Dec
06
2024
What Is a Shareholder Activist?

What Is a Shareholder Activist?

By | Growing Wealth, invest, Investing | Comments Off on What Is a Shareholder Activist?

A shareholder activist may be a hedge fund, institutional investor, or wealthy individual who uses an ownership stake in a company to influence corporate decision-making. Shareholder activists, sometimes called activist investors, typically seek to change how a company is run to improve its financial performance. However, they may also have other objectives, such as increasing transparency or promoting social responsibility.

Activist shareholders can impact the way a company is managed, thus affecting its stock price. As such, you may benefit from understanding shareholder activism and how these investors may impact the stocks in your portfolio.

Key Points

•   Shareholder activists use ownership stakes to influence corporate decisions, aiming to improve financial performance or promote transparency and social responsibility.

•   Activists can be hedge funds, institutional investors, or wealthy individuals seeking changes in company management.

•   Activist investors may use media and shareholder voting to gain support for their proposals and influence company strategies.

•   Goals of activism vary, from improving environmental impact to unlocking shareholder value through strategic changes.

•   Activism can lead to stock volatility, but targeted stocks may still be valuable for diversified portfolios if proposed changes are supported.

How Shareholder Activism Works

Shareholder activism is a process in which investors purchase a significant stake in a company to influence the management of the company. When an investor builds up a large enough stake in a company, this usually opens up channels where they may discuss business proposals directly with management.

Activist investors may also use the shareholder voting process to wield influence over a company if they believe it is mismanaged. This more aggressive tactic may allow activist shareholders to nominate their preferred candidates for the board of directors or have a say on a company’s management decisions.

Activist investors typically own a relatively small percentage of shares in a company, perhaps less than 10% of a firm’s outstanding stock, so they may need to convince other shareholders to support their proposals. They often use the media to generate support for their campaigns.

Shareholder activists may also threaten lawsuits if they do not get their way, claiming that the company and its board of directors are not fulfilling their fiduciary duties to shareholders.

Activist investors’ goals can vary. Some investors may want to see companies improve their environmental and social impact, so they will suggest that the company adopt a Corporate Social Responsibility framework. Other investors try to get the company to adopt changes to unlock shareholder value, like selling a part of the company or increasing dividend payouts.

However, shareholder activism can also be a source of conflict between shareholders and management. Some activist investors may prefer the company unlock short-term gains that benefit shareholders, perhaps at the expense of long-term business operations. These investors may exit a position in a company once they unlock the short-term gains with little concern for the company’s future prospects.

Recommended: Stakeholder vs. Shareholder: What’s the Difference?

Types of Shareholder Activists

There are three primary types of shareholder activists: hedge funds, institutional investors, and individual investors. So, your average investor who may be doing a bit of online investing or building a retirement portfolio likely wouldn’t qualify as a shareholder activist. Each type of shareholder activist has its distinct objectives and strategies.

Hedge Funds

Hedge funds are private investment vehicles usually only available to wealthy individuals who make more than $200,000 annually or have a net worth over $1 million. These funds often take a more aggressive approach to shareholder activism, like public campaigns and proxy battles, to force a company to take specific actions to generate a short-term return on its investment.

Institutional Investors

Institutional investors are typically large pension funds, endowments, and mutual funds that invest in publicly-traded companies for the long term. These investors often use their voting power to influence a company’s strategy or management to improve their investment’s financial performance.

Individual Investors

Though less common than hedge funds and institutional investors, very wealthy individual investors sometimes use their own money to buy shares in a company and then push for change.

Examples of Shareholder Activists

Shareholder activism became a popular strategy in the 1970s and 1980s, when many investors – called “corporate raiders” – used their power to push for changes in a company’s management. Shareholder activism has evolved since this period, but there are still several examples of activist investors

For example, Carl Icahn is one of the most well-known shareholder activists who made a name for himself as a corporate raider in the 1980s. He was involved in hostile takeover bids for companies such as TWA and Texaco during the decade.

Since then, Icahn has been known for taking large stakes in companies and pushing for changes, such as spin-offs, stock buybacks, and management changes. More recently, Icahn spearheaded a push in early 2022 to nominate two new directors to the board of McDonald’s. His goal was to get McDonald’s to change its treatment of pigs. However, his preferred nominees failed to get elected to the board.

Another well known activist investor is Bill Ackman, the founder and CEO of Pershing Square Capital Management, a hedge fund specializing in activist investing. Ackman is known for his high-profile campaigns, including his battle with Herbalife.

In 2012, Ackman shorted the stock of Herbalife, betting the company would collapse. He accused Herbalife of being a pyramid scheme and called for a government investigation. Herbalife denied the allegations, and the stock continued to rise. Ackman eventually closed out his position at a loss.

Recommended: Short Position vs Long Position, Explained

Other examples of shareholder activists include Greenlight Capital, led by David Einhorn, and Third Point, a hedge fund founded by Dan Loeb.

In 2013, Einhorn took a stake in Apple and pushed for the company to return more cash to shareholders through share repurchases and dividends. Apple eventually heeded his advice and initiated a plan to return $100 billion to shareholders through dividends and buybacks.

In 2011, Loeb’s hedge fund took a stake in Yahoo and pushed for the company to fire its CEO, Scott Thompson. Thompson eventually resigned, and Yahoo appointed Loeb to its board of directors. More recently, in 2022, Loeb took a significant stake in Disney and started a pressure campaign calling on the company to spin-off or sell ESPN. However, he eventually backed off that suggestion.

Is Shareholder Activism Good for Individual Investors?

Depending on the circumstances, a shareholder activist campaign may be good for investors. Some proponents argue that shareholder activism can improve corporate governance, promote ESG investing, and lead to better long-term returns for investors.

Others contend that activist investors are primarily interested in short-term gains and may not always have the best interests of all shareholders in mind. While individual investors may benefit from a stock’s short-term spike after an activist shareholder’s campaign, this rally may not last for investors interested in long-term gains.

The Takeaway

Shareholder activists use their financial power to try to influence the management of publicly traded companies. Because activist investors often leverage the media to promote their goals, individual investors may read about these campaigns and worry about how they could affect their holdings.

Generally, the impact of shareholder activism on investors depends on the specific goals of the activist and the response of the company’s management. If an activist successfully pressures management to make changes that improve the company’s performance, this can increase shareholder value. However, if an activist’s campaign is unsuccessful or the company’s management resists the activist’s demands, this can lead to a decline in the stock price.

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Dec
06
2024

Guide to IRA Contribution Deadlines

By | invest, Investing, Preparing for Retirement | Comments Off on Guide to IRA Contribution Deadlines

Fortunately for retirement savers, the IRS allows some flexibility in funding traditional or Roth IRAs. You have until tax day of the following year to make contributions.

In other words: Your last day to make an IRA contribution for tax year 2024 is April 15, 2025. If you file an extension on your return, your ability to contribute to an IRA is not extended, however.

Knowing how long you have to make an IRA contribution is important, as it can help you save a little more, and potentially reap some tax benefits.

What Is the IRA Contribution Deadline?

A conventional tax year extends from January 1 of the year through December 31 (corporate tax years can be different). However, the deadline for individuals making the maximum annual IRA contribution doesn’t follow that timeline; generally you have until tax day in April of the following year.

In most years, the deadline for filing your tax return is April 15. However, if the 15th falls on a holiday or weekend, the deadline is generally pushed to the next business day.

The deadline also applies to both annual contributions and catch-up contributions for regular IRAs. A catch-up contribution of $1,000 is allowed for taxpayers aged 50 or older.

Again, if you file an extension on your tax return, that will not give you extra time to contribute to an ordinary IRA. That said, the rules related to contribution deadlines and extensions are somewhat different for other types of IRAs, like SEP and SIMPLE IRAs designed for those who are self-employed or own small businesses. (see below).

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Traditional, Roth, SEP, and SIMPLE IRA Contribution Deadlines for 2024

Contributions limits and deadlines vary, depending on the type of IRA you have.

IRA Type

 2024 Annual Contribution Limit

 Contribution Deadline for the 2024 Tax Year
Traditional IRA $7,000, or $8,000 if you’re 50 or older April 15, 2025
Roth IRA $7,000, or $8,000 if you’re 50 or older April 15, 2025
SEP IRA 25% of compensation or $69,000, whichever is less (SEP plans do not have catch-up provisions) April 15, 2025, unless the employer filed an extension; the extension deadline is Oct. 15, 2025
SIMPLE IRA $16,000, or $19,500 if you’re 50 or older January 30, 2025 for employee contributions; April 15, 2025 for employer contributions (or Oct. 15, 2025, if there’s an extension)

How IRA Contributions Work

Contributions refer to the funds you deposit in a retirement account like an IRA (but also a 401(k) or 403(b)). Most retirement accounts have rules that govern the maximum amount you can contribute per year and the tax implications for contributing to one type of account vs. another.

•   Generally speaking, traditional IRAs, as well as SEP and SIMPLE IRAs, are considered tax-deferred accounts. That means your contributions are typically tax deductible in the year you make them (though some restrictions apply if you or your spouse is covered by a workplace retirement account). But you will owe taxes on withdrawals.

•   The money you contribute to a Roth IRA is an after-tax contribution, and is not tax deductible. Qualified withdrawals after age 59 ½ are tax-free, however.

Roth accounts have more restrictions than other types of IRAs. One important distinction is the income cap: For tax year 2024: Single filers whose modified adjusted gross income (MAGI) is $161,000 or higher, and those who are married, filing jointly with a MAGI of $240,000 or higher, are not eligible to open a Roth IRA.

Other Types of IRAs

In addition to the ordinary traditional and Roth IRA options, self-employed people, sole proprietors, and those with small businesses can set up SEP or SIMPLE IRAs.

•   A SEP IRA, or Simplified Employee Pension IRA, is a retirement plan that can be set up by employers, sole proprietors, or the self-employed. Employers make contributions for employees (employees don’t contribute). Employers are not required to contribute to a SEP every year.

•   A SIMPLE IRA, or Savings Incentive Match Plan for Employees IRA, is similar to a 401(k) but for businesses with 100 or employees or less. Both the employer and the employees can contribute to a SIMPLE IRA.

Both SEP and SIMPLE IRAs are tax-deferred accounts, similar to a traditional IRA. Contributions in most cases are tax deductible, but the account holder must pay ordinary income tax on withdrawals. The rules and restrictions governing withdrawals vary, so you may want to check the details at IRS.gov or consult a tax professional.

Pros and Cons of Maxing Out Your IRA Early or Late

Maxing out your IRA, i.e., making the full annual contribution allowed, could help you save more for retirement. And as with any contribution amount, there can be tax benefits depending on the type of IRA you’re funding.

Whether it makes sense to contribute earlier in the year or wait until the contribution deadline depends on your financial situation.

Here are some of the advantages and disadvantages of maxing out an IRA earlier vs. later.

Maxing Out an IRA Early

 Maxing Out an IRA Late
Pros

•  Maxing out your plan sooner allows it more time to grow, potentially. Growth depends on the investments you choose for your IRA; there are no guarantees of returns and there is always a risk of loss.

•  If your financial situation changes you’ll have the reassurance of knowing that your plan is fully funded for the year.

•  Waiting to max out your IRA until tax day could give you more time to max out your 401(k) before the year-end contribution deadline.

•  If you have a Roth IRA, waiting to make contributions can help you better gauge the maximum amount you can save, based on your income.

Cons

•  Fully funding an IRA early in the year could leave you short financially if you need money for other goals.

•  There’s a risk of contributing too much to a Roth IRA, based on what your income and filing status allows, which could trigger a tax penalty.

•  Delaying contributions might mean missing out on potential growth (but there are no guarantees your money will grow).

•  Waiting too long could result in missing the annual contribution deadline altogether if you come up short and don’t have enough money to save.

What If You Contribute Too Much to Your IRA?

If you contribute too much money to your IRA, the IRS can treat it as an excess contribution. Excess IRA contributions can happen if you:

•   Aren’t keeping track of contributions throughout the year

•   Miscalculate the amount you can contribute to a Roth IRA, based on your income and filing status

•   Make an improper rollover contribution

If you make excess IRA contributions, the IRS can apply a 6% penalty for each year the excess amounts remain in your account. You can avoid the 6% tax by withdrawing excess contributions and any earnings from those contributions by the tax filing deadline or extension deadline if you filed one.

The Takeaway

If you have any type of IRA, it’s important to mark your calendar each year with the contribution deadline so that you can plan the cadence of your contributions in relation to other expenses. Because most types of IRAs allow additional time for contributions, this can help you save more — and possibly reap additional tax benefits.

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FAQ

What is the last day to contribute to an IRA for tax year 2024?

The traditional and Roth IRA contribution deadline for the 2024 tax year is April 15, 2025. If you’re an employer, or self-employed individual contributing to an SEP IRA, you’d have until tax day to contribute, unless you filed a tax extension. In that case, you’d be able to use the extension deadline instead.

Can I contribute to an IRA after December 31?

Yes, you can contribute to an IRA for the current tax year up until the federal tax deadline, which is typically April 15 of the following year. In years where the federal tax deadline falls on a holiday or weekend, the date is pushed up to the next business day.

Can I open an IRA in 2025, but contribute for 2024?

If the 2025 tax year is already underway, and the April tax deadline has passed, you cannot open an IRA and make contributions for the 2024 tax year. You could, however, open a traditional or Roth IRA before the April 2025 tax filing deadline and fund it with contributions for the 2024 tax year.

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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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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

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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06
2024
What Is a Carbon Tax?

What Is a Carbon Tax?

By | Growing Wealth, invest, Investing | Comments Off on What Is a Carbon Tax?

In countries where there is a carbon tax, businesses must pay a levy based on the amount of carbon emissions produced by their business operations. A carbon tax is designed to reduce the amount of carbon in the atmosphere — also known as CO2 emissions.

There are generally two types of carbon taxes: a tax on quantities of greenhouse gases emitted, and a tax on carbon-intensive goods and services such as gasoline production. In the United States, several carbon tax proposals have been introduced in Congress, but none have yet been implemented.

Key Points

•   A carbon tax is a levy on businesses for their carbon emissions, aimed at reducing CO2 emissions and promoting low-emission energy sources.

•   Two main types of carbon taxes exist: one on greenhouse gas emissions and another on carbon-intensive goods and services.

•   The U.S. does not have a federal carbon tax, but several states and localities have implemented regional versions, with ongoing discussions about a national approach.

•   Revenue from carbon taxes can fund environmental restoration and decarbonization, though deciding the best use of these funds is challenging.

•   Countries like Finland, Norway, and Sweden have high carbon tax rates, and the concept is becoming increasingly popular as a climate change tool globally.

How Does a Carbon Tax Work?

When a government implements a carbon tax, a price per ton of greenhouse gas emissions is chosen, and a company is taxed the applicable amount for every ton of carbon it emits or is responsible for. In some cases, the price per ton increases the more an entity emits, thereby incentivizing companies to reduce and prevent emissions.

What Type of Carbon Is Taxed?

Although it is called a carbon tax, usually the price is actually per ton of CO2 gas emitted. That’s because every fossil fuel has a particular amount of carbon content in it, and when burned each carbon molecule combines with two oxygen molecules and becomes CO2 gas which goes into the atmosphere.

So the amount of emissions associated with the fuel can be taxed at the point of extraction, refinement, import, or use.

As many ESG investors likely know, burning coal emits the highest amount of CO2, followed by diesel, gasoline, propane, and natural gas. Therefore, coal gets taxed higher than other fossil fuels. Once CO2 is emitted into the atmosphere, it remains there for a hundred years or more, creating a greenhouse effect which heats up the planet and leads to climate change (hence the name “greenhouse gases”).

Only products associated with the burning of fossil fuels get taxed. So products such as plastic that contain petroleum but don’t directly result in CO2 emissions don’t get taxed.

What Is the Economic Impact of Carbon Taxation?

Since a carbon tax increases costs across the entire supply chain, everyone from extractors to consumers are theoretically incentivized to reduce fossil fuel consumption. Those being taxed can raise the prices of their goods and services, but only as much as the market is willing to pay while allowing them to remain competitive.

What Is the Social Impact of Carbon Emissions?

The theory around carbon pricing is that each ton of CO2 should have a price equal to the social cost of carbon. The social cost of carbon is the current amount of estimated damages over time that each ton of CO2 emitted causes today.

In addition to causing climate change, emissions and pollution typically lead to negative effects on human health and natural ecosystems. Thus investing in companies with lower carbon emissions can be considered a type of socially responsible investing.

Over time, the social cost of carbon increases, because each ton of emissions is more damaging as climate change worsens. Therefore, the price of carbon and the tax would increase over time.

Those producing emissions know that the tax will increase over time, and so investments into decarbonization are worth it to them today. For instance, a company can invest in solar energy and wind power, and while that might have a high upfront cost for them, over time it could be worth it could help them avoid a rising carbon tax.

Examples of Carbon Taxes

Understanding carbon taxes is an important facet of sustainable investing. Carbon taxes have been put into place in many countries around the world so far, and their popularity is rising. As of 2024, 75 countries had a form of carbon tax or energy tax.

•   Finland was the first country to implement a carbon tax in 1990, soon followed by Norway and Sweden in 1991. In 2024, Finland’s price per ton was more than $100. Norway is known to have one of the strictest carbon taxes.

•   The Canadian province of British Columbia implemented a carbon tax in 2008. In 2019, South Africa became the first African country to install a carbon tax.

•   Although there is not yet a federal carbon tax in the U.S., there are more than 50 regional ones. For instance, the city of Boulder, CO, implemented a carbon tax in 2006 after it passed a local vote.

Support for a U.S. federal carbon tax has generally increased over time, but one of the things holding it back is debate about how the revenue from the tax would be used. A few ideas include: paying back consumers through a carbon dividend; using the money to fund infrastructure upgrades or low-emissions technologies, or reducing other taxes.

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The Importance of Carbon Tax

Scientists believe that reducing global emissions is essential to stop the buildup of CO2 in the Earth’s atmosphere. The more CO2 gets emitted, the more the planet warms and the worse climate change becomes — including the frequency of climate-related disasters.

Global temperatures have already increased 1°C over pre-industrial levels, and if emissions are not reduced temperatures are projected to rise 4°C by the end of this century.

A carbon tax is a powerful tool to discourage the use of fossil fuels and incentivize a shift to low- and zero-emission energy sources. This is why many people invest in green stocks.

Pros and Cons of Carbon Tax

There are several pros and cons to a carbon tax.

Some of the pros of a carbon tax include:

•   The carbon tax is a way to regulate emissions without having to actually mandate production and consumption limits directly.

•   Carbon taxes incentivize companies and individuals to reduce and avoid emissions.

•   Carbon taxes are easy to administer.

•   A carbon tax may help reduce the buildup of greenhouse gasses, which in turn may help reduce pollution, improve air and water quality, and more.

•   The revenue raised through a tax can be used to fund decarbonization efforts, environmental restoration, and other projects.

•   Other programs, such as an incentive using renewable energy, haven’t been as successful in reducing fossil-fuel use.

A few cons of a carbon tax include:

•   It can be challenging to figure out how the revenues should be spent.

•   A carbon tax can be put on any point of a supply chain and it’s hard to decide which is best.

•   It’s hard to predict how much emissions will be reduced as a result of the carbon tax.

•   If a carbon tax increases energy costs, this can have a big impact on lower-income households which tend to spend a higher percentage of their income on energy than higher-income households.

•   If one country implements a carbon tax and others don’t, then that puts local industries at a competitive disadvantage. If they have to raise prices, customers may start buying from the countries that don’t have the tax, resulting in the same or more emissions. For this reason carbon tax plans build in ways to prevent emissions leakage and issues with competition. Some of these include rebates, exemptions for particular industries, and taxation based on past emissions.

•   Companies can purchase carbon offsets or carbon credits to lower the amount they pay in taxes. They can also use those offsets to claim that they are carbon neutral or carbon negative. This isn’t exactly true, since they are still emitting carbon. The ability to purchase offsets reduces their incentive to decarbonize.

Who Regulates Carbon Taxes?

Carbon tax programs are regulated by federal, state, or local governments. Regulation involves setting the price per ton of carbon, deciding which entities get taxed, collecting the tax, and deciding how the revenues are spent.

There is an ongoing discussion about the international coordination of carbon pricing. If a minimum price per ton is set, this would eliminate issues around competition and guarantee a certain amount of effort towards emission reduction. Canada has already implemented national price coordination. The minimum price per ton in Canadian provinces and territories is CAD $50.

Which Countries Have the Highest Carbon Tax?

Below are a few of the countries that have the highest carbon tax rates. The rates are in USD price per ton:

•   Uruguay: $155.87

•   Switzerland: $130.81

•   Sweden: $125.56

•   Liechtenstein: $96.30

•   Norway: $90.86

The Takeaway

A carbon tax can be a powerful tool for reining in carbon emissions, and potentially helping reduce the amount of greenhouse gasses in the atmosphere. Essentially, these taxes penalize companies by making them pay a fee for CO2 emissions relating to their products or operations.

While the U.S. doesn’t have a federally mandated carbon tax, there are state and local levies. Given concerns about climate change, it’s likely that more countries will continue to adopt and adjust carbon taxes.

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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.

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

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2024
Guide to Investment Risk Pyramids

Guide to Investment Risk Pyramids

By | Growing Wealth, invest, Investing | Comments Off on Guide to Investment Risk Pyramids

An investment risk pyramid is an illustration used to help investors understand the risk/reward profile of various assets. The investment risk pyramid uses a base, middle, and top to rank investments by the likelihood of losing money or seeing big returns. The tool is useful when getting started with investing.

Building a portfolio is no easy task. It requires due diligence and an assessment of your risk tolerance and return goals. The investment risk pyramid may help you determine what approaches work best for you.

What Are Investment Pyramids?

Investment pyramids are practical tools for gauging how risky certain asset types are. The pyramid model has been used in many areas for a long time, and it’s useful when learning what your risk tolerance is.

An investment risk pyramid has three levels grouped by risk/return profile. The least-risky securities are found in the large base; growth and moderately risky assets are in the middle; then the most speculative strategies are at the top.

Again, this can be helpful to investors who are looking to buy and sell stocks or other securities, and also get a sense of how much associated risk they’re introducing or jettisoning from their portfolio.

How Investing Pyramids Work

There are many investing risk need-to-knows, and the pyramid of investment risk works by helping investors understand the connection between their asset allocation and their risk tolerance.

The visual should ultimately lead individuals to better grasp what percentage of their investable assets should go to which types of investments based on risk level and return potential.

Using a risk pyramid investment strategy provides a basic framework for analyzing portfolio construction. The investment risk pyramid is structured so that it suggests people hold a higher percentage of lower-risk assets, and relatively little in the way of ultra-high-risk, speculative assets.

Base of the Pyramid

Managing investment risk is among the most fundamental aspects of investing, and risk is controlled by ensuring an allocation to some safe securities. The base of the investment risk pyramid, which is the bulk of total assets, contains low-risk assets and accounts. Investments such as government bonds, money markets, savings and checking accounts, certificates of deposit (CDs), and cash are included in the base.

While these securities feature relatively low risk, you might lose out to inflation over time if you hold too much cash, for example.

Middle of the Pyramid

Let’s step up our risk game a bit by venturing into the middle of the investment risk pyramid. Here we will find medium-risk assets. In general, investments with some growth potential and a lower risk profile are in this tier. Growth and income stocks and capital appreciation funds are examples.

Other holdings might include real estate, dividend stock mutual funds, and even some higher-risk bond funds.

Top of the Pyramid

At the top of the investment risk pyramid is where you’ll find the most speculative asset types and even margin investing strategies. Options, futures, and collectibles are examples of high-risk investments.

You will notice that the top of the pyramid of investment risk is the smallest – which suggests only a small portion of your portfolio should go to this high-risk, high-reward niche.

Sample Investment Pyramid

Here’s what a sample investment risk pyramid might contain:

Top of the pyramid, high risk: Speculative growth stocks, put and call options, commodities, collectibles, cryptocurrency, and non-fungible tokens (NFTs). Generally, just a small percentage of an overall portfolio should be allocated to the top of the pyramid.

Middle of the pyramid, moderate risk: Dividend mutual funds, corporate bond funds, blue-chip stocks, and variable annuities. Small-cap stocks and foreign funds can be included, too. A 30-40% allocation could make sense for some investors.

Base of the pyramid, low risk: U.S. government Treasuries, checking and savings accounts, CDs, AAA-rated corporate bonds. This might comprise 40-50% of the portfolio.

Pros and Cons of Investment Pyramids

The investment risk pyramid has advantages and disadvantages. Let’s outline those to help determine the right investing strategy for you.

Pros

The investment risk pyramid is useful as a quick introduction to asset allocation and bucketing. Another upside is that it is a direct way to differentiate asset types by risk.

Cons

While the investment risk pyramid is helpful for beginners, as you build wealth, you might need more elaborate strategies beyond the pyramid’s simplicity. Moreover, in the end, you determine what securities to own – the pyramid is just a suggestion.

Get up to $1,000 in stock when you fund a new Active Invest account.*

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

Examples of Low-Risk Investments

Let’s describe some low-risk investments in more detail since these are including the investment risk pyramid’s biggest tier.

Bonds

Bonds are essentially a loan you make to the government or other entity for a set amount of time. In return for lending your money, the debtor promises to pay you back at maturity along with periodic coupon payments, like interest.

Lower-risk bonds include short-term Treasury bills while riskier bonds are issued by speculative companies at a higher yield.

Cash

Cash feels like a low-risk asset, but ideally you would store it in an interest-bearing savings account in order to keep up with inflation.

Also consider that holding too much cash can expose you to inflation risk, which is when cash loses value relative to the cost of living.

Bank Accounts

You can earn a rate of return through a bank account with FDIC insurance. Keeping an emergency fund in a checking account can be a prudent move so you can pay expenses without having to sell assets like stocks and bonds or take on debt.

Examples of High-Risk Investments

At the top of the pyramid, you will find assets and strategies that may generate large returns, but also expose you to serious potential losses. Margin trading is a method often employed by some investors to try and increase their returns.

Margin Trading

Margin trading is using borrowed funds in an attempt to amplify returns. A cash account vs. margin account has key differences to consider before you go about trading. Trading with leverage offers investors the possibility of large short-term gains as well as the potential for outsize losses, so it is perhaps best suited for sophisticated investors.

Options

Options on stocks and exchange-traded funds (ETFs) are popular these days. Options, through calls and puts, are derivative instruments that offer holders the right but not the obligation to buy shares at a specific price at a predetermined time. These are risky since you can lose your entire premium if the option contract strategy does not work out for the holder.

Collectibles

Collectibles, such as artwork or wine, are alternative investment types that may provide some of the benefits of diversification, but it’s hard to know what various items are worth since they are not valued frequently. Consider that stocks and many bonds are priced at least daily.

Collectibles might also go through fad periods and booms and bust cycles, which can add to the risk factors in this category.

Discovering Your Risk Tolerance

The investment risk pyramid is all about helping you figure out your ability and willingness to accept risk. It is a fundamental piece of being an investor. You should consider doing more research and even speaking with a financial advisor for a more detailed risk assessment along with an analysis of what your long-term financial goals are.

The Takeaway

Using an investment risk pyramid can make sense for many investors. It’s an easy, visual way to decide which asset classes you might want to hold in your portfolio, so that the percentage of each (i.e. your asset allocation) is aligned with your risk tolerance.

The other helpful aspect of the investment risk pyramid is that it presumes a bigger foundation in lower-risk investments (the bottom tier), with gradually smaller allocations to moderate risk and higher-risk assets, as you move up the pyramid. This can be helpful for a long-term strategy. In a nutshell, the investment risk pyramid helps you figure out how to allocate investments based on your risk tolerance and return objectives.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, 11%*

FAQ

What are the levels of an investment pyramid?

The levels of an investment risk pyramid are low-risk at the base, moderate-risk in the middle, and high-risk at the top. The risk/return investment pyramid helps investors understand how to think about various assets they may want to own.

What does investment risk refer to?

Investment risk can be thought of as the variance in return, or how great the chance is that an investment will experience sharp losses. While the risk investment pyramid helps you build a portfolio, you should also recognize that a diversified stock portfolio performs well over time, while cash generally loses out due to the risk of inflation.

What are some examples of high-risk investments?

High-risk investments include speculative assets like options, trading securities on margin, and even some collectibles that might be hard to accurately value since they are based on what someone might be willing to pay for them. The low-risk to high-risk investments pyramid can include virtually any asset.

Photo credit: iStock/MicroStockHub

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.

*Borrow at 11%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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.

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

SOIN-Q324-024

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Dec
06
2024
Is Trading on Margin a Good Idea?

Risks and Benefits of Margin Trading: Is It a Good Idea?

By | Growing Wealth, invest, Investing | Comments Off on Risks and Benefits of Margin Trading: Is It a Good Idea?

Margin trading refers to trading or investing using funds borrowed from a brokerage. Investors should understand that trading on margin operates like a double-edged sword; while it allows you to potentially multiply your gains, it can also multiply your losses.

At its core, margin trading involves borrowing from your broker to increase your purchasing power. This allows you to buy well beyond the actual cash you have at your disposal. We’ll cover the mechanics of how this works, as well as the risks and benefits of undertaking such a strategy.

Key Points

•   Margin trading is trading or investing with funds borrowed from a brokerage.

•   Borrowing boosts purchasing power but requires interest repayment.

•   Risks include high interest costs and margin calls, leading to forced sales.

•   Margin trading may help some traders access more purchasing power.

•   Margin trading is risky, and may be unsuitable for some investors, especially those with long-term strategies.

Understanding Margin Trading

Margin trading means borrowing funds from your broker and using those funds to buy securities. Any borrowed funds must be repaid, with interest, regardless of whether or not you earn a profit on your trade. If you’re wondering about the difference between leverage vs. margin, you can think of margin as a form of leverage.

When investing – be it online investing or otherwise – with margin, your broker will require you to post cash collateral to match a percentage of the funds you borrowed. This is known as the margin, and the exact amount is set by your broker, the type of security traded, and prevailing market conditions.

Risks and Benefits of Margin Trading

Here’s a rundown of some of the most obvious risks and benefits to margin trading:

Risks

 Benefits
Amplified losses Increased purchasing power
High interest expense Added liquidity
Risk of margin call No set repayment schedule

Benefits of Margin Trading

Some of the benefits of margin trading include:

Added liquidity: Assuming you remain inside of acceptable maintenance margin requirements, margin trading grants additional buying power to smaller cash balances, which can be useful if you don’t want to liquidate existing holdings.

No set repayment schedule: Unlike standard fixed loans, there’s no repayment schedule for repaying your margin loan. The interest accrues while your balance remains outstanding, and is only repaid once the position is closed.

Risks of Margin Trading

Some of the risks of margin trading include:

Debt risks: Trading or investing with borrowed money has its risks, as you could end up in debt to your broker.

High interest expense: Interest rates on margin loans can range from low single digits to as high as 11% or more, depending on your broker and the size of your margin balance. At best, this is a drag on investment returns; at worst, an additional cost you have to pay on a loss.

Risk of margin calls: If at any point, the value of your investments fall beneath a broker’s posted margin requirements, you will be required to deposit additional collateral to cover the shortfall. This is known as a margin call. Failure to meet a margin call can result in a forced sale of your security, additional charges, and other penalties as dictated by your brokerage firm’s policies.

Is Margin Trading Ever Risk-Free?

Under no circumstances is margin trading ever considered free of risk. The core precept of all investing involves risk, and leveraged strategies like margin trading increase risk exposure.

Unlike cash accounts, which limit your losses to the value of your initial investment, margin accounts can result in losses that exceed the value of your initial deposit.

Is Margin Trading a Good Idea for You?

Margin trading isn’t for all investors, and its suitability depends on both the scenario as well as the experience and knowledge of each individual investor.

Trading on margin can be useful when you have a high conviction short-term trade idea. It can also provide the benefit of additional liquidity when much of your cash is tied up in existing investments that can’t be quickly unwound.

When considering margin trading, investors need to be willing and able to absorb any potential losses associated with this strategy. Make sure you fully understand the dynamics of each trade before opening a margin position.

Margin Trading With SoFi

Margin trading allows traders and investors to increase their purchasing power by using borrowed funds to buy securities. But it’s critical that traders and investors keep in mind that using margin can swing both ways – that is, it can allow them to invest more money, but it could also lead to increased losses.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, 11%*

FAQ

What are the downsides of trading on margin?

Trading on margin involves a number of possible downsides, including added interest costs, heightened portfolio volatility, and magnified losses that may exceed the value of your initial investment.

Do some people make a lot of money trading on margin?

Trading on margin can amplify your potential investment returns thanks to the added buying power it offers. However, this multiplier effect swings both ways and will amplify the size of your loss, should the market move against you.

Is margin trading a good long-term investment strategy?

Margin trading is a form of leveraged trading and therefore not recommended for long-term investors. Over extended periods of time, there’s a heightened risk that market volatility may force a margin call. Also, the added interest expense incurred by margin loans can act as a drag on your investment returns.

Photo credit: iStock/valentinrussanov

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.

*Borrow at 11%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN-Q424-016

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