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How to Negotiate Your Signing Bonus

Although many people believe that the negotiation process ends once they have accepted a job offer, that’s often not the case. One of the most critical aspects of the negotiation process is negotiating your signing bonus. A signing bonus is a monetary incentive that an employer agrees to pay you. This bonus is meant to entice you to accept the job offer, and is typically negotiable.

It can be beneficial to know the nuances of negotiating a signing bonus to get the most out of your job hunt. If you are offered a signing bonus, be sure to negotiate it to get the most money possible. And even if your initial job offer doesn’t include a signing bonus, it might be worth asking for one.

Understanding Why Companies Offer a Hiring Bonus

Employers aren’t obligated to offer job candidates a hiring bonus, which is sometimes called a signing bonus or sign-on bonus. However, companies may choose to extend this one-time financial benefit to attract new talent, especially in a competitive hiring landscape.

This one-time signing bonus can help an employer close the gap between a candidate’s desired pay and what the company can offer. Additionally, the hiring bonus may compensate a new hire for any benefits the candidate might otherwise miss out on by changing jobs or forgoing other job offers.

Companies may also use a sign-on bonus to incentivize an employee to stay with a company for a certain period of time. If an employee quits within an agreed-upon time after accepting the position, they may be required to pay back the bonus.

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How Signing Bonuses Work

If you’re being considered for a job, the hiring company can include a signing bonus as part of the job offer. You can then decide whether to accept the bonus and the position, attempt to negotiate for a larger sign-on bonus, or walk away from the offer altogether.

Should you accept the offer, the hiring bonus can be paid out to you as a lump sum or as employee stock options. If the company pays the bonus as a lump cash sum, they may pay it out with a first paycheck, or after a specified period, like 90 days.

Like any other bonuses, salary, or wages you receive, a signing bonus is taxable. So you’ll have to report that money on your tax return when you file. If the signing bonus is paid with regular pay, it’s taxed as ordinary income. If it isn’t, then the sign-on bonus is taxed as supplemental wages. For 2024, the supplemental wage tax rate is 22%, which increases to 37% if your bonus exceeds $1 million.

Additionally, bonuses, whether they’re paid when starting a new job or as a year-end bonus, may also be subject to Social Security and Medicare tax as well as state income tax. Employers withhold these taxes and pay them to the IRS for you. So when you get your bonus, you’re getting the net amount, less taxes withheld.

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Average Signing Bonus

The average signing bonus can vary greatly depending on the company, position, and location. In general, signing bonuses may range from $10,000 to more than $50,000 for management and executive positions, while entry and mid-level position hiring bonuses are usually less than $10,000.

But again, there’s no guarantee that you’ll be offered a signing bonus, or that they’ll be pervasive in your given industry.

What Industries Offer the Highest Hiring Bonuses?

The industries that offer the highest hiring bonuses tend to be in the financial and technology sectors.

However, during competitive labor markets, signing bonuses may be offered in various industries that usually don’t offer a bonus. For instance, following the Covid-19 pandemic and subsequent labor shortage, industries like healthcare, warehousing, and food and beverage offered substantial hiring bonuses to attract potential employees.

💡 Recommended: The Highest-Paying Jobs in Every State

Pros & Cons of Signing Bonuses

Receiving a sign-on bonus could make a job offer more attractive. But before you sign on the dotted line, it’s helpful to consider the advantages and potential disadvantages of accepting a bonus.

Signing Bonus Pros

A signing bonus could help make up a salary shortfall. If you went into salary negotiations with one number in mind, but the company offered something different, a sign-on bonus could make the compensation package more attractive. While the bonus won’t carry on past your first year of employment, it could give you a nice initial bump in pay that might persuade you to accept the position.

You may be able to use a signing bonus as leverage in job negotiations. When multiple companies make job offers, you could use a signing bonus as a bargaining chip. For instance, if Company A represents your dream employer but Company B is offering a larger bonus, you might be able to use that to persuade Company A to match or beat their offer.

A sign-on bonus could make up for benefits package gaps. Things like sick pay, vacation pay, holiday pay, insurance, and a retirement plan can all enhance an employee benefits package. But if the company you’re interviewing with doesn’t offer as many benefits as you’re hoping to get, a large sign-on bonus could make those shortcomings easier to bear.

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Signing Bonus Cons

Since sign bonuses are taxable as supplemental wages, you might see a temporary bump in your tax liability for the year. You may want to talk to a tax professional about how you could balance that out with 401(k) or IRA contributions, deductions for student loan interest payments, and other tax breaks.

Additionally, changing jobs might mean having to repay the bonus, depending on your contract. Employers can include a clause in your job offer that states if you leave the company within a specific time frame after hiring, you’d have to pay back your sign-on bonus. If you have to pay back a bonus and don’t have cash on hand to do so, that could lead to debt if you have to get a loan to cover the amount owed.

This might cause you to get stuck in a job you don’t love. If your employer requires you to pay back a signing bonus and six months into the job, you realize you hate it, you could be caught in a tough spot financially. Unless you have money to repay the bonus, you might have to tough it out with your employer a little longer until you can change jobs without any repayment obligation.

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Reasons to Negotiate a Signing Bonus

There are several reasons it can be beneficial to negotiate a signing bonus rather than just accept whatever the employer offers.

For one, a signing bonus can help offset the costs of relocating for a new job. Additionally, a signing bonus can help you maintain your current standard of living while you transition to a new city or state. Finally, a signing bonus can allow you to negotiate for other perks and benefits, such as a higher salary, stock options, or a more generous vacation policy.

When Is a Hiring Bonus Negotiated?

A hiring bonus is typically negotiated during the job offer stage after the employer has extended a job offer to the candidate. You don’t want to get ahead of yourself and ask for a hiring bonus immediately because that could hurt your chances of getting one. You generally want to wait for the hiring manager to start the conversation.

After receiving your official job offer with your projected salary and benefits, you will be able to gauge your potential bonus opportunity; one rule of thumb is that a hiring bonus is about 10% of your annual salary. And if the hiring manager offers you a bonus initially, you might have an advantage in negotiating for a better one.

Tips on How to Ask for a Signing Bonus

If an employer doesn’t offer a sign-on bonus, you don’t have to assume it’s off the table. It’s at least worth it to make the request since the worst that can happen is they say no.

Here are some tips on how to ask for a signing bonus:

1. Know Your Value to the Company

Before asking for more money, either with a bonus or your regular salary, get clear on what value you can bring to the company. In other words, be prepared to sell the company on why you deserve a signing bonus.

2. Choose a Specific Amount

Having a set number in mind when asking for a bonus can make negotiating easier. Do some research to learn what competitor companies are offering new hires with your skill set and experience. Then use those numbers to determine what size bonus it makes sense to ask for.

3. Make Your Case

Signing bonuses are gaining steam in industries such as technology, engineering, and nursing, where there is more competition for the best job candidates. You are also sometimes in a better position to ask for a signing bonus if the company did not meet the salary you requested when interviewing — a signing bonus is an opportunity to recoup some of that difference. Regardless, it never hurts to consider asking for more money.

Just be sure to do your research first. For instance, perhaps discreetly ask your contacts whether the company might be open to offering a signing bonus, and be sure to do some research online or within your network to see how your job offer stacks up.

4. Split the Difference With Your Salary

One way to potentially have your cake and eat it, too, when it comes to signing bonuses is to use your salary to offset it. Specifically, instead of asking for a large bonus, you could ask for a smaller one while also asking for a bump in pay.

An employer may be more open to paying you an additional $2,000 a year to keep you on the payroll, for instance, versus handing out a $20,000 bonus upfront when there’s no guarantee you might stick around after the first year.

5. Get it in Writing

If a signing bonus wasn’t part of your original job offer, and you’ve negotiated for one, ensure you receive an updated contract with the bonus included.

The agreement should spell out the amount of the bonus, how it will be paid (separate check or part of your regular paycheck), and the terms of the bonus. The contract should note how long you must stay employed at the company to retain your bonus (typically one year).

How to Maximize Your Signing Bonus

After receiving a signing bonus, the next question should be: What do I do with the extra money?

There are several ways you can put a signing bonus to work. For example, if you have credit card debt, your best move might be to pay that off. This could be especially helpful if you have credit cards with high-interest rates.

You could also use a sign-on bonus to eliminate some or all of your remaining student loan debt. But if you’d rather save your bonus, you might refinance your loans and use the bonus money to grow your emergency fund. Having three to six months’ worth of living expenses saved up could be helpful in case you lose your job or get hit with an unexpected bill.

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You might also consider longer-term savings goals, such as buying a car or putting money down on a home. Keeping your money in a savings account that earns a high-interest rate can help you grow your money until you’re ready to use it.

Using Your Bonus for Retirement

If you are caught up with your credit card payments and already have an emergency fund, you might consider investing your bonus for the long-term.

This could be a wise financial move considering that a $5,000 signing bonus isn’t as lucrative as negotiating a $2,000 increase in your annual salary. If you can’t negotiate the higher salary, you can at least use your bonus to invest. Investing can be an excellent way to build wealth over time.

For example, you might use part of the money to open a traditional or Roth IRA. This can help you get a head start on saving for retirement and supplement any money you’re already saving in your employer’s 401(k). And you can also enjoy tax advantages by saving your bonus money in these accounts.

💡 Recommended: Should I Put My Bonus Into My 401(k)?


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The Takeaway

There’s a lot to think about when you’re looking for a new job. You want to make sure you find a position you love that will compensate you fairly. So adding another step in the job search process may seem overwhelming. However, asking for and negotiating a signing bonus using the tips above is critical to help you get hired with the bonus you deserve.

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FAQ

What is a signing bonus?

A signing bonus, also known as a hiring bonus or a sign-on bonus, is a bonus given to employees when they are hired. A company will pay a signing bonus to help entice the employee to accept the job offer.

How can you negotiate your signing bonus?

To negotiate a signing bonus, you should be clear about what you are asking for, be reasonable in your request, and have a backup plan if your initial request is not met. It is also important to remember that the company you are negotiating with likely has a budget for signing bonuses, so be mindful of that when making your request.

What is the average signing bonus?

The average signing bonus depends on several factors, including the company, position, and location. In general, the average hiring bonus for managers and executives may range from $10,000 to more than $50,000. For lower-level employees, a signing bonus may be less than $10,000.


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.

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

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What Is Considered a Good Return on Investment?

A “good” return on investment is subjective, but in a very general sense, a good return on investment could be considered to be about 7% per year, based on the average historic return of the S&P 500 index, and adjusting for inflation. But of course what one investor considers a good return might not be ideal for someone else.

And while getting a “good” return on your investments is important, it’s equally important to know that the average return of the U.S. stock market is just that: an average of the market’s performance, typically going back to the 1920s. On a year-by-year basis, investors can expect returns that might be higher or lower — and they also have to face the potential for outright losses. In addition, the S&P 500 is a barometer of the equity markets, and it only reflects the performance of the 500 biggest companies in the U.S. Most investors will hold other types of securities in addition to equities, which can affect their overall portfolio return.

Key Points

•   A good return on investment is generally considered to be around 7% per year, based on the average historic return of the S&P 500 index, adjusted for inflation.

•   The average return of the U.S. stock market is around 10% per year, adjusted for inflation, dating back to the late 1920s.

•   Different investments, such as CDs, bonds, stocks, and real estate, offer varying rates of return and levels of risk.

•   It’s important to consider factors like diversification and time when investing long-term.

•   Investing in stocks carries higher potential returns but also higher risk, while investments like CDs offer lower returns but are considered lower-risk.

What Is the Historical Average Stock Market Return?

Dating back to the late 1920s, the S&P 500 index has returned, on average, around 10% per year. Adjusted for inflation that’s roughly 7% per year.

Here’s how much a 7% return on investment can earn an individual after 10 years: If an individual starts out by putting in $1,000 into an investment with a 7% average annual return, compounded annually, they would see their money grow to $1,967 after a decade, assuming little or no volatility (which is unlikely in real life). It’s important for investors to have realistic expectations about what type of return they’ll see.

For financial planning purposes however, investors interested in buying stocks should keep in mind that that doesn’t mean the stock market will consistently earn them 7% each year. In fact, S&P 500 share prices have swung violently throughout the years. For instance, the benchmark tumbled 38% in 2008, then completely reversed course the following March to end 2009 up 23%.

Factors such as economic growth, corporate performance, interest rates, and share valuations can affect stock returns. Thus, it can be difficult to say X% or Y% is a good return, as the investing climate varies from year to year.

A better approach is to think about your hoped-for portfolio return in light of a certain goal (e.g. retirement), and focus on the investment strategy that might help you achieve that return.

Line graph: 10 Year Model of S&P 500

Why Your Money Might Lose Value If You Don’t Invest it

It’s helpful to consider what happens to the value of your money if you simply hang on to cash.

Keeping cash can feel like a lower-risk alternative to investing, so it may seem like a good idea to deposit your money into a traditional savings account. But cash slowly loses value over time due to inflation; that is, the cost of goods and services increases with time, meaning that cash has less purchasing power. Inflation can also impact your investments.

Interest rates are important, too. Putting money in a savings account that earns interest at a rate that is lower than the inflation rate guarantees that money will lose value over time. This is why, despite the risks, investing money is often considered a better alternative to simply saving it: The inflation risk is typically lower.

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What Is a Good Rate of Return for Various Investments?

As noted above, determining a good rate of return will also depend on the specific investments you hold, and your asset allocation. You can always calculate the expected rate of return for various securities. Here are different types of securities to consider.

Bonds

Purchasing a bond is basically the same as loaning your money to the bond-issuer, like a government or business. Similar to a CD, a bond is a way of locking up a certain amount of money for a fixed period of time.

Here’s how it works: A bond is purchased for a fixed period of time (the duration), investors receive interest payments over that time, and when the bond matures, the investor receives their initial investment back.

Generally, investors earn higher interest payments when bond issuers are riskier. An example may be a company that’s struggling to stay in business. But interest payments may be lower when the borrower is trustworthy, like the U.S. government, which has never defaulted on its Treasuries.

Stocks

Stocks can be purchased in a number of ways. But the important thing to know is that a stock’s potential return will depend on the specific stock, when it’s purchased, and the risk associated with it. Again, the general idea with stocks is that the riskier the stock, the higher the potential return.

This doesn’t necessarily mean you can put money into the market today and assume you’ll earn a large return on it in the next year. But based on historical precedent, your investment may bear fruit over the long-term. Because the market on average has gone up over time, bringing stock values up with it, but stock investors have to know how to handle a downturn.

As mentioned, the stock market averages a return of roughly 7% per year, adjusted for inflation.

Real Estate

Returns on real estate investing vary widely. It mostly depends on the type of real estate — if you’re purchasing a single house versus a real estate investment trust (REIT), for instance — and where the real estate is located.

As with other investments, it all comes down to risk. The riskier the investment, the higher the chance of greater returns and greater losses. Investors often debate the merit of investing in real estate versus investing in the market.

Likely Return on Investment Assets

For investors who have a high risk tolerance (they’re willing to take big risks to potentially earn high returns), some investments are better than others. So for those who are looking for higher returns, adding riskier investments to a portfolio may be worth considering.

Remember the Principles of Good Investing

Investors focused on seeing huge returns over the short-term may set themselves up for disappointment. Instead, remembering basic tenets of responsible investing can best prepare an investor for long-term success.

First up: diversification. It can be a good idea to invest in a wide variety of assets — stocks, bonds, real estate, etc., and a wide variety of investments within those subgroups. That’s because each type of asset tends to react differently to world events and market forces. Due to that, a diverse portfolio can be a less risky portfolio. Time is another important factor when investing. Investing early for more distant goals, such as retirement, may result in larger returns in the long-term.


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The Takeaway

While every investor wants a “good return” on their investments, there isn’t one way to achieve a good return – and different investments have different rates of return, and different risk levels. Investing in other types of assets tends to deliver lower returns, while stocks (which are more volatile) may deliver higher returns but at much greater risk.

Your own investing strategy and asset allocation will have an influence on the potential returns of your portfolio over time.

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For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

S&P 500 IndexThe S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an investment product, but a measure of U.S. equity performance. Historical performance of the S&P 500 Index does not guarantee similar results in the future. The historical return of the S&P 500 Index shown does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns.
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Can a Roth IRA Lose Money?

It is possible to lose money when you invest in a traditional or Roth IRA (Individual Retirement Account), depending on what investments you choose for your Roth. All investments can lose money — including those within any type of retirement account.

That’s why it’s important to invest your Roth in assets that reflect your risk tolerance. If you invest mostly in stocks, you are at a higher risk for losses in your account. If you invest in less volatile assets (e.g. bond funds), you may be at a lower risk for losses.

Are Roth IRAs safe? No investment account is ever 100% safe, but because retirement accounts are generally long-term investments, they offer the possibility of growth over time. Also, the more years you invest in a traditional or Roth IRA, the more time that retirement account may have to recover from any losses.

Key Points

•   It is possible to lose money in a Roth IRA depending on the investments chosen.

•   Roth IRAs are not 100% safe, but they offer the potential for growth over time.

•   Market fluctuations and early withdrawal penalties can cause a Roth IRA to lose money.

•   Investing late or contributing too much can also result in potential losses.

•   Diversification and considering time horizon can help mitigate risks in a Roth IRA.

Understanding IRAs

An IRA is a type of tax-advantaged account that may help individuals plan and save for retirement. IRAs can offer investors specific tax advantages that could be beneficial when compared with traditional brokerage accounts (which can be taxed as income).

There are also a few types of IRAs, with the most popular or well-known being the traditional IRA and Roth IRA account.

With a traditional IRA your contributions are pre-tax, meaning the amount you deposit in an IRA is deducted from your taxable income and is therefore not taxed until you withdraw the funds.

The key distinction is that contributions to Roth IRAs involve money that’s already been taxed, so it grows tax free, and withdrawals are also tax free. More on the differences between them below.

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Can You Lose Money in a Roth IRA?

Now, to the main question: Can a Roth IRA lose money? The answer is yes, it can. This is one of the main differences between a Roth IRA vs. savings: Investing involves risk, whereas parking your money in the bank usually does not (with the exception of inflation risk).

There are several reasons that your Roth IRA may lose money.

Market Fluctuations

Given that the money in retirement accounts, including IRAs, is typically invested, the overall value of the account is subject to the whims of the market. That means that if the market experiences a downturn or correction, your Roth IRA balance is likely to decline as well.

That’s not a certainty, however, as IRAs are generally invested in a range of assets, not all of which may be affected by larger market conditions.

Early Withdrawal Penalties

Your Roth IRA can also lose money if you withdraw funds from it prematurely, and thus, are forced to pay early withdrawal penalties. Roth IRAs are complicated, however, in that your contributions can be withdrawn at any time. But you have to be careful with earnings.

If you withdraw earnings from your Roth IRA before age 59 ½ , you’ll likely be assessed a 10% penalty by the IRS.

Depending on the type of IRA you have, you may also need to pay ordinary income taxes, too.

You may want to consult a tax professional to make sure you understand Roth IRA rules that can trigger penalties.

Investing Late

It’s also possible to “lose money” in the sense that you miss out on market gains over time by investing in your Roth IRA too late. Time is an important factor in investing and saving for retirement, and if you start relatively young, time will work for you as the markets tend to rise over the years.

But if you’re about to hit retirement age and have only been investing in your Roth IRA for, say, a few years, you likely missed out on many years’ of appreciation by investing too late. This is why it’s generally a good idea to start funding an IRA as soon as possible.

Contributing Too Much

It’s possible to contribute too much to your Roth IRA, which may end up costing you. There are limits to how much you can contribute each year. For tax years 2024 and 2025, the annual contribution limit for Roth IRAs is $7,000. These IRAs allow for a catch-up contribution of up to $1,000 per year if you’re 50 or older. If you blow past that maximum, you must withdraw the excess amount or it can trigger a 6% tax penalty from the IRS.

Note that if your modified adjusted gross income (MAGI) reaches a certain amount, you cannot contribute the maximum amount to a Roth IRA. In 2024, those amounts are $146,000 for single filers and $230,000 for those married and filing jointly. In 2025, those amounts are $150,000 for single filers and $236,000 for those married and filing jointly.

Allowable contributions are gradually reduced up until certain MAGI caps, at which point you cannot contribute to a Roth IRA at all. In 2024, those caps are $161,000 for single filers and $240,000 for married filing jointly, and in 2025, $165,000 for single filers and $246,000 for married filing jointly.

Custodial Fees

There are also fees to consider. Someone manages your Roth IRA, and they don’t do it for free. As such, you may incur managerial or custodial fees that can affect your account’s overall balance, in addition to the cost of the investments themselves.

Can You Lose Your Entire Roth IRA?

It’s unlikely that you’d lose your entire Roth IRA’s value. Most fees, penalties, and taxes are levied as a percentage of that value, so they would not be able to fully drain the account. Perhaps the closest you could get to losing all of the money in your Roth IRA is if the market sees an all-out collapse, and most assets see their values reduced to zero.

Again — that’s very unlikely, but not impossible. If it were to happen, too, you’d probably have bigger problems to worry about other than the value of your investments!

With all of this in mind, it’s fair to ask, Are Roth IRAs safe to invest your money in?

The answer is that IRAs in general can provide less risk exposure than, say, day trading, although there are still risks to take into consideration. A Roth IRA that’s 100% invested in equities could be quite risky compared with a Roth invested in other assets (e.g. bonds or bond funds, mutual funds, and so on).

Also, the assets in a Roth IRA are usually long-term investments, which tend to help mitigate the risk of losses over time, as your money may have a chance to recover from any market downturns.

Limiting Risk in IRAs

One thing all of the IRAs above have in common is they offer the individuals who hold them a lot of flexibility in investment choices — including mutual funds, property, stocks, bonds, ETFs, annuities, and more. As a result, IRA investors can have a big say in what their retirement portfolio will look like.

And while it is possible that their portfolio may lose money, there are ways to manage that risk. By contrast, 401(k) retirement plans often offer limited investment options, such as a handful of mutual funds or target date funds.

Diversification

Diversification is chief among an investor’s risk management tools. A diversification strategy means spreading money across multiple asset classes, such as stocks and bonds. A portfolio can be further diversified within each asset class. For example, diverse stock holdings might include stocks from companies of different sizes, sectors, and geographical locations.

Diversification helps minimize the effects market risk can have on an investor’s portfolio. There are two main types: market risk, also called systematic risk, and specific or unsystematic risk.

Systematic risk is caused by factors that have a broad impact on the market as a whole, such as inflation or a global pandemic. Unfortunately, there’s not much an investor can do about this sort of risk, unless you’re an active investor familiar with hedging strategies.

The second type of market risk, unsystematic risk, is limited to individual companies, industries, or geographies. For instance, a workers’ strike at a factory could halt production and drag down an automaker’s stock price.

Diversification helps mitigate unsystematic risk. So, if an individual holds stocks in hundreds of different companies, one poorly performing company may have minimal negative impact on their portfolio’s performance. While diversification cannot prevent the risk of loss entirely, it may help individuals’ portfolios less vulnerable to market volatility.

How Safe Are Roth IRAs Considered to Be?

It depends how you define “safe.” If you’re thinking 100% free from loss, there are no safe investments. That said, Roth IRAs, and many other retirement account types, are generally considered to provide investors with lower risk exposure. They’re generally safer than investing in, say, penny stocks or cryptocurrencies, which are usually referred to as “speculative” investments.

Roth IRAs are usually managed and diversified, and as such, have some degrees of safety built into them to keep investors’ money relatively safe. That said, they aren’t completely risk-free. As mentioned, there are things that can lower a Roth IRA’s overall value — some of which investors can attempt to mitigate.

Time Horizon for Investments

Some investors might want to consider their time horizon in an effort to minimize portfolio losses that can occur at inopportune times. A time horizon is the amount of time an investor anticipates holding an investment until they want the money back.

When an investor is young, they may choose to hold riskier investments, such as stocks in their portfolio. Stocks can offer more opportunity for growth, but — on the flip side — stocks can also suffer big drops in value.

Investors who are many years away from a financial goal, such as retirement, may opt to hold more stocks to take advantage of their growth potential. With many years to go before they need to tap their investments, these investors have time to ride out the market’s swings.


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The Takeaway

It’s possible to lose money in a Roth IRA, or any retirement or investment account — it really depends what types of investments are in the Roth.

The market may take a dip, for example, which can have an effect on your Roth IRA’s overall value. You can also see some of that value eaten up by custodial fees or penalties, if you decide to withdraw money. In a broader sense, if you start investing too late, you can miss out on market gains over many years — likewise costing you money.

It’s unlikely you would see your entire Roth IRA’s value fall to zero. But it’s also important to remember that retirement accounts are not risk-free investment vehicles. And depending on the type of IRA you have (traditional or Roth, SEP or SIMPLE), there will be different considerations you’ll need to make about how, when, and why you’re investing.

Ready to make an IRA part of your retirement plan? Learn more about opening an IRA with SoFi Invest®. SoFi doesn’t charge commissions (you can read the full fee schedule here), and members have access to a complimentary 30-min session with a SoFi Financial Planner.

Help grow your nest egg with a SoFi IRA.

FAQ

What happens to my Roth IRA if the stock market crashes?

It’s likely that you would see the overall value of your Roth IRA diminish in the event of a stock market crash. That doesn’t mean that it would have no value or you’d lose all of your money, but fluctuations in the market do affect the values of the investments in IRAs.

What are the risks of investing in a Roth IRA?

Risks of investing in a Roth IRA involve potentially incurring penalties for early withdrawals, seeing values decline due to market fluctuations, and even the potential of being assessed tax penalties for contributing too much money during a given year, among other things.


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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.


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.

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.

Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

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The Black Scholes Model, Explained

The Black-Scholes Model, Explained

The Black-Scholes option pricing model is a mathematical formula used to calculate the theoretical price of an option. It’s a commonly-used formula for determining the price of contracts, and as such, can be useful for investors in the options market to know and have in their pocket for use.

But there are some important things to know about it, such as the fact that the model only applies to European options, and more.

Key Points

•   The Black-Scholes model is a mathematical formula used to calculate the theoretical price of an option.

•   It is commonly used for pricing options contracts and helps investors determine the value of options they’re considering trading.

•   The model takes into account factors like the option’s strike price, time until expiration, underlying stock price, interest rates, and volatility.

•   The Black-Scholes model was created by Myron Scholes and Fischer Black in 1973 and is also known as the Black-Scholes-Merton model.

•   While the model has some assumptions and limitations, it is considered an important tool for European options traders.

What Is the Black-Scholes Model?

As mentioned, the Black-Scholes model is one of the most commonly used formulas for pricing options contracts. The model, also known as the Black-Scholes formula, allows investors to determine the value of options they’re considering trading.

The formula takes into account several important factors affecting options in an attempt to arrive at a fair market price for the derivative. The Black-Scholes options pricing model only applies to European options.

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💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

The History of the Black-Scholes Model

The Black-Scholes model gets its name from Myron Scholes and Fischer Black, who created the model in 1973. The model is sometimes called the Black-Scholes-Merton model, as Robert Merton also contributed to the model’s development. These three men were professors at the Massachusetts Institute of Technology (MIT) and University of Chicago.

The model functions as a differential equation that requires five inputs:

•   The option’s strike price

•   The amount of time until the option expires

•   The price of its underlying stock

•   Interest rates

•   Volatility

Modern computing power has made it easier to use this formula and made it more popular among those interested in stock options trading.

The model only works for European options, since American options allow contract holders to exercise at any time between the time of purchase and the expiration date. By contrast, European options come at cheaper prices and only allow the owner to exercise the option on the expiration date. So, while European options only offer a single opportunity to earn profits, American options offer multiple opportunities.

Recommended: American vs European Options: What’s the Difference?

What Does the Black-Scholes Model Tell?

The main goal of the Black-Scholes Formula is to determine the chances that an option will expire in the money. To this end, the model goes deeper than simply looking at the fact that a call option will increase when its underlying stock price rises and incorporates the impact of stock volatility.

The model looks at several variables, each of which impact the value of that option. Greater volatility, for example, could increase the odds the options will wind up being in the money before its expiration. The more time the investor has to exercise the option also increases the likelihood of it winding up in the money and lowers the present value of the exercise price. Interest rates also influence the price of the option, as higher rates make the option more expensive by decreasing the present value of the exercise price.

The Black-Scholes Formula

The Black-Scholes formula expresses the value of a call option by taking the current stock prices multiplied by a probability factor (D1) and subtracting the discounted exercise payment times a second probability factor (D2).

Explaining in exact detail what D1 and D2 represent can be difficult because the original research papers by Black and Scholes didn’t explain or interpret D1 and D2, and neither did the papers published by Merton. Entire research papers have been written on the subject of D1 and D2 alone.


💡 Quick Tip: If you’re an experienced investor and bullish about a stock, buying call options (rather than the stock itself) can allow you to take the same position, with less cash outlay. It is possible to lose money trading options, if the price moves against you.

Why Is the Black-Scholes Model Important?

The Black-Scholes option pricing model is so important that it once won the Nobel Prize in economics. Some even claim that this model is among the most important ideas in financial history.

Some traders consider the Black-Scholes Model one of the best methods for figuring out fair prices of European call options. Since its creation, many scholars have elaborated on and improved this formula. In this sense, Black and Scholes made a significant contribution to the academic world when it comes to math and finance.

Some claim that the Black-Scholes model has made a significant contribution to the efficiency of the options and stock markets. While designed for European options, the Black-Scholes Model can still help investors understand how an option’s price might react to its underlying stock price movements and improve their overall options trading strategies.

This allows investors to optimize their portfolios by hedging accordingly, making the overall markets more efficient. However, others assert that the model has increased volatility in the markets, as more investors constantly try to fine tune their trades according to the formula.

How Accurate Is the Black-Scholes Model?

Some studies have shown the Black-Scholes model to be highly predictive of options prices. This doesn’t mean the formula has no flaws, though.

The model tends to undervalue calls that are deeply in the money and overvalue calls that are deeply out of the money.

That means the model might assign an artificially low value to options that are much higher than the price of their underlying stock, while it may overvalue options that are far beneath the stock’s current value. Options that deal with stocks yielding a high dividend also tend to get mispriced by the model.

Assumptions of the Black-Scholes Model

There are also a few assumptions made by the model that can lead to less-than-perfect predictions. Some of these include:

•   The assumption that volatility and the risk- free rate within a stock remain constant

•   The assumption that stock prices are stable and large price swings don’t happen

•   The assumption that a stock doesn’t pay dividends until after an option expires

Recommended: How Do Dividends Work?

Such assumptions are necessary, even if they may negatively impact results. Relying on assumptions like these make the task possible, as only so many variables can reasonably be calculated.

Over the years, math scholars have elaborated on the work of Black and Scholes and made efforts to compensate for some of the gaps created by the original assumptions.

This leads to another flaw of the Black-Scholes model, unlike other inputs in the model, volatility must be an estimate rather than an objective fact. Interest rates and the amount of time left until the option expires are concrete numbers, while volatility has no direct numerical value.

The best a financial analyst can do is calculate an estimation of volatility by using something like the formula for variance. Variance is a measurement of the variability of an asset, or how much prices change from time to time. One common measurement of volatility is the standard deviation, which is equivalent to the square root of variance.


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The Takeaway

The Black-Scholes option-pricing model is among the most influential mathematical formulas in modern financial history, and it may be the most accurate way to determine the value of a European call option. It’s a complicated formula that has some drawbacks that traders must understand, but it’s a useful tool for European options traders.

Given the Black-Scholes model’s complexity, it’s likely that many investors will never use it. That doesn’t mean it isn’t important to know or understand, of course, but many investors may not get much practical use out of it unless they delve deeper into the world of options trading.

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

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


Photo credit: iStock/akinbostanci

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

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.
Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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