Is it good if a stock is volatile?

It can be good if a stock is volatile, as price movements open up opportunities for investors to generate returns — assuming they play their cards right. That said, volatility can also be a bad thing, as values can go down, too.

What is the meaning of volatility in the stock market?

Volatility, as it relates to the stock market, refers to the up-and-down nature of stock values. Stock prices go up and down all the time, but usually within a given range. That’s what volatility generally refers to, and investors should anticipate some level of volatility for each investment they buy.

Financial Topics Archives | Page 197 of 791

Q: What Is Stock Volatility?

Stock volatility refers to how much a stock’s price or value increases and decreases within a specific period of time. Generally, the more volatile a stock is, the more risk an investor incurs when they purchase or hold it.

Q: What is the best stock volatility indicator?

There may not be a 'best' stock market volatility indicator, but perhaps the most common or popular one is the VIX. An internet search will lead you to many more, however, that may be useful as well.

Q: What is good volatility for a stock?

Every stock is going to have some level of volatility, so investors should expect it. But the higher the volatility, the riskier (and potentially worse) it is for investors. As such, a 'good' level of volatility for a given stock is probably around 15% during a given year.

Q: What causes volatility in a stock?

Just about anything and everything can cause stock volatility. Some of the more common causes of volatility, though, are earnings reports, geopolitical news and developments, or broader economic changes, such as recessions — or news of economic changes.

May

2024

What Is Stock Volatility and How Do You Measure It?

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

Key Points

• Stock volatility refers to the variation in a stock’s price from its mean, and it can provide opportunities for investors.

• Standard deviation, beta, VIX, and maximum drawdown are common measures used to gauge stock volatility.

• Standard deviation measures how far a stock’s performance deviates from its average, while beta compares a stock’s volatility to the overall market.

• Factors such as company performance, investor behavior, global events, seasonality, and market cycles can contribute to stock market volatility.

• Balancing risk and reward, diversifying your portfolio, sticking to long-term investing strategies, avoiding timing the market, and considering dollar-cost averaging are effective ways to manage volatility when investing.

What Is Stock Volatility?

Stock volatility is often defined as big swings in price, but technically the volatility of a stock refers to how much its price tends to vary from the mean. The same is true of stock market volatility; when an index tends to perform a certain percentage above or below the mean, it’s a signal of volatility.

Generally, the higher the volatility of a stock, the more risk an investor incurs when they purchase or hold it. But volatility can also provide opportunities for some investors.

How to Measure Stock Volatility

There are a handful of ways to measure stock volatility. Each metric gives investors different information, and a different view of stock market fluctuations.

Standard Deviation

Standard deviation is a common stock volatility measure; it refers to how far a stock’s performance varies from its average. Investors often measure an investment’s volatility by the standard deviation of returns compared with a broader market index or past returns. Standard deviation measures the extent to which a data point deviates from an expected value, i.e. the mean return.

Beta

Beta is another way to measure volatility; it captures systematic risk, which refers to the volatility of a security (or of a portfolio) versus the market as a whole.

For example, beta can measure the volatility of a stock versus its benchmark (e.g. the S&P 500 or another relevant index). If a stock or mutual fund has a beta of 1.0, its inherent volatility is no different than the market at large. If the beta of a stock is higher or lower than its benchmark, that indicates higher or lower volatility.

Recommended: How to Find Portfolio Beta

VIX

The Cboe Global Markets Volatility Index, known as the VIX for short, is a tool used to measure implied volatility in the market. In simple terms, the VIX index tells investors how professional investors feel about the market at any given time.

The VIX Index is a real-time calculation that measures expected volatility in the stock market. One of the most recognized barometers of fluctuations in financial markets, the VIX measures how much volatility investing experts expect to see in the market over the next 30 days. This measurement reflects real-time quotes of S&P 500 Index (SPX) call option and put option prices.

Maximum Drawdown

Maximum drawdown, or MDD, is another stock volatility measure, and can give investors a sense of how much downside risk exists for a given stock (though not the risks of the stock market overall). It basically measures the maximum fall in value that a stock has seen in the past, and is reflected in the difference between that maximum trough, and the highest peak in value before its value fell.

You may recognize the terms peak and trough when discussing the business cycle and bull markets, too. MDD is a peak-to-trough calculation, in other words. It’s a simpler calculation than standard deviation, too:

MDD= Trough Value−Peak Value / Peak Value

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Using Standard Deviation to Calculate Volatility

You can use the standard deviation and variance of returns to create a basic measure of stock volatility. This measure captures variance in price changes over a certain period of time, so you can gauge how far from the mean the stock price tends to go (i.e. how volatile it is).

Formula: σ √T = volatility, where:

σ = standard deviation of returns

T = number of time periods

1. To arrive at the variance, imagine a stock that starts in January with a monthly closing price of $10, and adds $1 per month. Month 1 = $10. Month 2 = $11. Month 3 = $12 … and so on, for all 12 months (or whatever time period you choose).

2. Add the stock price for each month, to arrive at a total of $186.

3. Divide $186 by the number of time periods (12 months in this case) to get an average stock price of $15.50 for the year.

4. Subtract the mean ($15.50) from each monthly value; include results that are negative numbers.

5. Square all the deviations (which will also remove negative numbers), and add them together to get the sum ($50.50); divide the sum by the number of time periods (in this case 12) to get a variance of $4.21.

6. Take the square root of $4.21 to get $2.05 = which is the standard deviation for this particular stock. Knowing this provides an important point of comparison for investors, because it indicates whether a stock’s price fluctuations could be within ‘normal’ ranges or too volatile.

Recommended: What Is a Stock?

Types of Stock Volatility

types of stock volatility

There are two common types of stock volatility that investors use to measure the riskiness of an investment: implied volatility and historical volatility. These two types of volatility are often used by options traders, who make trades based on the potential volatility of the options contract’s underlying asset.

Historical Volatility

Historical volatility (HV), also known as statistical volatility, is a measurement of the price dispersion of a financial security or index over a period of time. Investors calculate this by determining the average deviation from an average price. Historical volatility typically looks at daily returns, but some investors use it to look at intraday price changes.

As the name implies, historical volatility used past performance to assess present volatility. When a stock sees large daily price swings compared to its history, it will typically have a historical volatility reading. Historical volatility does not measure direction; it simply indicates the deviation from an average.

Implied Volatility

Implied volatility (IV) is a metric that captures the market’s expectation of future movements in the price of a security. Implied volatility employs a set of predictive factors to forecast the future changes of a security’s price.

Implied volatility doesn’t anticipate which way prices might move, up or down, only how likely the volatility will be.

What Causes Market Volatility?

what causes stock market volatility

The stock market is known for having boom-and-bust cycles, which is another way of describing stock market volatility. And there are numerous factors that can influence market volatility. Here are just a few:

• Company Performance: Regarding individual stocks, events tied to the company’s performance can drive volatility in its shares. This can include countless factors including: earnings reports, a product announcement, a merger, a change in management, and much more.

• Investor Behavior: Long periods of rising share prices tend to drive investors to take on more risk. They enter into more speculative positions and buy assets like high-risk stocks.

In doing so, investors may disregard their own risk tolerance, and make themselves more vulnerable to market shocks. This pattern can lead to market busts when investors need to sell their holdings en masse when the market is shaky.

• Global Events: For instance, the early stages of the COVID pandemic in February and March 2020 created shockwaves in the markets. As economies across the globe shut down, investors began to sell off risky assets, bringing about high levels of volatility in the financial markets.

Governments enacted extraordinary fiscal and monetary stimulus programs to calm this volatility and bring stability to the markets.

But even as these efforts took effect, other global factors — the war in Ukraine impacting energy prices — also took a toll. And federal reserve interest rate increases during 2022 — instituted at the fastest rate in history in an effort to tamper inflation — likewise roiled the markets, causing stock volatility.

• Seasonality: You’ve heard the old saying, “Sell in May and go away.” That’s a reflection of a phenomenon called market seasonality, which means that year in and year out there are certain patterns that tend to occur around the same times.

While seasonality certainly doesn’t guarantee any investment outcomes, some sectors do see more demand and greater production during specific times of year. Summer months tend to impact the travel sector; the fall might see an uptick in school-related consumer goods, and so on.

Depending on the year, this rise and fall of demand can impact volatility for some stocks.

• Market Cycles: In a similar way, markets also have their cycles; these cycles emerge thanks to trends generated by what’s going on in different business sectors. For example, the rapid evolution of AI in 2023 and early 2024 may have sparked a bit of a market cycle in the tech sector, as the demand for certain products and technologies jumped.

That said, it’s difficult to spot a market cycle until it’s over. Sometimes what appears to be a cycle is simply a normal set of fluctuations. But the anticipation or perception of a cycle can drive volatility.

• Liquidity: Other factors that can drive volatility include liquidity and the derivatives market. Stock liquidity is the ease with which an asset can be bought and sold without affecting prices. If an asset is tough to unload and gets sold at a significantly lower price, that could inject fear into the market and cause other investors to sell, ramping up volatility.

Separately, there’s sometimes a debate as to whether equity derivatives — contracts that are based on an underlying asset (e.g. futures and options) — can cause volatility. For instance, in 2020, investors debated whether large volumes of stock options trading caused sellers of the options, typically banks, to hedge themselves by buying stocks, exposing the market to sudden ups and downs when the banks had to purchase or sell shares quickly.

What Causes Stock Prices to Go Up?

As noted, any number of things can cause a stock’s price to go up — be it good or bad news. For instance, geopolitical events can cause certain stocks to appreciate in price, while others may fall. When there’s political instability, some investors seek safer investments and may pile into consumer staple stocks, or investments that track the price of precious metals.

When the economy is faring well, earnings season can be another time during which stock prices go up as companies report positive news to investors, who may, in turn, feel better about the economy overall, which can affect their investing decisions.

What Causes Stock Prices to Go Down?

Just as nearly anything and everything can drive stock prices up, there are countless factors that can likewise drive values down. That can include bad earnings reports from companies, or earnings data that doesn’t live up to expectations. Political or regulatory changes can also spook investors, who may sell certain stocks and drive prices down.

Again: Stock prices can go down for any and every reason, or no reason at all. This is as good a time as any to remind you that there really is no such thing as a completely safe investment.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

How to Manage Volatility When Investing

Let’s imagine that it’s 2007, and an individual has money invested in the U.S. stock market. Unfortunately, this investor is about to face one of the largest stock market crashes in history: The S&P 500 fell by 48% during the crash of 2008-2009.

This sort of dramatic drop in the stock market isn’t typical, and it can be traumatic even for the savviest and most experienced investor. So, the first step to handling stock market volatility is understanding that there will always be some price fluctuation.

The second step is to know one’s risk tolerance and financial goals, then invest, readjust, and rebalance your portfolio accordingly.

Balance Risk and Reward

Generally speaking, higher rewards sometimes come with higher risks. For example, younger investors in their 20s might want to target higher growth options and be open to more volatile stocks. They may have enough time to weather the gains and losses and, possibly, come out ahead over time.

The reverse is true for someone approaching retirement who wants stable portfolio returns. With a shorter time horizon there’s less time to recover from volatility, so investing in lower-risk securities may make more sense.
Some strategies offer ways that more cautious investors might take to mitigate volatility in their portfolios. One way is diversification.

Portfolio diversification involves investing your money across a range of different asset classes — such as stocks, bonds, and real estate — rather than concentrating all of it in one area. Studies have shown that by diversifying the assets in your portfolio, you may offset a certain amount of investment risk and thereby improve returns.

For example: Lower volatility stocks, such as utility or consumer staple companies, can add stability to a stock portfolio. Meanwhile, energy, technology, and consumer discretionary shares tend to be more turbulent because their businesses are more cyclical, or tied to the broader economy.

Another way to diversify one’s portfolio is to add bonds, alternative investments, or even cash. When deciding to add bonds or stocks to a portfolio, it’s helpful to know that the former is generally a less volatile asset class.

This is useful to know if you’re managing your own portfolio, or if you want to try automated investing, where a sophisticated algorithm provides different asset allocation options in pre-set portfolios.

There are a few other things to take into consideration when managing volatility in your portfolio.

Assess Risk Tolerance

A big part of effectively managing stock volatility as it relates to your portfolio is knowing your limits, or, as discussed, your risk tolerance. How much risk can you actually handle when it comes down to it?

Every investor will need to give that question some thought when deciding how to deploy their money.

While bigger risks often come with bigger rewards, when the market does experience a downturn, there’s the outstanding question of whether you’ll stick to your investing strategy or cut and run. Each investor’s risk tolerance will be different, but it’s important to think about how you can actually handle the risk you take on when investing.

Stick to Long-Term Investing Strategies

One way to manage market volatility is to stick to a long-term investing strategy, such as a buy-and-hold strategy. If you stick to long-term investments rather than derivatives or other short-term assets or tools, you can somewhat ignore the day-to-day ups and downs of stock prices, and in doing so you may be able to better weather market volatility.

Avoid Timing the Market

Timing the market, as it relates to trading and investing, means waiting for ideal market conditions, and then making a move to try and capitalize on the best market outcome. But nobody can predict the future, and this is a high-risk strategy.

When seeing stock market charts and business news headlines, it can be tempting to imagine you can strike it rich by timing your investments perfectly. In reality, figuring out when to buy or sell securities is extremely difficult. Both professional and at-home investors make serious mistakes when trying to time the market.

Consider Dollar-Cost Averaging

Dollar cost averaging is essentially a way to manage volatility as you continue to save and build wealth. It’s a basic investment strategy where you buy a fixed dollar amount of an investment on a regular cadence (e.g. weekly or monthly). The goal is not to invest when prices are high or low, but rather to keep your investment steady, and thereby avoid the temptation to time the market.

That’s because with dollar cost averaging (DCA) you invest the same dollar amount each time. When prices are lower, you buy more; when prices are higher, you buy less. Otherwise, you might be tempted to follow your emotions and buy less when prices drop, and more when prices are increasing (a common tendency among investors).

How Much Stock Volatility Is Normal?

The average stock market return in the U.S. is roughly 10% annualized over time, or about 6% or 7% taking inflation into account.

When looking at nearly 100 years of data, as of the end of July 26 2023, the yearly average stock market return was between 8% and 12% only eight times. In reality, stock market returns are typically much higher or much lower.

It’s also important to remember that past market performance is not indicative of future returns. But looking at history can help an investor gauge how much volatility and market fluctuation might be considered normal. Since the end of World War II, the S&P 500 has posted 14 drops of more than 20%, including the most recent in 2022 — a dip precipitated by the rapid rise in interest rates.

These prolonged downturns of 20% or more are considered bear markets. While bear markets have a bad name, they don’t always lead to recession, and on average bear markets are shorter than bull markets.

Investing in Stocks With SoFi

Stock volatility is the pace at which the price of a company’s shares move up or down during a certain period of time. Volatility is a complex topic, and it often sparks debate among investors, traders, and academics about what causes it.

While equities are considered an important part of any investment portfolio, they are also known for being volatile, and some degree of turbulence is something most stock investors have to live with.

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

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

FAQ

Is volatility the same as risk?

In a sense, yes. Volatility is an indicator of risk. So a stock that is highly volatile, with big price changes, is considered riskier than a stock that is less volatile and maintains a more stable price.

Who should buy stocks when volatility strikes?

Certain types of investors, e.g. day traders and options traders, may have strategies that enable them to profit from volatile securities (although there are no guarantees). In some cases, ordinary investors with a very high risk tolerance may want to invest in a volatile stock — but they have to be willing to face the possibility of steep losses.

What is the best stock volatility indicator?

Perhaps the most common or popular one is the VIX. Depending on which way the VIX is trending, it may throw off buy or sell signals to investors. The VIX can be helpful for assessing risk in order to capitalize on anticipated market movements.

What is good volatility for a stock?

Deciding whether the volatility of a certain stock is “good” is a matter of your personal investing style and goals. Some investors may seek out volatile equities if they believe they have a strategy that can capitalize on price fluctuations. Other investors with a long-term view may not mind volatility if they believe the outcome over time will be favorable — while others may opt for as little volatility in their portfolios as possible.

What causes volatility in a stock?

Just about anything can cause stock volatility. Some of the more common causes of volatility are earnings reports or other company news; geopolitical news and developments; or broader economic changes, such as interest rate hikes or inflation.

Photo credit: iStock/FluxFactory

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.

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

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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May

2024

Mutual Funds vs Index Funds: Key Differences

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

Mutual funds and index funds are similar in many ways, but there are some key differences that investors need to understand to effectively implement them into an investment strategy. Those differences might include investing style, associated fees and taxes, and how they work.

The choice between an index fund and an actively managed mutual fund can be a hard one, especially for investors who are unsure of the distinction. The differences between index funds and other mutual funds are actually few — but may be important, depending on the investor.

Key Points

• Index funds aim to mirror the performance of a specific market index, using a passive investment strategy.

• Mutual funds are actively managed by fund managers who select securities to potentially outperform the market.

• The costs associated with mutual funds are generally higher due to active management fees.

• Index funds typically have lower expense ratios, making them a cost-effective option for investors.

• The choice between index and mutual funds depends on individual investment goals and preferences for active versus passive management.

What’s the Difference between Index Funds and Mutual Funds?

Index funds and mutual funds are similar in many ways, but they do differ in some others, such as how they work, associated costs, and investment style.

How They Work

Index funds are a type of mutual fund, interestingly enough. Index funds are distinguished by their investing approach: Index funds invest in an index, and only change the securities they hold when the index changes, or to realign their holdings to better match the index they invest in.

Rather than rely on a portfolio manager’s instincts and experience, an index fund tracks a particular index. There are benchmark indexes across all of the different asset classes, including stocks, bonds, currencies, and commodities. As an example, the S&P 500® Index tracks the stocks of 500 of the leading companies in the United States.

An index fund aims to mirror the performance of a given benchmark index by investing in the same companies with similar weights. With these funds, it’s not about beating the market, it’s about tracking it, and as such, index funds typically follow a passive investment strategy, known as a buy-and-hold strategy.

A mutual fund is an investment that holds a collection — or portfolio — of securities, such as stocks and bonds. The “mutual” part of the name has to do with the structure of the fund, in that all of its investors mutually combine their funds in this one shared portfolio.

Mutual funds are also called ’40 Act funds, as they were created in 1940 by an act of Congress that was designed to correct some of the investment abuses that led to the Stock Market Crash of 1929. It created a regulatory framework for offering and maintaining mutual funds, including requirements for filings, service charges, financial disclosures, and the fiduciary duties of investment companies.

To get people to invest, the portfolio managers of a given mutual fund offer a unique investment perspective or strategy. That could mean investing in tech stocks, or only investing in the fund manager’s five best ideas, or investing in a few thousand stocks at once, or only in gold-mining stocks, and so on.

Fees and Taxes

There may be different associated costs with index funds and mutual funds as well.

Mutual-fund managers generally charge investors a management fee, which comes from the assets of the fund. Those fees vary widely, but an active manager will generally charge more, as they have to pay the salaries of analysts, researchers, and the stock pickers themselves. Passive managers of index funds, on the other hand, simply have to pay to license the use of an index.

An actively-managed mutual fund may charge an expense ratio (which includes the management fee) of 0.5% to 0.75%, and sometimes as high as 1.5%. But for index funds, that expense ratio is typically much lower — often around 0.2%, and as low as 0.02% for some funds.

Investing Style

The two also differ on a basic level in that index funds are a passive investing vehicle and mutual funds are typically actively managed. That means that investors who want to take a hands-off approach may find index funds a more suitable choice, whereas investors who want a guiding hand in their portfolio may be more attracted to mutual funds.

Mutual Funds vs. Index Funds: Key Differences
Mutual Funds	Index Funds
Overseen by a fund manager	Track a market index
May have higher associated costs	Typically has lower associated costs
Active investing	Passive investing

Index vs Mutual Fund: Which is Best for You?

There’s no telling whether an index or mutual fund is better for you — it’ll depend on specific factors relevant to your specific situation and goals.

When deciding how to invest, everyone has their own unique approach. If an investor believes in the expertise and human touch of a fund manager or team of professionals, then an actively managed fund like a mutual fund may be the right fit. While no one beats the market every year, some funds can potentially outperform the broader market for long stretches.

But for those individuals who want to invest in the markets and not think about it, then the broad exposure — and lower fees — offered by index funds may make more sense. Investing in index funds tends to work best when you hold your money in the funds for a longer period of time, or use a dollar-cost-average strategy, where you invest consistently over time to take advantage of both high and low points.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

The Takeaway

Index funds and mutual funds are similar investment vehicles, but there are some key differences which include how they’re managed, costs associated with them, and how they function at a granular level.

The choice between index funds and other mutual funds is one with decades of debate behind it. For individuals who prefer the expertise of a hands-on professional or team buying and selling assets within the fund, a mutual fund may be preferred. For investors who’d rather their fund passively track an index — without worrying about “beating the market” — an index fund might be the way to go.

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

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

FAQ

Do index funds outperform mutual funds?

Actively-managed funds, such as mutual funds, tend to underperform the market as a whole over time. That’s to say that most of the time, a broad index fund may be more likely to outperform a mutual fund.

Do people prefer index funds over mutual funds, or mutual funds over index funds?

The types of funds that investors prefer to invest in depends completely on their own financial situation and investment goals. But some investors may prefer index funds over mutual funds due to their hands-off, passive approach and lower associated costs.

Are mutual funds riskier than index funds?

Mutual funds may be riskier than index funds, but it depends on the specific funds being compared — mutual funds do tend to be more expensive than index funds, and tend to underperform the market at large, too.

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.
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.

Mutual Funds (MFs): 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 clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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

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

Probability of Member receiving $1,000 is a probability of 0.028%.

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May

18

2024

Taxes, Fees, Commissions, and Your Investments

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off on Taxes, Fees, Commissions, and Your Investments

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

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

Key Points

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

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

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

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

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

Investment Expenses 101

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

Fund Fees

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

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

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

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

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

Advisor Fees

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

Broker Fees and Commissions

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

How to Minimize the Cost of Investing

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

Index Funds

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

Automated Investing Platforms

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

Discount Brokerage

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

How Taxes Eat into Investing Profits

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

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

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

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

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

Strategies to Minimize Taxes

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

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

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

The Takeaway

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

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

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

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May

18

2024

Can You Contribute to Both a 401(k) and an IRA?

By Rebecca Lake | Budgeting & Goals, Growing Wealth, invest | Comments Off on Can You Contribute to Both a 401(k) and an IRA?

Table of Contents

Introduction to Retirement Savings Accounts

Can I Contribute to a 401(k) and an IRA?

2023 and 2024 Contribution Limits for 401(k) and IRA Plans

The Intricacies of IRA Contributions

How Contributing to Both a 401(k) and an IRA Affects Your Taxes

Choosing Between a 401(k) and an IRA

The Combined Power of a 401(k) and IRA

Step-by-Step Guide to Contributing to Both 401(k) and IRA

FAQ

“Can I contribute to a 401(k) and IRA?” It’s a question many individuals ask themselves as they start planning for their future. The short answer is yes, it’s possible to have a 401(k) or other employer-sponsored plan at work and also make contributions to an individual retirement plan, either a traditional or a Roth IRA.

If you have the money to do so, contributing to both a 401(k) and an IRA could help you fast track your retirement goals while enjoying some tax savings. But your income and filing status may affect the amounts you are allowed to contribute, in addition to the tax benefits you might see from a dual contribution strategy.

Read on to learn more about the guidelines and restrictions for having these two types of accounts and to answer the question “Can I contribute to a 401(k) and IRA?”

Key Points

•   It is possible to contribute to both a 401(k) and an IRA for retirement savings.

•   401(k) plans are employer-sponsored and allow both employee and employer contributions.

•   IRAs are individual retirement accounts that anyone can set up for themselves.

•   Contribution limits and tax benefits vary for 401(k)s and IRAs based on income and filing status.

•   Having both types of accounts can provide flexibility and help optimize taxes and distribution strategies.

Introduction to Retirement Savings Accounts

Although both IRAs and 401(k)s are retirement savings accounts, there are some important differences to know. The main one is that a 401(k) is an employer-sponsored retirement plan that allows both the employee and employer to contribute to the account.

IRAs are Individual Retirement Accounts that anyone can set up for themselves. There are two main types of IRAs: traditional and Roth.

Here’s a closer look at key differences between 401(k) plans and IRAs.

Understanding the Basics of 401(k)s and IRAs

A 401(k) is an employer-sponsored retirement plan. Employees sign up for a 401(k) through work and their contributions are automatically deducted directly from their paychecks. The money contributed to a 401(k) is tax deferred, which means you are not taxed on it until you withdraw it in retirement. Some employers match employees’ contributions to a 401(k) up to a certain amount.

An IRA is a tax-advantaged savings account that you can use to put away money for retirement. Money in an IRA can potentially grow through investment. While there are different types of IRAs, two of the most common types are traditional IRAs and Roth IRAs. The main difference between the two is the way they are taxed.

With a Roth IRA, you make after-tax contributions, and those contributions are not tax deductible. However, the money can potentially grow tax-free, and typically, you won’t owe taxes on it when you withdraw it in retirement (or at age 59 ½ and older). Individuals need to fall within certain income limits to open a Roth IRA (more about that later).

With a traditional IRA, your contributions are made with pre-tax dollars. Your contributions may lower your taxable income in the year you contribute. The money in a traditional IRA is tax-deferred, and you pay income taxes on it when you withdraw it. Traditional IRAs tend to have fewer eligibility requirements than Roth IRAs.

The Importance of Investing in Your Future

Retirement might seem like a long way off, but it’s vital to keep in mind that saving for it now can help you to meet your lifestyle needs and goals in your post-working years.

As you start planning your retirement savings, it’s a good idea to determine the estimated age you can retire, as the timing can influence other choices — like how much you choose to save, and what investments you might pick.

There are plenty of resources available online, including SoFi’s retirement calculator to help you determine potential retirement timelines and scenarios.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

Can I Contribute to a 401(k) and an IRA?

This is a good question to ask if you’re just getting started on your retirement planning journey. For example, if you’re already contributing to a plan at work, you may be wondering if you can also save money in an IRA.

Or maybe you opened an IRA in college but now you’re starting your career and have access to a 401(k) for the first time. You may be unsure whether it makes sense to keep making contributions to an IRA if you’ll soon be enrolled in your employer’s retirement plan.

Having a basic understanding of how 401(k)s and IRAs work can help you make the most of these accounts when mapping out your retirement strategy.

Get a 1% IRA match on rollovers and contributions.

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.¹

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

Rules and Regulations for Multiple Retirement Accounts

There is no limit to the number of retirement accounts you can have. However, there are IRS rules about how much you can contribute to these accounts. And if you have multiples of the same type of retirement account, like two IRAs, you need to stay within the overall limit for both accounts combined. In other words, there is one single annual contribution limit for multiple IRAs.

In many cases, it may be beneficial to have more than one retirement account type. Brian Walsh, CFP® at SoFi says multiple accounts allow you have “added flexibility to optimize your taxes and your overall distribution strategy in 30, 40, or 50 years.”

Key Takeaways for Dual Contributions

When contributing to a 401(k) and an IRA you’ll want to remember these important points:

•   You can contribute up to the limit on your workplace 401(k) and up to the limit on your IRA annually.

•   If you have multiples of the same type of retirement account, such as two IRAs, you cannot exceed the single annual contribution limit across the accounts.

•   If you have a 401(k) at work, the tax deduction on your contributions for a traditional IRA may be limited, or you may not be eligible for a deduction at all.

2023 and 2024 Contribution Limits for 401(k) and IRA Plans

The IRS sets annual contribution limits for 401(k) and IRA plans and those limits change each year. These are the contribution limits for 2023 and 2024.

401(k) Contribution Limits and Considerations

As noted, a 401(k) plan may be funded by employer and employee contributions. Here are the annual 401(k) contribution limits for 2023:

•   $22,500 for employee contributions

•   $7,500 in catch-up contributions for employees age 50 or older

•   $66,000 limit for total employer and employee contributions ($73,500 including catch-up contributions for those 50 and older)

These are the annual 401(k) contribution limits for 2024:

•   $23,000 for employee contributions

•   $7,500 in catch-up contributions for employees age 50 or older

•   $69,000 limit for total employer and employee contributions ($76,500 including catch-up contributions for those 50 and older)

IRA Contribution Limits and Income Thresholds

IRAs are funded solely by individual contributions. Here are the annual contribution limits for traditional and Roth IRAs for 2023:

•   $6,500 for regular contributions

•   $1,000 catch-up contributions for those age 50 and older

And here are the annual contribution limits for traditional and Roth IRAs for 2024:

•   $7,000 for regular contributions

•   $1,000 catch-up contributions for those age 50 and older

These limits apply to total IRA contributions, as mentioned earlier. So if you have more than one IRA, the most you could add to those accounts combined in 2023 is $6,500 — or $7,500 if you’re 50 or older. And the most you could contribute to these IRA accounts combined in 2024 is $7,000 or $8,000 if you’re 50 or over.

The Intricacies of IRA Contributions

There are some rules about IRA contributions that it’s vital to be aware of. For instance, you can’t save more than you earn in taxable income in your IRA. That means if you earn $4,000 for a year, you can only contribute $4,000 in your IRA.

Plus, as discussed above, the most you can contribute, whether you have one IRA or multiple IRAs, is the annual contribution limit.

And finally, the type of IRA you have affects the portion of your contributions (if any) you can deduct from your taxes.

Traditional vs Roth IRA: What You Need to Know

The main difference between a traditional IRA and a Roth IRA is how and when you are taxed. There are also some eligibility requirements and deduction limits.

IRA Deduction Limits and Eligibility Requirements

Traditional IRAs offer the benefit of tax-deductible contributions. The money you deposit is pre-tax (meaning, you don’t pay taxes on those funds), and contributions grow tax-deferred. You pay tax when making qualified withdrawals in retirement.

However, if either you or your spouse is covered by a retirement plan at work and your income is higher than a certain level, the tax deduction of your annual contributions to a traditional IRA may be limited.

Specifically, if either you or your spouse has a workplace retirement plan, a full deduction of the amount you contribute to an IRA in 2023 is allowed if:

•   You file single or head of household and your modified adjusted gross income (MAGI) is $73,000 or less

•   You’re married and file jointly, or a qualifying widow(er), with an MAGI of $116,000 or less

For 2024, you can take a full deduction of your yearly contributions to a traditional IRA if:

•   You file single or head of household and your modified adjusted gross income (MAGI) is $77,000 or less

•   You’re married and file jointly, or a qualifying widow(er), with an MAGI of $123,000 or less

A partial deduction is allowed for incomes over these limits, though it does eventually phase out entirely.

Roth IRAs allow you to make contributions using after-tax dollars. This means you don’t get the benefit of deducting the amount you contribute from your current year’s taxes. The upside of Roth accounts, though, is that you can typically make qualified withdrawals in retirement tax-free.

But there’s a catch: Your ability to contribute to a Roth IRA is based on your income. So how much you earn could be a deciding factor in answering the question, can you have a Roth IRA and 401(k) at the same time.

You can make a full contribution to a Roth IRA if:

•   In 2023, you file single or head of household, or you’re legally separated, and have a modified adjusted gross income of less than $138,000. For 2024, your MAGI must be less than $146,000 to make the full contribution.

•   In 2023, you’re married and file jointly, or are a qualifying widow(er), and your MAGI is less than $218,000. For 2024, you need a MAGI less than $230,000 to be able to make a full contribution.

The amount you can contribute to a Roth IRA is reduced as your income increases until it phases out altogether.

💡 Quick Tip: The advantage of opening a Roth IRA and a tax-deferred account like a 401(k) or traditional IRA is that by the time you retire, you’ll have tax-free income from your Roth, and taxable income from the tax-deferred account. This can help with tax planning.

How Contributing to Both a 401(k) and an IRA Affects Your Taxes

Both 401(k) plans and IRAs can offer tax benefits. Here are the key tax benefits to know when contributing to these plans:

•   401(k) contributions are tax-deductible

•   Traditional IRA contributions can be tax-deductible for eligible savers

•   Roth IRA contributions are not tax deductible, but Roth plans allow you to make tax-free withdrawals in retirement

Understanding the Tax Implications

You might choose to contribute to a Roth IRA and a 401(k) if you anticipate being in a higher tax bracket when you retire. By paying taxes now, rather than when you’re in the higher tax bracket later, you could limit your tax liability.

However, if you expect to be in a lower tax bracket when you retire, you may want to opt for a traditional IRA so that you pay the taxes later.

Strategies for Minimizing Taxes on Withdrawals

Both 401(k) plans and IRAs are designed to be used for retirement, which is why the taxes you pay are deferred (and why these accounts are typically called tax-deferred accounts). As such, early withdrawals from 401(k) plans are discouraged and you may trigger taxes and a penalty when taking money from these plans prior to age 59 ½.

Here are the most important things to know about withdrawing money from 401(k) plans or traditional and Roth IRAs:

•   Withdrawals from 401(k) and traditional IRA accounts are subject to ordinary income tax at the time you withdraw them. If you withdraw funds before age 59 ½, you would owe taxes and a 10% penalty — although some exceptions apply (e.g. an emergency or hardship withdrawal).

•   Roth IRA contributions and earnings are treated somewhat differently. Withdrawals of original contributions (not earnings) to a Roth IRA can be made tax- and penalty-free at any time.

•   If you withdraw earnings from a Roth account prior to age 59 ½, and if you haven’t owned the account for at least five years, the money could be subject to taxes and a 10% penalty. This is called the five-year rule. Special exceptions may apply for a first-time home purchase, college expenses, and other situations.

In addition to taxes, a 10% early withdrawal penalty can apply to withdrawals made from 401(k) plans or IRAs before age 59 ½ unless an exception applies. But the IRS does allow for several exceptions. In terms of what constitutes an exception, the IRS waives the penalty in certain scenarios, including total and permanent disability of the plan participant or owner, payment for qualified higher education expenses, and withdrawals of up to $10,000 toward the purchase of a first home.

You might also avoid the penalty with 401(k) plans if you meet the rule of 55. This rule allows you to withdraw money from a 401(k) penalty-free if you leave your job in the year you turn 55, although you would still owe ordinary income taxes on that money. This scenario also has some restrictions, so you may want to discuss it with your plan administrator or a financial advisor.

Finally, once you reach a certain age, you are required to withdraw minimum amounts from 401(k) plans and traditional IRAs or else you could be charged a significant tax penalty. These are known as required minimum distributions or RMDs.

The IRS generally requires you to begin taking RMDs from these plans at age 73 (as long as you reached age 72 after December 31, 2022). The amount you’re required to withdraw is based on your account balance and life expectancy, and many retirement plan providers offer help calculating the exact amount of your required distributions.

This is critical, because if you don’t take RMDs on time you may trigger a 50% tax penalty on the amount you were required to withdraw.

RMDs are not required for Roth IRAs.

Choosing Between a 401(k) and an IRA

If you are deciding between a 401(k) and an IRA, there are a number of factors you’ll want to weigh carefully before making a decision.

Factors to Consider When Making Your Choice

Overall, IRAs tend to offer more investment options, and 401(k)s allow higher annual contributions. If your employer matches 401(k) contributions up to a certain amount, that’s another important consideration. Additionally, you’ll want to think about the tax advantages and implications of each type of account.

Comparing Benefits and Drawbacks of Each Plan

Both 401(k)s and IRAs have advantages and disadvantages. It’s important to consider all variables in determining which account is best for your situation.

401(k)
IRA

Pros
•   Larger contribution limits than IRAs.

•   Employers may match employee contributions up to a certain amount.

•   Wide array of investment options.

•   A traditional IRA may allow tax deductions for contributions for those who meet the modified adjusted income requirements.

Cons
•   Limited investment options.

•   Potentially high fees.

•   Contribution amount is much smaller than it is for a 401(k).

•   Roth IRAs have income requirements for eligibility.

Neither plan is necessarily better than the other. They each offer different features and possible benefits. If your employer doesn’t offer a 401(k) plan, you may want to set up a traditional or Roth IRA depending on your personal financial situation. And if you’re already contributing to a 401(k), you may still want to think about opening an IRA.

The Combined Power of a 401(k) and IRA

Instead of investing in only an IRA or your company’s retirement plan, consider how you can blend the two into a powerful investment strategy. One reason this makes sense is that you can invest more for your retirement, with the additional savings and potential growth providing even more resources to fund your retirement dreams.

How to Strategically Invest in Both Accounts

Since employers often match 401(k) contributions up to a certain percentage (for instance, your company might match the first 3% of your contributions), this boosts your overall savings. The employer match is essentially free money that you could get simply by making the minimum contribution to your plan.

Now imagine adding an IRA to the picture. Remember, with an IRA you have flexibility when investing. With a 401(k), you have limited options when it comes to investment funds. With an IRA, you’re able to decide what you’d like to invest in, whether it be stocks, bonds, mutual funds, exchanged-traded funds (ETFs), or other options.

To strategically invest in both accounts, consider contributing to 401(k) and IRA plans up to the annual limits, if you can realistically afford to. Make sure this is feasible given your budget, spending, and other financial goals you may have such as paying down debt or saving for your child’s education. And do some research into how this approach may affect your retirement tax deductions.

Not everyone is able to max out both retirement fund options, but even if you can’t, you can still create a powerful one-two punch by making strategic choices. First, think about your company-matching benefit for your 401(k). This is a key benefit and it makes sense to take as much advantage as you can.

Let’s say that your company will match a certain percentage of the first 6% of your gross earnings. Calculate what 6% is and consider contributing that much to your 401(k) and opening an IRA with other money you can invest this year.

And, if you end up having even more money to invest? Consider going back to your 401(k). There still may be value in contributing to your 401(k) beyond the amount that can be matched — for the simple reason that company-sponsored plans allow you to save more than an IRA does.

Now, let’s say you have a 401(k) plan but your employer doesn’t offer a matching benefit. Then, consider contributing to an IRA first. You may benefit from having a wider array of investment choices. Once you’ve maxed out what you can contribute to your IRA, then contribute to your 401(k).

These are all just options and examples, of course. What you ultimately decide to do depends on your financial and personal situation.

Long-term Growth Potential

By investing in both a 401(k) and IRA, you are taking advantage of employer-matched contributions and diversifying your retirement portfolio which can help manage risk and may potentially improve the overall performance of your investments in aggregate.

In addition, while a 401(k) offered by your employer may have limited investment options to choose from, with an IRA, you have more access to different investment options. That could, potentially, help grow your money for retirement, depending on what you invest in and the rate of return of those investments.

Plus, by contributing to both kinds of retirement accounts, you are likely putting more money overall into saving for retirement.

Step-by-Step Guide to Contributing to Both 401(k) and IRA

If you’ve decided to open and contribute to both a 401(k) and an IRA, here’s how to get started.

Eligibility Verification and Contribution Processes

To determine if you’re eligible to contribute to a 401(k), find out if your employer offers such a plan. Your HR or benefits department should be able to help you with this.

If a 401(k) is available, fill out the paperwork to enroll in the plan. Decide how much you want to contribute. This will typically either be a set dollar amount or a percentage of your paycheck that will usually be automatically deducted. Next, select the type of investment options you’d like from those that are available. You could diversify your investments across a range of asset classes, such as index funds, stocks, and bonds, to help reduce your risk exposure.

Individuals with earned income can open an IRA — even if they also have a 401(k). First, decide what type of IRA you’d like to open. A traditional IRA generally has fewer eligibility requirements. A Roth IRA has income limits on contributions. So, in this case, you’ll need to find out if you are income-eligible for a Roth.

You can typically open an IRA through a bank, an online lender, or a brokerage. Once you’ve decided where to open the account and the type of IRA you’d like, you can begin the process of opening the account. You’ll need to supply personal information such as your name and address, date of birth, Social Security number, and employment information. You’ll also need to provide your banking information to transfer funds into the IRA.

Next decide how much to invest in the IRA, based on the annual maximum contribution amount allowed, as discussed above, and choose your investment options. Remember, diversifying your investments across different asset classes and investment sectors can help manage risk.

Examples of Diversified Retirement Portfolios

To build a diversified portfolio, one guideline is the 60-40 rule of investing. That means investing 60% of your portfolio in stocks and 40% in fixed income and cash.

However, that formula varies depending on your age. The closer you get to retirement, the more conservative with your investments you may want to be to help minimize your risk.

No matter what your age, make sure your investments are in line with your financial goals and tolerance for risk.

The Takeaway

Not only is it possible to have a 401(k) and also a traditional or Roth IRA, it might offer you significant benefits to have both, depending on your circumstances. The chief upside, of course, is that having two accounts gives you the option to save even more for retirement.

The main downside of deciding whether to fund a 401(k) and a traditional or Roth IRA is that it can be a complicated question: You have to consider your ability to save, your risk tolerance, and the tax implications of each type of account, as well as your long-term goals. Then, if you decide to move ahead with both types of accounts, you can work on opening them up and contributing to them.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
Invest with as little as $5 with a SoFi Active Investing account.

FAQ

Can you max out both a 401(k) and an IRA?

Yes, you can max out both a 401(k) and an IRA up to the annual amounts allowed by the IRS. For 2023 that’s $6,500 for an IRA ($7,500 if you’re 50 or older), and $22,500 ($30,000 if you’re 50 or older) for a 401(k). For 2024, it’s $7,000 for an IRA ($8,000 if you’re 50 or older), and $23,000 for a 401(k) or ($30,500 if you’re 50 or older).

How do employer contributions affect your IRA contributions?

Employer contributions to a 401(k) don’t affect your IRA contributions. You can still contribute the maximum allowable amount annually to your IRA even if your employer contributes to your 401(k). However, having a retirement plan like a 401(k) at work does affect the portion of your IRA contributions that may be deductible from your taxable income. In this case, the deductions are limited, and potentially not allowed, depending on the size of your salary.

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.

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.

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.

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

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.
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May

18

2024

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

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off on What Is the Rule of 55? How It Works for Early Retirement

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

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

Key Points

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

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

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

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

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

What Is the Rule of 55?

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

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

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

How Does the Rule of 55 Work?

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

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

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

Get a 1% IRA match on rollovers and contributions.

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Rule of 55 Requirements

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

•   Be age 55 or older

•   Separate from your employer at age 55 or older

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

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

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

Example of the Rule of 55

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

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

Should You Use the Rule of 55?

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

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

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

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

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

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

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

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

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

•   Reach age 59 ½

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

•   Become totally and permanently disabled

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

•   Need the money to pay health insurance premiums while unemployed

•   Are a qualified reservist called to active duty

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

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

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

The Takeaway

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

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

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

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

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

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

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

How do I claim the rule of 55?

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

What is the rule of 55 lump sum?

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

Photo credit: iStock/bagi1998

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.

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.

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

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What Is Stock Volatility and How Do You Measure It?

What Is Stock Volatility?

How to Measure Stock Volatility

Standard Deviation

Beta

VIX

Maximum Drawdown

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Using Standard Deviation to Calculate Volatility

Types of Stock Volatility

Historical Volatility

Implied Volatility

What Causes Market Volatility?

What Causes Stock Prices to Go Up?

What Causes Stock Prices to Go Down?

How to Manage Volatility When Investing

Balance Risk and Reward

Assess Risk Tolerance

Stick to Long-Term Investing Strategies

Avoid Timing the Market

Consider Dollar-Cost Averaging

How Much Stock Volatility Is Normal?

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FAQ

Is volatility the same as risk?

Who should buy stocks when volatility strikes?

What is the best stock volatility indicator?

What is good volatility for a stock?

What causes volatility in a stock?

Mutual Funds vs Index Funds: Key Differences

What’s the Difference between Index Funds and Mutual Funds?

How They Work

Fees and Taxes

Investing Style

Index vs Mutual Fund: Which is Best for You?

The Takeaway

FAQ

Do index funds outperform mutual funds?

Do people prefer index funds over mutual funds, or mutual funds over index funds?

Are mutual funds riskier than index funds?

Taxes, Fees, Commissions, and Your Investments

Investment Expenses 101

Fund Fees

Advisor Fees

Broker Fees and Commissions

How to Minimize the Cost of Investing

Index Funds

Automated Investing Platforms

Discount Brokerage

How Taxes Eat into Investing Profits

Strategies to Minimize Taxes

The Takeaway

Can You Contribute to Both a 401(k) and an IRA?

Introduction to Retirement Savings Accounts

Understanding the Basics of 401(k)s and IRAs

The Importance of Investing in Your Future

Can I Contribute to a 401(k) and an IRA?

Get a 1% IRA match on rollovers and contributions.

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.1

Rules and Regulations for Multiple Retirement Accounts

Key Takeaways for Dual Contributions

2023 and 2024 Contribution Limits for 401(k) and IRA Plans

401(k) Contribution Limits and Considerations

IRA Contribution Limits and Income Thresholds

The Intricacies of IRA Contributions

Traditional vs Roth IRA: What You Need to Know

IRA Deduction Limits and Eligibility Requirements

How Contributing to Both a 401(k) and an IRA Affects Your Taxes

Understanding the Tax Implications

Strategies for Minimizing Taxes on Withdrawals

Choosing Between a 401(k) and an IRA

Factors to Consider When Making Your Choice

Comparing Benefits and Drawbacks of Each Plan

The Combined Power of a 401(k) and IRA

How to Strategically Invest in Both Accounts

Long-term Growth Potential

Step-by-Step Guide to Contributing to Both 401(k) and IRA

Eligibility Verification and Contribution Processes

Examples of Diversified Retirement Portfolios

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