader is hyping up a stock and showing their huge profits, that doesn’t mean it’s a good idea to listen to their advice. As such, it may be a good idea to review stock market basics to get a sense of whether the hype is justified.

Some traders have put their entire life savings into trades without doing DD, just based on someone’s advice, and lost money as a result. Hence the term DD stock became commonly used – though it’s important to remember that losses can occur even when due diligence is done.

Items to Review When Conducting Due Diligence

There are many different measures used to evaluate stocks, and it’s up to each investor to decide how in-depth they want to go in their analysis. Every investor has different goals and risk tolerance, so it’s important to find the stocks that fit one’s particular criteria. For instance, one investor might be looking for stable, relatively low-risk, long-term growth while another might want to go for the potentially highest returns with a higher degree of risk.

Some of the most common items to review when conducting due diligence are:

Market Cap

One of the key factors to look at for due diligence is a company’s market cap. This is the total market value of the company’s shares. It’s also useful to look at how a company’s market cap has changed over time and consider how it might change in the future. For instance, an investor can look at stock price movements, ownership makeup of the company, and the market caps of competitors.

Researching market cap may indicate, for an investor, how volatile a stock might be, how many shareholders might own stock, and how big the end market is.

Large-cap and mega-cap companies tend to have more stable revenue streams and market caps since they are serving larger and broader markets, while mid-cap and small-cap companies may come with more risk and have the potential to see higher returns since they may only be serving a small segment of the market.

Revenue, Profit, and Margin Trends

Analyzing stock trends involves looking at the movement of metrics over time. These metrics include profits, revenue expenditures, profit margin trends, and return on equity. Trends can be monitored over weeks, months, and years.

A good way to start is to find the revenue and net income trends for the past two years, and looking at profit and loss statements. Those can be found on financial news sites and some trading apps that allow investors to search for stocks by name or ticker symbol. These documents may also help you get a sense of which way a stock’s profit margin is trending, if at all.

Investors can see whether trends are consistent or choppy, and if there are major price swings one way or the other. One can also see whether profits are rising, falling, or remaining about the same over time.

Competition

Due diligence also involves looking at a company’s competitors to understand whether the company one is considering investing in is performing better or worse. Competitors are companies in the same industry that are around the same size. In addition to competitors, investors can look at how the industry is performing compared to the overall market, and consider whether any external factors might affect industry performance in the near or long-term future.

Valuation Multiples

Other things to look at in the due diligence process are a company’s price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, price/earnings-to-growth (PEG) ratio, and overall valuation. Investors can compare the ratios of the company they are researching with those of its competitors.

This step helps figure out whether a company is a value stock or a growth stock, and gain an understanding of its profitability.

Management

The makeup and performance of a company’s management can have a huge effect on its performance. Investors can look at who is on the board of directors, whether the founders are still involved in the company, how long the company has been around, what proportion of shares are owned by managers, and whether major shareholders have been selling off shares.

If the founders and managers don’t own a lot of stock, or are selling it off at high rates, that may be a red flag.

Balance Sheet

A company’s balance sheet shows all of its assets, liabilities, and expenditures. Investors can look at how much debt a company has as well as its available cash balance.

Stock History

Another key part of due diligence is to look at how a stock has changed over time, including its price, liquidity, and dilution. Both short and long-term stock history may provide valuable insights.

Professional Reports

Professional analysts write reports about individual companies, industries, and the overall market. These can provide information that regular or inexperienced investors wouldn’t know.

Expectations and Risks

This step of due diligence involves looking at long-term profit estimates and industry trends. Investors can also look into joint development plans, intellectual property, and roadmaps to try and understand where a company is headed.

It’s critical for investors to also look at the industry and company risks involved with purchasing a stock. These include legal matters, global events, ESG factors, and more.

Ten Steps of Due Diligence

Below are ten steps investors may take when doing due diligence. Each step adds new information that builds upon the previous steps. By the end of the ten steps, an investor should have a solid understanding of the stock and be able to make an informed decision about whether to buy.

1. Market Cap

2. Revenue, Profit, and Margin Trends

3. Industry and Competitors

4. Valuation

5. Management and Ownership

6. Balance Sheet

7. Stock Price History

8. Stock Options and Dilution

9. Expectations

10. Risks

In the first steps, one simply gathers information without coming to any conclusions about the stock. As more information is gathered, it should start to become more clear what the pros and cons are of buying the stock. Investors can then make their decision accordingly.

The Takeaway

Doing due diligence research is a critical part of investing. Before purchasing any stock or asset, investors should have enough information to make an informed decision. Each of the steps of due diligence helps build a comprehensive picture of a stock’s past and potential future performance.

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Dec

2024

Understanding the Environmental Services Industry

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

The environmental services sector is a multi-billion-dollar industry, which includes companies that collect and dispose of hazardous and non-hazardous types of waste and pollutants. Waste can include toxic waste in soil and water, as well as medical waste, trash, and sewage.

Companies in the environmental services industry include waste treatment plants, landfills, sewage systems, incinerator operators, testing and analysis services, and companies that provide technologies to deal with radioactive waste and other specialized areas.

The environmental services sector may offer a wide array of potential investment opportunities, thanks to an active regulatory climate, as well as growing corporate and consumer commitment to sustainability goals in the U.S. and abroad.

Key Points

• Environmental services is a multi-billion-dollar industry; it includes companies that collect and dispose of hazardous and non-hazardous waste.

• Waste can include consumer refuse, toxic waste in soil and water, as well as medical waste, sewage, and more.

• Environmental services also encompass a number of subsectors that range from testing to engineering, consulting, development, and more.

• Owing to the rising concern about environmental impacts, there is a robust regulatory climate that has helped shape and spur the growth of this sector.

• Given that continued population growth and urbanization are adding to the increase in waste and pollution, environmental services may see commensurate demand over time.

What Is the Environmental Services Sector?

Environmental services generally encompass infrastructure-based organizations and public utilities, such as sanitation and sewage processing, as well as water and wastewater treatment, and recycling.

Environmental services can also include non-infrastructure services that deal with air, water, ground, and noise pollution, as well as contaminated site remediation.

The removal and treatment of medical and hospital waste is another important environmental services function.

💡 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.

Subsectors of Environmental Services

While environmental services are often couched as waste management, it’s important to remember that environmental services encompass a number of subsectors that range from testing to engineering, consulting, development, and more. These companies prevent and reduce pollution to the air, land, cities, and waterways.

Environmental services subsectors include:

• Testing and analysis for pollutants and chemical contaminants, which is an important part of regulatory compliance, as well as ensuring baseline environmental protections.

• Environmental engineering and project management services, which support sustainable infrastructure development, public services, and sustainable project management.

• Environmental assessment and permitting to ensure legally compliant project management and infrastructure development.

• Environmental services processing, which includes the facilities that handle recycling, smelting, incineration, and more.

• Environmental consulting, which includes companies that help organizations meet local and governmental sustainability standards, or improve their visibility as an environmental steward.

6 Biggest Companies Within Environmental Services

Environmental services is a $35 billion global sector, which is projected to grow at a compound annual growth rate (CAGR) of about 6.3%, and reach some $50 billion by 2028.

Some of the biggest companies by revenue, according to CSIMarket, include:

Company	Ticker	Market capitalization (in billions)
Waste Management, Inc.	WM	$87.69
Republic Services, Inc.	RSG	$65.16
Waste Connections, Inc.	WCN	$46.29
GFL Environmental, Inc.	GFL	$17.15
Clean Harbors, Inc.	CLH	$14.00
Casella Waste Systems	CWST	$6.77

Source: CSIMarket; data from Yahoo Finance, as of Nov. 7, 2024.

Investing in Environmental Services Stocks

Several factors are contributing to the growth of the environmental services sector. These include population growth, urbanization, industrialization, increased government regulations, and rising concern among consumers and investors about environmental, social, and governmental (ESG) factors.

Growth of Waste and Pollution

According to the U.S. Environmental Protection Agency, municipal solid waste (MSW) amounts alone have increased 93% from 1980 to 2018, the last year for which data is available. MSW refers to consumer waste or garbage (e.g., everything from food waste to packaging to durable goods refuse like furniture). MSW does not include industrial or hazardous waste.

On the whole, the world population is getting richer, and with that comes more consumption and more waste creation. Many people move into cities as income increases, resulting in the need for more urban waste management.

On the plus side, technology is improving within collection, recycling, and waste processing. More waste is being converted into energy, and advanced technology systems help with processing, remediation, and more.

Benefits of Investing in Environmental Services

There are several reasons why investing in environmental services and green stocks may offer investors certain opportunities. For instance:

• Environmental services are frequently needed and demand is projected to increase.

• There is a growing body of governmental regulations in this sector that require companies to rely on a range of environmental services.

• Environmental and waste management technology (e.g., water treatment, air pollution abatement) is improving and investments are being made into new systems.

• More product packaging is now recyclable.

• As more people move to cities it is easier to collect their waste and economies of scale become relevant.

Disadvantages of Investing in Environmental Services

However, there are some downsides and things to keep in mind when considering investing in environmental services stocks and ETFs. Like stocks in any sector, it’s important to do research and consider what might happen in the future. Some things to keep in mind are:

• Consumption and waste generation are closely tied to economic cycles. If there is a recession or economic downturn, people consume less, which can affect the revenue of waste management companies.

• Inflation and currency fluctuations can affect the waste management sector as well, especially in emerging markets.

• There are efforts being made by governments, NGOs, and others to educate people and encourage them to consume and waste less. While this is great news for the environment and global health, it may not be great news for waste management companies.

• Environmental services companies are increasingly involved in energy and materials sectors, making them vulnerable to fluctuations in commodities pricing and supply chain changes.

The Takeaway

Environmental services are an essential part of hazardous and non-hazardous waste management, processing, remediation, and more. And as consumption and urbanization increase, the sector is projected to grow as well. Robust environmental services systems are crucial to sustainability efforts, and interested investors may find investment opportunities in the environmental services sector, but it’s important to weigh the risks in this field as well.

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FAQ

What are examples of environmental services?

Examples of environmental services include hazardous and non-hazardous waste collection and disposal, sewage treatment, recycling, landfill management, composting, toxic waste removal and remediation, and medical waste management. Environmental services can also include engineering and consulting for legal and regulatory compliance, and more.

What’s the meaning of environmental services?

Environmental services are companies and organizations whose aim is to help corporations and municipalities manage the constant generation of waste products and pollutants that are a natural but potentially hazardous aspect of modern life.

Why do we need environmental services?

As the world’s population grows and urban areas expand, there is a commensurate increase in environmental waste products and pollutants. Environmental services companies clean up, manage, and process waste and meet certain regulatory standards. This is essential to keep land, cities, air, and water clean and unpolluted.

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Dec

2024

Value-Weighted Index: Explanation and How to Calculate

By Brian O'Connell | Growing Wealth, invest, Investing | Comments Off

Value weighted indexes, also called cap-weighted indexes, may be used by investors to gauge the performance of various sectors of the stock market. Indexes effectively measure a specific portion or subset of the market, which can help investors get a sense of the market’s performance.

Some of the most commonly known and used value weighted indexes include the S&P 500, Nasdaq Composite, or Wilshire 5000. While these indexes can help investors get an idea of the market’s performance, they do have flaws, which investors would do well to keep in mind.

Key Points

• Value weighted indexes aggregate stock performance using market capitalization.

• These indexes serve as benchmarks for evaluating performance in financial markets.

• Calculation involves multiplying stock price by shares outstanding, normalized by a divisor.

• Other index types include price weighted and fundamentally weighted indexes, each distinct.

• Value weighted indexes reflect market trends but can be skewed by large companies.

Value Weighted Index Explained

Value weighted indexes are often used in the investment world as a stock market evaluation tool. A value weighted index is a tool used to aggregate the performance of multiple stocks into a cohesive whole represented by a single number. In other words, it’s a way to simplify a subset of the market’s performance, and make it relatively easy to get an idea of what’s happening in the market.

Value weighted indexes multiply current share prices by the number of shares outstanding to get the market cap for each component, or asset, of the index. These individual market caps are then totaled to get the overall value of the index.

When value weighted cap indexes began, the typical method of combining these values was by using a weighted average. For instance, if a stock’s market cap represented 10% of the overall market it would be weighted at 10%.

However, that method quickly becomes complicated as stocks are removed and added from the index, and some companies may be acquired or merged. Because of this, almost all indexes calculate a divisor to normalize the business decisions made at each company so that the index represents performance as accurately as possible without being affected by individual company decisions.

Let’s examine how different constituencies use the indexes for their particular needs, including traders, investors, and fund managers.

How Traders Use Indexes

Traders may differ from “investors” in that they’re characterized by short-term decision making. Traders use indexes as a benchmark to judge performance. They try to use indexes that match with their market moves.

For example, a technology focused investor might use the Nasdaq Composite to measure how well they are meeting their investment goals. They might also use the market index to determine when to enter or exit trades by gleaning any information they can about how the overall market is moving.

How Investors Use Indexes

Investors may differ from “traders” in that they have long-term horizons or investment goals, and thus, may be a bit more conservative in their investing approach. But similar to traders, investors also use indexes as a benchmark to compare how they’re doing in comparison. But investors may also be looking for less-risky investments with broad diversification.

Exchange-traded funds, or ETFs, may align with their goals, and ETFs often seek to replicate the various indexes by holding shares in proportions to match the index. Index investing can be a relatively simple way to start investing for beginners, as it allows for a degree of built-in diversification, tends to align with market performance, and typically comes with the benefit of low transaction fees.

But further research is always required to ensure that a specific ETF aligns with an investor’s strategy. With that in mind, it may be worthwhile to review available resources to help you learn more about investing in ETFs.

How Mutual Fund Managers Use Indexes

Mutual funds pool investment resources from a number of investors to try and provide diversification across sectors, and often pursue more conservative investments. Mutual fund managers may, again, use value weighted indexes as a north star, and try to match a market index’s performance, or beat it with the goal of generating returns for investors. However, keep in mind that investors can always lose money, too.

Mutual funds are also generally aligned with an index that parallels the investment philosophy of the fund, be that stocks, bonds, commodities, etc. So, there may be mutual funds that specialize or focus on investing in certain market segments, and use those as indexes to try and match.

How Hedge Funds Use Indexes

Hedge funds pool investment resources in a similar way to mutual funds, but typically follow a far more aggressive investment strategy and managers stick to an active investing style. Though they may be a bit more aggressive and less risk-averse, like other types of funds, hedge fund managers may use indexes as a benchmark to meet or beat in an attempt to generate returns for investors. Remember: There’s a potential for losses, too.

Pros and Cons of Value Weighted Indexes

Value weighted indexes have their pros and cons, of course. Here’s a quick rundown of what the advantages and disadvantages of using value weighted indexes may be for investors.

thumb_up

Pros:

• Tend to offer a comprehensive market perspective

• Are often comprised of less volatile, more mature companies

• Often include a broad-based, well-diversified list of companies and have low transaction costs

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Cons:

• The largest companies in the index may overwhelm performance

• May help generate market bubbles, with overpriced assets

• May encourage buying-high, selling-low investor behavior

How Market Value Weighted Index Is Calculated

Theoretically, the calculation of a value weighted index and the weights assigned to each component are easy to calculate. But as with most things, reality is a little more complicated.

To calculate a value weighted index, the first step is to multiply the price and shares outstanding (both of which are in near constant flux) of each component to get the market capitalization for each stock. For example, if you were trying to calculate a value weighted index comprising only three companies (which would not be indicative of a true index, but for simplicity’s sake, will work for an example), you’d first figure out the market capitalization of each company.

Market Capitalization = Price per share x Shares Outstanding

In this hypothetical example, here’s how that might look:

• Company 1: 50 shares outstanding at a current price of $10 = $500

• Company 2: 100 shares outstanding at a current price of $5 = $500

• Company 3: 75 shares outstanding at a current price of $15 = $1,125

Adding those up, the entire market value of this index is $2,125. To calculate the weights of each company in the index, you divide the value of the given company by the overall value of the index:

• Company 1: $500 ÷ $2,125 = weight of 23.5%

• Company 2: $500 ÷ $2,125 = weight of 23.5%

• Company 3: $1,125 ÷ $2,125 = weight of 53%

So, our total weight between the three companies is 100%, and Company 3 carries the highest weighting.

But remember: Due to complications with adding and removing companies from the index, dividends paid, buybacks, mergers, etc., there must be some normalizing done to the formula to remove large fluctuations caused by anything other than core performance.

This function is accomplished by the divisor, which oftentimes performs double duty by scaling the index values much smaller, say in the thousands rather than in the trillions, resulting in the following formula.

Index Value = ∑_𝑖𝑝_𝑖𝑞_𝑖 / Divisor

Other Forms of Weighted Market Indexes

Value weighted indexes aren’t the only index-based securities measuring tool. Investors can utilize the following market index assessment options as well.

The Price Weighted Index

Price weighted indexes are another form of weighted market index, and a good example is the Dow Jones Industrial Average.

A price weighted index weights each component based on its stock price. Therefore a company trading at $200 will have a higher weighting than a stock trading at $5. This is despite the revenue, employment, or market capitalization of the respective companies.

The Fundamentally Weighted Index

A fundamentally weighted market index weighs companies based on some other financial criteria such as revenues, earnings, dividend rates, or other factors. Fundamentally weighted indexes allow tremendous flexibility in creating an index to match an investing criteria and strategy.

Unweighted Index

The term “unweighted” simply means that no weight is applied when measuring a stock against an index. Instead, the measurement gives equal weight to each index component. It is common to see unweighted versions of major indexes compared to the weighted indexes to get deeper market insights on, for example, how broad-based a market rally truly is.

The Takeaway

Value weighted indexes can be useful as performance benchmarks and to provide a quick overview of market conditions. By observing the index performance, investors may be better informed on entry and exit opportunities, as well as to measure their own investing performance.

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Dec

2024

Evaluating the Pros and Cons of Alternative Investments

By MP Dunleavey | Growing Wealth, invest, Investing | Comments Off

As alternative investments have become more accessible for all investors, it’s essential to weigh the pros and cons of these assets: on the one hand, alts offer the potential for diversification and higher returns — but they’re often higher cost, illiquid, and subject to complex tax treatment.

Understanding the advantages and disadvantages of these assets is especially crucial right now, because alts used to be the province of high net-worth and accredited investors. Now, however, alts are accessible to individual (retail) investors via conventional instruments like mutual funds and ETFs, as well as some retirement accounts like certain types of IRAs.

Pros and Cons of Alternative Investments
Advantages	Disadvantages
May provide portfolio diversification.	Many alts have low liquidity and/or come with redemption restrictions.
May offer higher returns compared with traditional assets.	Alts may employ high-risk strategies like short selling and leverage.
May offer passive income opportunities.	Some alts could be subject to higher volatility in some circumstances.
May be a hedge against inflation or interest rate fluctuations.	Owing to lack of transparency, obtaining historic data on certain alternatives can be difficult.
Accessible through ETFs and mutual funds, and some available via traditional retirement accounts, e.g. an IRA.	Investing directly in alternatives, or via a fund, may require complex tax treatment that varies from one asset class to the next.
Alts may appeal to investors’ personal hobbies and interests (e.g. wine, art, collectibles).	May require high minimum investment and often charge higher fees.

Recommended: What Are Alternative Investments?

Pros of Investing in Alts

There are a number of reasons why investors may find alternative investments attractive.

Diversification

Whereas traditional investments tend to move in tandem with the markets, this makes them vulnerable to market volatility, and increases risk exposure. But because most alternative investments have a low correlation with stock and bond markets, they generally move independently, and can thus provide a buffer against risk.

Investing in alts therefore can provide portfolio diversification, which may also help improve risk-adjusted returns over time.

Potential for Higher Returns

There are a couple of reasons why some alts may deliver higher portfolio returns. The first relates to the factors above. Because alternative investments have a low correlation with other assets and provide diversification (and a hedge against inflation or interest rates), this can improve a portfolio’s risk-adjusted returns.

The second is that some alts — e.g. hedge funds, private equity, venture capital, derivatives trading — employ high-risk strategies like short selling, various types of options trading, and leverage (among others), that may deliver higher returns.

Keep in mind that pursuing above-average returns almost always means a much higher risk exposure.

Potential for Passive Income

Some alternatives, like real estate, not only offer the potential for gains but the possibility of passive income as well. For example, real estate investment trusts (REITs) are required to distribute at least 90% of the fund’s income to shareholders.

In addition, certain types of alts (for example, some private equity stocks and funds that invest in these) may also pay dividends, which can also enhance income.

Hedge Against Inflation

Similarly, investing in alternative assets like real estate or commodities (e.g precious metals) can, in some cases, provide a hedge against inflation. That’s because tangible alts may increase in value during inflationary periods versus more traditional asset classes, which may see their value eroded by inflation.

By the same token, some alts can provide a hedge against interest rate risk, again because they have a low correlation with the asset classes that suffer in periods of rising rates.

The challenge here for investors is that both interest rates and inflation can be unpredictable, and using certain assets as a hedge is no guarantee of success.

Recommended: 2023 Capital Gains Tax Guide

Alts Are Available Through ETFs and Mutual Funds

As noted above, a shift has occurred in recent years, allowing individual investors to access different alternative asset classes within traditional fund structures like ETFs and mutual funds.

This is one way that retail investors can gain access to this class of assets that once was limited to high net-worth and accredited investors.

The relative accessibility of publicly traded funds can allow individuals to invest in different alternative sectors — e.g. private equity, private credit, real estate, currencies (including digital currencies) — through these vehicles.

That said, although a mutual fund is a type of pooled investment fund, that doesn’t eliminate all the risk factors that can come with investing in alts.

Accessible via Retirement Accounts

Related to the above, another advantage to investing in alts for individual investors is that it’s possible in some cases to add alts to your IRA. While most mainstream or discount brokers don’t yet offer this option, it’s possible to find asset managers that do.

It bears repeating, though, that retirement funds are meant for the long term, and it’s wise to carefully vet all investment choices in order to limit losses.

Personal Appeal

Some alternatives, such as collectibles (e.g. wine, art, memorabilia, antiques, classic cars) offer the additional gratification of fulfilling an investor’s passion or hobby.

Alternative investments,
now for the rest of us.

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

💡 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.

Cons of Investing in Alts

Alternative investments, which fall outside the realm of conventional securities and strategies, by their nature come with a few disadvantages investors must keep in mind.

Low Liquidity/Redemption Issues

Alternative investments are notoriously illiquid. That means that they aren’t traded frequently, and the markets for these assets can be smaller with lower trading volume.

For example, some collectibles also come with a high degree of risk because a car, case of wine, set of sports cards, could become worthless if there is a shift in taste or trends. These types of tangible or physical investments — including certain types of real estate and commodities — are also more vulnerable to environmental factors (fire, flood, weather, deterioration) that can instantly erode the asset’s value.

High-Risk Strategies

In the quest for higher returns, many alternative asset classes use high-risk strategies that include the risk of total loss. Trading futures, options, and other derivatives, for example, can be highly risky, especially for less experienced investors.

The same is true of certain vehicles, like investing in hedge funds (which also come with high fees) which employ a high degree of leverage, or venture capital, where an investment in a particular venture can go south.

Recommended: What Are Liquid Assets?

Complex Tax Treatment

Some alts may offer certain tax advantages. However, alts can be taxed in different ways, and don’t necessarily lower your investment taxes.

Most investment gains are taxed according to capital gains tax rules, but that isn’t always true of alternative investments when purchased directly, or when investing in a fund. It might be wise to consult a tax professional.

Higher Costs

Some alts come with a higher barrier to entry in terms of investment fees, management fees, and other charges that are not as common with conventional securities.

Hedge funds, for example, typically have a very high minimum investment requirement, often in the six or seven figures, in addition to management and performance fees that can hit 20%.

Lack of Transparency and Publicly Available Data

One of the most troubling aspects of alternative investments is that there is very little transparency around how these assets are traded, their historical price data, and so on.

This can make it difficult to conduct certain types of technical or fundamental analysis, as you might with stocks, in order to gauge the real-time value of a certain asset, never mind its long-term potential.

The Takeaway

As investors’ interest in branching out beyond the traditional asset classes continues to grow, alternative investments may continue to spark new interest among individuals, especially as the availability of alts expands into new vehicles, like conventional mutual funds, ETFs, and even retirement accounts.

Understandably, investors are often on a quest to find the next new thing that will help tamp down risk and improve returns. But alts do come with some notable risk factors that investors must take into account before embarking on any new strategies.

Invest with as little as $5 with a SoFi Active Investing account.

Photo credit: iStock/cagkansayin

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
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.

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

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.
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.

SOIN1123004

Dec

2024

Benefits of ETFs — Pros & Cons in Investment Portfolio

By Inyoung Hwang | Growing Wealth, Investing | Comments Off

Exchange-traded funds (ETFs) are funds that can be used to build a relatively simple and low-cost diverse portfolio. There are many investing benefits to ETFs, which is why they’ve grown in popularity both for DIY investors and for more traditional money managers. However, there are cons investors should be aware of, too.

Key Points

• ETFs offer diversified exposure across various assets, potentially reducing large swings in overall portfolio value.

• They tend to be cost-effective due to lower management fees compared to mutual funds.

• ETFs provide flexibility with real-time trading, similar to stocks.

• Tax efficiency is enhanced in ETFs because of fewer capital gains distributions.

• However, ETFs can have hidden costs like bid-ask spreads and brokerage fees.

What Are the Benefits of ETFs?

Exchange-traded funds (ETFs) have become increasingly popular in recent years, especially with the rise of online investing allowing people to buy and sell them quickly.

As an investment tool, ETFs have become popular: there were almost 10,000 ETFs in the world with trillions of dollars in assets under management (AUM) at the end of 2023. In the U.S., there was more than $7 trillion in AUM in ETFs.

Here are some of the benefits of ETFs, which has helped spur their popularity.

ETFs Trade Similar to Stocks

ETFs are traded on stock exchanges and can be bought and sold throughout the day, like individual stocks. The market determines the price for a share of an ETF and changes throughout the day. This means investors can buy and sell ETFs efficiently, making them a convenient investment option.

Portfolio Diversification

An additional benefit of an ETF is that you don’t need a lot of money to invest in many different things. One share of an ETF offers investors a way to diversify their portfolio by investing in a basket of assets, such as stocks, bonds, or commodities, rather than just a single asset. This can help to reduce the overall risk of an investment portfolio.

Accessible Across Markets

There is also a range of ETFs on the market now: stocks, bonds, commodities, real estate, and hybrids that offer a mix. ETFs also vary in how they target certain assets — aggressively or defensively, specific to one asset class or broad. So investors should be able to find what they want and build a diverse portfolio.

Lower Costs

Most ETFs are passively managed and track a benchmark index, meaning portfolio managers don’t actively manage the fund to try to beat the market or an index. Passive investing, as opposed to active investing, may be more cost-effective because there tends to be less overhead and fewer investment fees.

Because there is often less overhead, ETFs generally charge investors a lower operating expense ratio than actively managed mutual funds. The operating expense ratio is the annual rate the fund charges to pay for portfolio management, administration, and other costs.

There are other costs investors need to consider, like commissions for trades and a bid/ask spread.

Tax Efficiency

ETFs tend to be more tax efficient than mutual funds because they typically generate fewer capital gains and capital gains taxes. This is because passively managed ETFs tend to have lower turnover than actively managed mutual funds, which means they sell fewer assets and, thus, result in fewer capital gains.

Transparency

ETFs generally disclose their holdings daily, so investors can see exactly what assets the ETF holds. This can be helpful for investors who want to know what they are investing in.

Flexibility

ETFs can be used as a part of various investment strategies, including as part of a long-term buy-and-hold strategy or as a short-term trading tool. This makes them a flexible investment option for a wide range of investors.

Moreover, investors can trade thematic ETFs — funds focusing on a specific trend or niche industry, like robotics, artificial intelligence, or gender equality. However, there are pros and cons to thematic ETFs. While they allow investors to make more targeted investments, the shares of these funds can be volatile. Because they’re so focused, these ETFs may also diminish the most important benefit of ETFs: broad, diverse exposure.

Disadvantages of ETFs

While ETFs offer many benefits to investors, there are also some potential disadvantages to consider. These disadvantages include the following:

Lack of Personalization

Because ETFs are not actively managed, they do not consider an investor’s specific financial goals or risk tolerance. A lack of personalization means that ETF investors may be unable to tailor their investment portfolio to their particular financial needs.

Tracking Error

ETFs are usually designed to track the performance of a particular index or basket of assets. However, the performance of the ETF may not precisely match the performance of the underlying index due to various factors, such as the fund’s expenses or the timing of when it buys and sells assets. This is known as a tracking error.

Short-Term Trading Costs

ETFs can be traded on the market throughout the day, making them attractive to short-term traders. However, the commission costs of trading ETFs can add up over time, which can eat into investment returns.

Limited Choices

While many ETFs are available, the range of options may be limited compared to other investment vehicles, such as mutual funds. Thus, investors may be unable to find an ETF that perfectly matches their investment needs.

Counterparty Risk

Certain ETFs may use financial instruments, such as futures contracts or swaps, to gain exposure to specific assets. These instruments carry counterparty risk, which means that there is a risk that the counterparty will not fulfill its obligations under the contract. This can expose ETF investors to additional risks.

Complexity

Some ETFs use complex investment strategies, such as leveraged or inverse ETFs, which can be difficult for some investors to understand. Complex investing strategies can make it challenging for investors to fully understand the risks and potential returns of these types of ETFs.

Market Risk

ETFs, like all investments, are subject to market risk, meaning the value of an ETF can go up or down depending on the performance of the underlying assets.

What to Consider When Investing in ETFs

When investing in ETFs, it is essential to consider the following factors:

• Investment objective: Determine your investment goals and how ETFs fit into your overall investment strategy. This can help you choose an ETF that aligns with your financial goals and risk tolerance.

• Asset class: Consider which asset classes you want to invest in and whether an ETF that tracks those assets is available. For example, if you want to invest in large-cap domestic stocks, look for an ETF that tracks a particular large-cap domestic stock index.

• Diversification: ETFs offer a way to diversify your investment portfolio by investing in a basket of assets rather than just a single asset. Consider the level of diversification an ETF offers and whether it aligns with your investment goals.

• Expenses: ETFs typically have lower fees than mutual funds because they are not actively managed. However, it is still important to compare the expenses of different ETFs to ensure you are getting the best value for your money.

• Tax considerations: ETFs tend to be more tax efficient than mutual funds because they generate fewer capital gains. However, it is still important to consider the tax implications of investing in an ETF and whether it aligns with your overall financial plan.

Investing With SoFi

ETFs are becoming increasingly more popular and ubiquitous in the financial markets, with some being more targeted in focus than others. So, being aware of an ETF’s investments can be important for an investor who chooses to put dollars into this financial vehicle. But, as with any investment, they have their pros and cons, which investors should familiarize themselves with before investing.

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 the benefit of investing in an exchange-traded fund?

Exchange-traded funds (ETFs) offer investors a convenient and cost-effective way to diversify their portfolios by investing in a basket of assets. ETFs are also typically more tax efficient than mutual funds and offer investors the ability to buy and sell their shares on a stock exchange.

Are ETFs a good investment?

Depending on their investment goals and risk tolerance, ETFs may be a good investment for some investors. ETFs offer a convenient and cost-effective way to diversify a portfolio and provide access to a wide range of asset classes. However, it is important for investors to consider the specific ETF they are considering and how it fits into their overall investment plan.

Why are ETFs better than stocks?

For some investors, ETFs may be a better investment option than individual stocks because they offer diversification by investing in a basket of assets rather than just a single stock.

Is an ETF better than a mutual fund?

Whether an ETF is better than a mutual fund depends on the specific circumstances of the investor and their investment goals. ETFs tend to have lower fees than mutual funds because they are not actively managed and may also be more tax efficient due to their lower turnover. However, mutual funds offer a more comprehensive range of investment options and may be more suitable for some investors.

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
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.

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN-Q424-028

What Does DD Mean in Stocks?

DD Stock Meaning

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Items to Review When Conducting Due Diligence

Market Cap

Revenue, Profit, and Margin Trends

Competition

Valuation Multiples

Management

Balance Sheet

Stock History

Professional Reports

Expectations and Risks

Ten Steps of Due Diligence

The Takeaway

Understanding the Environmental Services Industry

What Is the Environmental Services Sector?

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Subsectors of Environmental Services

6 Biggest Companies Within Environmental Services

Investing in Environmental Services Stocks

Growth of Waste and Pollution

Benefits of Investing in Environmental Services

Disadvantages of Investing in Environmental Services

The Takeaway

FAQ

What are examples of environmental services?

What’s the meaning of environmental services?

Why do we need environmental services?

Value-Weighted Index: Explanation and How to Calculate

Value Weighted Index Explained

How Traders Use Indexes

How Investors Use Indexes

How Mutual Fund Managers Use Indexes

How Hedge Funds Use Indexes

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Pros and Cons of Value Weighted Indexes

Pros:

Cons:

How Market Value Weighted Index Is Calculated

Other Forms of Weighted Market Indexes

The Price Weighted Index

The Fundamentally Weighted Index

Unweighted Index

The Takeaway

Evaluating the Pros and Cons of Alternative Investments

Pros of Investing in Alts

Diversification

Potential for Higher Returns

Potential for Passive Income

Hedge Against Inflation

Alts Are Available Through ETFs and Mutual Funds

Accessible via Retirement Accounts

Personal Appeal

Alternative investments, now for the rest of us.

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

Cons of Investing in Alts

Low Liquidity/Redemption Issues

High-Risk Strategies

Complex Tax Treatment

Higher Costs

Lack of Transparency and Publicly Available Data

The Takeaway

Benefits of ETFs — Pros & Cons in Investment Portfolio

What Are the Benefits of ETFs?

ETFs Trade Similar to Stocks

Portfolio Diversification

Accessible Across Markets

Lower Costs

Tax Efficiency

Transparency

Flexibility

Disadvantages of ETFs

Lack of Personalization

Tracking Error

Short-Term Trading Costs

Limited Choices

Alternative investments,
now for the rest of us.

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