May
18
2024
businessman at desk

Direct Listings vs. IPOs: How Are They Different?

By | invest, Investing | Comments Off on Direct Listings vs. IPOs: How Are They Different?

When you hear of a company “going public,” one route is via an initial public offering, or IPO — but a company can also go public through a direct listing, where no new shares are created and underwriters are not required.

Direct listings, also known as the direct listing process (DLP), direct placement, or direct public offering (DPO), are a way for companies to raise capital by selling existing shares without the complexity of engaging investment banks and other intermediaries.

While a direct listing is typically less expensive than an IPO, and typically there’s no lock-up period, there is a risk in direct listing shares without the support of underwriters.

Key Points

•   Direct listings allow companies to go public by selling existing shares without underwriters.

•   Initial Public Offerings (IPOs) involve issuing new shares and usually require underwriters.

•   Direct listings can be less costly and avoid lock-up periods unlike IPOs.

•   IPOs provide companies with support from underwriters, which can help stabilize share prices.

•   Direct listings offer immediate liquidity for existing shareholders, allowing them to sell shares directly to the public.

What Is the Difference Between Direct Listings and IPOs?

A direct listing is one method by which a company can list shares of stock on a public exchange such as the New York Stock Exchange (NYSE) or Nasdaq directly, without using underwriters to create new shares, as you might with an IPO.

While some listing choices involve selling shares of stock to investors, IPOs and direct listings have many differences. The main difference between the two is that with an IPO a company issues and sells new shares of stock, while with a direct listing shareholders sell existing shares.

Comparing the Direct Listing and IPO Process

The differences between using a direct listing vs. an IPO to take a company public are pretty straightforward.

How a Direct Listing Works

If a private company is interested in going public, but doesn’t want the hassle of working with underwriters, they may choose to do a direct listing. With a direct listing, anyone who owns shares in the company can sell them directly to the public once the new company is listed on a public exchange. Shareholders may include investors, promoters, and employees.

By choosing a direct listing over an IPO, a company can avoid using an underwriter, which potentially saves money and time. Underwriters fulfill multiple roles in the IPO process, including working with the fledgling company to meet regulatory standards and set the initial price per share. These are important steps, but not necessary if a new company is only selling existing shares.

Further, because no new shares are created with a direct listing, existing shares won’t get diluted.

💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.

How an Initial Public Offering Works

When a company offers shares of stock to the general public for the first time, it’s known as an initial public offering (IPO).

Before an IPO, a company is considered private, which means that shares of stock are not available for sale to the general public. Also, a private company is not generally required to disclose financial information to the public.

To have an IPO, a company must file a prospectus with the Securities and Exchange Commission (SEC). The company will use the prospectus to solicit investors, and it includes key information like the terms of the securities offered and the business’s overall financials.

Initial public offerings are a popular choice for companies looking to raise capital. The company works with an underwriter (typically part of an investment bank), who helps navigate regulations and figure out the initial price of the shares. They may also purchase shares from the company and sell them to investors (such as mutual funds, insurance companies, investment banks, and broker-dealers) who will in turn sell them to the public.

One benefit of working with an underwriter is the greenshoe option. This is an agreement that a company can enter into with the underwriter in which the underwriter has the right to sell a greater number of shares during the sale than they originally intended to, if there is a lot of market demand. This can help the company gain additional investment.

Working with an underwriter creates some security for the company, which is one reason so many companies go the route of the IPO.

Pros and Cons of Direct Listings

There are advantages and disadvantages for companies and investors when it comes to direct listings vs. IPOs.

Pros of a Direct Listing

Less expensive than an IPO for the company

Unlike IPOs, direct listings do not require underwriters, since no new shares are being created. Typically, an underwriter charges a fee between 3% and 7% per share. Depending on the scope of the IPO, these fees can add up to hundreds of millions of dollars.

In addition, underwriters often purchase shares below their agreed-upon market value, so companies don’t receive as much investment as they may have had they sold those shares directly to retail investors.

No lock-up periods for shares

If a company goes through an IPO, existing shareholders are generally not allowed to sell their shares to the public during the sale and for a period of time following the sale. These lock-up periods are required in order to prevent stock prices from decreasing due to an oversupply.

The direct listing model is essentially the opposite, in which existing shareholders sell their stock to the public and no new shares are sold.

Provides liquidity for existing shareholders

Anyone who owns stock in the company can sell their shares during a direct listing.

💡 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.

Cons of a Direct Listing

There are also some potential drawbacks when it comes to direct listings.

Risk that shares won’t sell

With a direct listing, the amount of shares sold is based solely on market demand. Because of this, it’s important for a company to evaluate the market demand for its stock before deciding to go the route of a direct listing.

Companies best suited to direct listings are those that sell directly to consumers and have both a strong, recognizable brand and a business model that the public can easily understand and evaluate.

No help from underwriters with marketing and sales

Underwriters provide guarantees, promotion, and support during the listing process. Without an underwriter involved, the company may find that shares are difficult to sell, there may be legal issues during the sale, and the share price may see extreme swings.

No guarantee of stock price

Just as there is no guarantee that shares will sell, there is also no guarantee of stock price. In contrast, having an underwriter can help manage potentially extreme price swings.

This chart outlines the main points covered above.

Pros of Direct Listings

 Cons of Direct Listings
Less expensive than an IPO Potential for initial volatility
No lock-up periods Risk that shares won’t sell
Liquidity for existing shareholders No help from underwriters
No stock price guarantee

The Takeaway

Direct listings are an appealing alternative to IPOs for private companies who want to go public, thanks in part to lower costs and reduced regulations. A direct listing may also be appealing to retail investors who want to purchase shares from companies that are going public.

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


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

FAQ

Why would a company do a direct listing?

A direct listing offers a more direct path to going public on a stock exchange. The company doesn’t have to issue new shares, as only existing shares get sold in a direct listing. This eliminates the need for intermediaries like underwriters.

Can anyone buy a direct listing stock?

Yes, investors can buy a direct stock listing as they would any other stock listed on an exchange.

Is a direct offering good for a stock?

Since direct listings bypass the middleman and eliminate the need for underwriters, they can be less expensive for a company vs. IPOs, but the lack of marketing support could hurt the stock price and initial sales.

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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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.

SOIN0124047

Read more
May
18
2024
Guide to Deposit Interest Rates

Guide to Deposit Interest Rates

By | Budgeting & Goals, Growing Wealth, money | Comments Off on Guide to Deposit Interest Rates

A deposit account — such as a savings account or interest-bearing checking account — can be an attractive place to park your cash. It’s safe, allows relatively quick access, and even helps you earn a little bit of money, thanks to what’s known as the deposit interest rate.

The deposit interest rate is the amount of interest that a bank or other financial institution will pay you when you make a deposit. (You may also hear it referred to by such terms as simply the interest rate or the APY, for annual percentage yield.) Understanding deposit interest rates can help you choose among banking products and find the one that best suits your needs. Learn more here.

What Is a Deposit Interest Rate?

When you put money into a deposit account, your bank or financial institution will pay you interest. Why? Banks make money by using a portion of the money that’s deposited with them to make loans to other customers, perhaps as a mortgage, business loan, or personal loan.

The bank pays you interest for the privilege of lending out your money. They will then charge a higher interest rate on the loans they make, which is how the bank turns a profit.

Incidentally, just because a bank is loaning out your money doesn’t mean your cash won’t be there when you need it. Banks typically carry a cash reserve to cover withdrawals their customers need to make.

Earn up to 4.00% APY with a high-yield savings account from SoFi.

No account or monthly fees. No minimum balance.

9x the national average savings account rate.

Up to $2M of additional FDIC insurance.

Sort savings into Vaults, auto save with Roundups.


How Does a Deposit Interest Rate Work?

Deposit interest rates in banking are expressed as percentages. The amount of interest you earn will be based on how much cash you’ve deposited in your account, also known as your principal.

The interest rate you’re offered will vary by account. For example, a simple savings account may offer a relatively low interest rate, while a high-yield savings account or a money market account may offer a higher rate.

Your interest rate will also be determined in part by the federal funds rate. That rate is the amount the Federal Reserve suggests banks charge to lend each other money overnight.

Recommended: How Does a High Yield Savings Account Work?

How Is Deposit Interest Rate Calculated?

Wondering how interest rates are calculated? It usually is done in one of two ways: as simple interest or compounding interest.

Simple interest is a matter of multiplying the principal by the interest rate. As the name suggests, it is easier to calculate. However, most banks will use compounding to calculate interest rates. Compounding interest essentially allows you to earn a return on your returns, which can help your money grow exponentially. So your principal earns interest, and that amount of interest is added to the principal. Then the interest rate gets calculated again at a certain interval based on that pumped-up principal. This keeps happening, helping your savings grow. Interest can compound at various rates, such as continuously, monthly, or annually, depending on the product and financial institution.

Ways Deposit Interest Rates Are Applied by Institutions

Financial institutions can apply interest rates in a variety of ways. First, they can be fixed or variable. A fixed interest rate guarantees that you will receive an interest payment equal to a certain percentage of your principal. This percentage won’t change over the life of the account. So if your interest rate on your money is set at, say, 2%, that is what you will get, period.

A variable interest rate, on the other hand, may change according to shifts in a benchmark interest rate, such as the federal funds rate. As the benchmark rises, so too will the interest rate. What if the benchmark drops? That means you’re paid less interest.

Additionally, some deposit accounts will offer higher interest rates for larger balances. A certificate of deposit, or CD, may offer you better interest rates if you agree to park your cash in the account for a longer term.

Here’s how to do the math on a couple of examples of deposit interest rates. If you’re a bank customer with $10,000 to deposit, here are two scenarios:

•   Bank 1 is a bricks-and-mortar bank offering 0.01% interest. (Remember, one percentage point is one-hundredth of a whole.) If you deposit your $10,000 for one year, you’ll earn: 10,000 x 0.0001 = 1. At the end of 365 days, you will have the principal plus the interest, or $10,001.

•   Bank 2 is an online bank offering 1.0% interest. If you deposit the same $10,000 for a year, you’ll earn: 10,000 x 0.01 = 100. You’ll have $10,100 at year’s end.

Types of Deposit Interest Rate Accounts

There are a variety of different deposit account types that you might encounter. Here are four of which you should be aware. We’ll explain how each one works.

1. Savings Accounts

Savings accounts are designed specifically as a place for you to put cash you might need in the short-term. For example, you might keep your emergency fund in a savings account, since you’d need quick access to cash if your car’s transmission failed or you had to cover an unexpected medical bill.

Not only does your savings account allow you to earn interest, it is also one of the safest places you can put your money. That’s because the Federal Deposit Insurance Corporation (FDIC) guarantees your money, up to $250,000, per depositor, per account category, per insured institution, as it does with the deposit accounts below. That means in the rare case that your bank fails, you will still have access to your money.

You can deposit cash at an ATM, in person, or through mobile deposits. You can deposit checks or cash into the account, too. When you make a deposit, your funds may not be immediately available for use. Check with your bank to understand their rules around fund availability.

2. Interest-Bearing Checking Accounts

Many checking accounts have very low fees and don’t pay interest. As a result, it doesn’t make sense to keep a lot of money in this type of account. In fact, you may want to keep just enough to pay your bills.

Interest-bearing checking accounts are an exception. They allow you to collect interest on your account, which could be a nice perk. After all, you may well have your paycheck deposited there by setting up direct deposit, which can make your funds available quickly. Whatever remains in your account after paying your bills could be earning you some interest.

However, these accounts may be more complicated and expensive, with higher fees and minimum balance requirements. It’s important to make sure that the expense of holding the account doesn’t outweigh the interest paid.

💡 Quick Tip: If your checking account doesn’t offer decent rates, why not apply for an online checking account with SoFi to earn 0.50% APY. That’s 7x the national checking account average.

3. Certificates of Deposit

A certificate of deposit, or CD, is a product offered by financial institutions that offers a higher interest rate if you agree to keep your funds in place for a period of time. Typically, the length of time is from six months to a few years, but it could be anywhere from one month to 20 years. The longer the period, the higher the interest rate you will probably be offered.

Here’s the rub: If you find that you need the money in the CD before the account matures (meaning the agreed-to time period passes), you’ll likely have to pay early withdrawal penalties. That said, it is possible to get CD’s with no-penalties, but you may have to compromise, such as by accepting lower interest rates.

4. Money Market Accounts

Money market accounts, on the other hand, pay interest and allow for withdrawals. They often pay higher interest rates than traditional savings accounts. However, in return, these accounts may require you to make higher initial deposits and they may have minimum balances, which could be $10,000 or more.

Like checking accounts, money market accounts can offer checks and debit cards, though they may limit the number of transactions you may make per month.

The Takeaway

There are a number of different deposit accounts that offer a deposit interest rate, ranging from checking and savings accounts to CDs and money market accounts. The interest rates will likely vary. For example, with CDs, the rates may depend on factors such as account minimums or term of deposit. Understanding these kinds of “fine print” differences will help you find the right match for your needs, whether your goal is the highest possible interest or having enhanced access to your funds.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.


Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

Do you get interest when you deposit money?

When you deposit money in an interest-bearing deposit account, you will start to earn interest. In other words, your money makes money.

Which deposits pay more interest?

The amount of interest you earn will depend on your interest rate and the amount of money in the account. The more money you deposit and the higher the interest rate, the more interest you will earn. Also, online banks typically pay interest rates than bricks-and-mortar banks.

Do all banks have deposit interest rates?

Banks that offer interest-bearing deposit accounts will always offer a deposit interest rate.

Photo credit: iStock/AsiaVision

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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

Third-Party 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.

SOBK-Q224-1890392-V1

Read more
May
18
2024
Is a Backdoor Roth IRA Right for You?

Backdoor Roth IRAs

By | Growing Wealth, invest, Investing, Preparing for Retirement, Terminology | No Comments

Want to contribute to a Roth IRA, but have an income that exceeds the limits? There’s another option. It’s called a backdoor Roth IRA, and it’s a way of converting funds from a traditional IRA to a Roth.

A Roth IRA is an individual retirement account that may provide investors with a tax-free income once they reach retirement. With a Roth IRA, investors save after-tax dollars, and their money generally grows tax-free. Roth IRAs also provide additional flexibility for withdrawals — once the account has been open for five years, contributions can generally be withdrawn without penalty.

But there’s a catch: Investors can only contribute to a Roth IRA if their income falls below a specific limit. If your income is too high for a Roth, you may want to consider a backdoor Roth IRA.

Key Points

•   A backdoor Roth IRA allows high earners to contribute to a Roth IRA by converting funds from a traditional IRA.

•   This strategy involves paying income taxes on pre-tax contributions and earnings at conversion.

•   There are no income limits or caps on the amount that can be converted to a Roth IRA.

•   The process includes opening a traditional IRA, making non-deductible contributions, and then converting these to a Roth IRA.

•   Potential tax implications include moving into a higher tax bracket and owing taxes on pre-tax contributions and earnings.

What Is a Backdoor Roth IRA?

If you aren’t eligible to contribute to a Roth IRA outright because you make too much, you can do so through a technique called a “backdoor Roth IRA.” This strategy involves contributing money to a traditional IRA and then converting it to a Roth IRA.

The government allows individuals to do this as long as, when they convert the account, they pay income tax on any contributions they previously deducted and any profits made. Unlike a standard Roth IRA, there is no income limit for doing the Roth conversion, nor is there a ceiling to how much can be converted.

💡 Quick Tip: How much does it cost to open an IRA account? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

How Does a Backdoor IRA Work?

This is how a backdoor IRA typically works: An individual opens a traditional IRA and makes non-deductible contributions. They then convert the account into a Roth IRA. The strategy is generally most helpful to those who earn a higher salary and are otherwise ineligible to contribute to a Roth IRA.

Example Scenario

For instance, let’s say a 34-year-old individual whose tax filing status is single and who makes $150,000 a year wants to open a Roth IRA. Their income is too high for them to be eligible for a Roth directly (more on this below), but they can use the “backdoor IRA” strategy. In order to do this, the individual would open a traditional IRA and contribute non-deductible funds to it. They then convert that money to a Roth IRA.

Recommended: Traditional Roth vs. Roth IRA: How to Choose the Right Plan

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.

Income and Contribution Limits

In general, Roth IRAs have income limits. In 2024, a single person whose modified adjusted gross income (MAGI) is more than $161,000, or a married couple filing jointly with a MAGI more than $240,000, cannot contribute to a Roth IRA. For tax year 2023, a single filer whose MAGI is more than $153,000, or a married couple filing jointly with a MAGI over $228,000, cannot contribute to a Roth IRA.

There are also annual contribution limits for Roth IRAs. In 2024, an individual can contribute up to $7,000 in a Roth IRA (or up to $8,000 if they are 50 or older). For tax year 2023, an individual can contribute up to $6,500 in a Roth IRA (or up to $7,500 if they are 50 or older). Traditional IRAs have the same contribution limits as Roth IRAs.

How to Set Up and Execute a Backdoor Roth

Here’s how to initiate and complete a backdoor Roth IRA.

•   Open a Traditional IRA. You could do this with SoFi Invest®, for instance.

•   Make a non-deductible contribution to the Traditional IRA.

•   Open a Roth IRA, complete any paperwork that may be required for the conversion, and transfer the money into the Roth IRA.

Tax Impact of a Backdoor Roth

If you made non-deductible contributions to a traditional IRA that you then converted to a Roth IRA, you won’t owe taxes on the money because you’ve already paid taxes on it. However, if you made deductible contributions, you will need to pay taxes on the funds.

In addition, if some time elapsed between contributing to the traditional IRA and converting the money to a Roth IRA, and the contribution earned a profit, you will owe taxes on those earnings.

You might also owe state taxes on a Roth IRA conversion. Be sure to check the tax rules in your area.

Another thing to be aware of: A conversion can also move people into a higher tax bracket, so individuals may consider waiting to do a conversion when their income is lower than usual.

And finally, if an investor already has traditional IRAs, it may create a situation where the tax consequences outweigh the benefits. If an individual has money deducted in any IRA account, including SEP or SIMPLE IRAs, the government will assume a Roth conversion represents a portion or ratio of all the balances. For example, say the individual contributed $5,000 to an IRA that didn’t deduct and another $5,000 to an account that did deduct. If they converted $5,000 to a Roth IRA, the government would consider half of that conversion, or $2,500, taxable.

The tax rules involved with converting an IRA can be complicated. You may want to consult a tax professional.

💡 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.

Is a Backdoor Roth Right for Me?

It depends on your situation. Below are some of the benefits and downsides to a backdoor Roth IRA to help you determine if this strategy might be a good option for you.

Benefits

High earners who don’t qualify to contribute under current Roth IRA rules may opt for a backdoor Roth IRA.

As with a typical Roth IRA, a backdoor Roth may also be a good option when an investor expects their taxes to be lower now than in retirement. Investors who hope to avoid required minimum distributions (RMDs) when they reach age 73 might also consider doing a backdoor Roth.

Downsides

If an individual is eligible to contribute to a Roth IRA, it won’t make sense for them to do a backdoor conversion.

And because a conversion can also move people into a higher tax bracket, you may consider waiting to do a conversion in a year when your income is lower than usual.

For those individuals who already have traditional IRAs, the tax consequences of a backdoor Roth IRA might outweigh the benefits.

Finally, if you plan to use the converted funds within five years, a backdoor Roth may not be the best option. That’s because withdrawals before five years are subject to income tax and a 10% penalty.

Is a Backdoor Roth Still Allowed for 2023? For 2024?

Backdoor IRAs are still allowed for tax year 2023. And at this point, they are still allowed for 2024 as well.

There had been some discussion in previous years of possibly eliminating the backdoor Roth IRA, but as of yet, this has not happened.

The Takeaway

A backdoor Roth IRA may be worth considering if tax-free income during retirement is part of an investor’s financial plan, and the individual earns too much to contribute directly to a Roth.

In general, Roth IRAs may be a good option for younger investors who have low tax rates and people with a high income looking to reduce tax bills in retirement.

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).

Help grow your nest egg with a SoFi IRA.

FAQ

What are the rules of a backdoor Roth IRA?

The rules of a backdoor Roth IRA include paying taxes on any deductible contributions you make; paying any other taxes you may owe for the conversion, such as state taxes; and waiting five years before withdrawing any earnings from the Roth IRA to avoid paying a penalty.

Is it worth it to do a backdoor Roth IRA?

It depends on your specific situation. A backdoor Roth IRA may be beneficial if you earn too much to contribute to a Roth IRA. It may also be advantageous for those who expect to be in a higher tax bracket in retirement.

What is the 5-year rule for backdoor Roth IRA?

According to the 5-year rule, if you withdraw money from a Roth IRA before the account has been open for at least five years, you are typically subject to a 10% tax on those funds. The five year period begins in the tax year in which you made the backdoor Roth conversion. There are some possible exceptions to this rule, however, including being 59 ½ or older or disabled.

Do you get taxed twice on backdoor Roth?

No. You pay taxes once on a backdoor IRA — when you convert a traditional IRA with deductible contributions and any earnings to a Roth. When you withdraw money from your Roth in retirement, the withdrawals are tax-free because you’ve already paid the taxes.

Can you avoid taxes on a Roth backdoor?

There is no way to avoid paying taxes on a Roth backdoor. However, you may be able to reduce the amount of tax you owe by doing the conversion in a year in which your income is lower.

Can you convert more than $6,000 in a backdoor Roth?

There is no limit to the amount you can convert in a backdoor Roth IRA. The annual contribution limits for IRAs does not apply to conversions. But you may want to split your conversions over several years to help reduce your tax liability.

What time of year should you do a backdoor Roth?

There is no time limit on when you can do a backdoor Roth IRA. However, if you do a backdoor Roth earlier in the year, it could give you more time to come up with any money you need to pay in 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.

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.

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.

SOIN0124018

Read more
May
18
2024
What Is the Arms Index (TRIN)? How to Use the Indicator

What Is the Arms Index (TRIN)? How to Use the Indicator

By | Growing Wealth, invest, Investing | Comments Off on What Is the Arms Index (TRIN)? How to Use the Indicator

The Arms Index or Trading Index (TRIN) is a breadth indicator used to indicate when the stock market is overbought and oversold. In simpler terms, it measures how strong or weak the market is on any given day.

Technical analyst Richard W. Arms developed the Arms Index formula in 1967 as a tool for gauging market sentiment. Investors still use TRIN indicators to track volatility and price movements. By looking for upward or downward trends in the TRIN and comparing them to other technical indicators, investors can potentially identify buy or sell signals.

Key Points

•   The Arms Index, also known as TRIN, measures stock market strength or weakness.

•   It was developed by Richard W. Arms in 1967 to gauge market sentiment.

•   TRIN calculates by dividing the Advance/Decline ratio by the Advance/Decline volume ratio.

•   A TRIN value above 1.0 suggests a bearish market, while below 1.0 indicates bullish conditions.

•   Investors use TRIN alongside other indicators to identify potential buy or sell signals.

What Is the Arms Index (TRIN)?

The Arms Index, Trading Index or TRIN for short is a breadth oscillator used to identify pricing and value trends in the stock market. Specifically, the index looks at two things: Advance Decline ratio and Advance Decline volume ratio.

The former represents the number of advancing and declining stocks while the latter represents advancing and declining stock volume.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

The TRIN Formula

TRIN = (Advancing stocks/Declining stocks) / (Composite volume of advancing stocks/Composite volume of declining stocks)

In this formula:

•   Advancing stocks refers to the number stocks trading higher

•   Declining stocks refers to the number of stocks trading lower

•   Advancing volume is the total volume of all advancing stocks

•   Declining volume is the total volume of all declining stocks

Investors use moving averages to smooth out the data and understand the relationship between the supply and demand for stocks during a given time period. The Arms Index aims to highlight bearish or bullish trends based on the relationship between the number of stocks being traded and the volume.

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

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

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

How to Calculate TRIN

To calculate TRIN, you’d simply apply the formula outlined earlier. Again, it looks like this:

TRIN = (Advancing stocks/Declining stocks) / (Composite volume of advancing stocks/Composite volume of declining stocks)

Here’s what calculating TRIN might look like in action:

•   Find AD ratio by dividing the number of advancing stocks by the number of declining stocks

•   Find AD volume ratio by dividing total advancing volume by total declining volume

•   Divide AD ratio by AD volume ratio

You’d perform these calculations over a set time period, recording each figure on a graph or chart as you go. For example, you might space the calculations out every few minutes, hourly or daily. You’d then connect each data point on your graph or chart to whether the TRIN is moving up or down.

Dive Deeper: How to Calculate AD Ratio

What Does TRIN Show You?

TRIN shows you the market’s volatility and the short-term direction of prices to help investors identify buying opportunities. When reading or interpreting TRIN data, you’re looking to see if it’s above 1.0 or below 1.0. This can tell you whether the market is bearish or bullish. A reading of exactly 1.0 is considered neutral.

For example, a reading below 1.0 is common when there are strong upward trends in price movements. Meanwhile, a reading above 1.0 is typical when there’s a strong downward trend. Here’s another way to think of it. When the reading is below 1.0 that means advancing stocks are driving volume but when it’s above 1.0, declining stocks are in the driver’s seat for generating volume.

You may also look at the direction TRIN is moving. A rising TRIN could indicate a weak market, while a falling TRIN may mean the market is getting stronger. Understanding how to read the data matters when determining whether the market is overbought or oversold at any given time.

Overbought

In stock trading, overbought means a stock is selling at a price above its intrinsic value. When the market is overbought, there’s generally a bullish attitude as investors keep buying in and driving up market capitalizations.

But a sell-off can happen if market sentiment turns negative. In that case, you get a reversal and prices begin to drop, potentially pushing market capitalizations down. Investors use the Arms Index or TRIN to spot this type of price movement trend and get ahead of a reversal before it happens.

Oversold

When an asset is oversold it means it’s trading below its intrinsic value. In other words, it’s trading for less than what it’s actually worth. This scenario can happen if an asset is undervalued for an extended period of time.

When investors assume the market is oversold, that can lead to an increase in buying activity. This, in turn, can drive stock prices up.

💡 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.

Example of Using TRIN

If you wanted to apply the TRIN in real time, you could do that using stock charts that illustrate technical indicators. So, say you want to track the movements of the S&P 500 Index for a single day, looking at prices in five-minute intervals. You begin calculating TRIN at 10:00 am, at which time it’s 1.10. This sends a sell signal to the market and prices begin edging down.

An hour later, you see that TRIN has dropped to 0.85 sending a buy signal. At this point, prices begin to move upward again. By following TRIN throughout the day you could see whether the upward trend looks like it will continue or whether it will eventually reverse. If you’re following the rule of “buy low, sell high“, you might want to time trades to correlate with stock price movements based on the trends forecasted by the TRIN.

How Is TRIN Different Than TICK?

The TRIN measures the spread or gap between supply and demand in the markets. The Tick Index or Tick Indicator shows the number of stocks trading on an uptick minus the number of stocks trading on a downtick. This trend indicator measures all of the stocks that trade on an exchange such as the New York Stock Exchange (NYSE) or Nasdaq.

Unlike Arms Index or TRIN, the Tick indicator does not factor in volumes. Instead, Tick index aims to pinpoint extreme buying or extreme selling on an intraday basis.

Is TRIN a Good Indicator?

The TRIN has both good points and bad points when used as an investment decision-making tool. No technical analysis indicator can yield precise answers when determining the best time to buy or sell.

It’s important to keep in mind that the Trading Index is just one indicator analysts use to evaluate the stock market and stock volatility. The TRIN is most helpful when used with other indicators in order to create a more comprehensive snapshot of the markets at a particular moment in time.

Pros of TRIN

The Arms Index or TRIN closely analyzes trends between advancing and declining assets. By comparing net advances to volume, it provides a picture of price movements. Volume can be a useful indicator in itself, as higher volumes can suggest more significant shifts in stock pricing.

The TRIN is forward-looking so it can be useful in forecasting which way the market will head next. By pointing out stocks that may be overbought or oversold, the indicator can provide investors with some direction when trying to buy the bottom or sell the top to maximize profits in the market.

Cons of TRIN

If the TRIN has one big flaw it’s that it may generate inaccurate readings because of the way the index accounts for volume. Specifically, you can run into problems when advancing volume falls short of expectations.

For example, say that on a given day the number of stocks advancing significantly outpaces the number of stocks declining. Meanwhile, the same trend happens with volumes, with advancing volume outstripping declining volume. When you calculate TRIN, the numbers could effectively cancel one another out, resulting in a neutral reading.

This can make it difficult to figure out if the market is trending bearish or bullish. For that reason, it may be helpful to apply a 10-day moving average (MA) to help even out the numbers and provide a more accurate picture of pricing trends.

How Investors Can Use TRIN

Technical investors can use the TRIN to analyze the market, decide whether to buy or sell, and when to make those trades to produce the best results. When using the index, you’re looking for clear markers of strength or weakness in the markets. By gauging overall market sentiment, it may become easier to make predictions about future prices.

The TRIN is, by nature, designed to monitor short-term trading activity so it may not work as well for spotting longer term trends. But you can use it to get a feel for whether the market is leaning more on the bullish or bearish side and how likely that trend is to either continue or reverse.

The Takeaway

The Arms Index or TRIN is an important concept to understand if you’re an active day trader using technical analysis. With technical analysis, you’re trying to find trends in the near term so that you can take action to capitalize 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).

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

Photo credit: iStock/Delmaine Donson

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.


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

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

SOIN0124090

Read more
May
18
2024
percent sign yellow background

How to Calculate Portfolio Beta

By | Growing Wealth, invest, Investing | Comments Off on How to Calculate Portfolio Beta

Portfolio beta refers to a popular metric that investors use to measure a portfolio’s risk, or its sensitivity to price swings in the broader market. While past performance does not indicate future returns, knowing a portfolio’s beta can help investors understand the price variability of their stocks, or how much their holdings may move if there’s stock volatility or big gains in a benchmark index like the S&P 500.

Investors often consider beta a measure of systematic risk, or risk that stems from the entire market and that investors can not diversify away. Macro events such as interest-rate or economic changes often fall into the category of systematic risk, while idiosyncratic, stock-specific risk includes events like a change in company management, new competitors, changed regulation, or product recalls.

Key Points

•   Portfolio beta is a metric used to measure the sensitivity of a portfolio’s returns to market movements, indicating its systematic risk.

•   To calculate the beta of a portfolio, the beta of each stock is multiplied by its proportional value in the portfolio, and these products are then summed.

•   Stocks with a beta greater than one are more volatile than the market, while those with a beta less than one are less volatile.

•   Negative beta values indicate an inverse relationship to the market, which can be characteristic of assets like gold or defensive stocks.

•   Understanding a portfolio’s beta is crucial for investors aiming to manage risk in alignment with their investment strategy and market outlook.

How to Calculate Beta of a Portfolio

The Beta of a portfolio formula requires relatively simple math, as long as investors know the Beta for each stock that they hold and the portion of your portfolio that each stock comprises.

Here are the steps you’d follow to calculate the Beta of a hypothetical portfolio:

1.    Calculate the total value of each stock in the portfolio by multiplying the number of shares that you own of the stock by the price of its shares:

Stock ABB: 500 shares X $20 a share each = $10,000.

2.    Figure out what proportion each stock in their portfolio represents by dividing the stock’s total value by the portfolio’s total value:

Stock ABB’s total value of $10,000/Portfolio’s total value of $80,000 = 0.125.

3.    Multiply each stock’s fractional share by its Beta. This will calculate the stock’s weighted beta:

Stock ABB’s beta of 1.2 X its fractional portfolio of 0.125 = 0.15.

4.    Add up the individual weighted betas.

Here is the whole hypothetical portfolio with a total beta of 1.22, benchmarked to the S&P 500. That means when the index moves 1%, this portfolio as a whole is 22% more risky than the index.

Stock

 Value

 Portfolio Share

 Stock Beta Weighted Beta
ABB $10,000 0.125 1.20 0.15
CDD $30,000 0.375 0.85 0.319
EFF $15,000 0.1875 1.65 0.309
GHH $25,000 0.3125 1.42 0.44375
Sum 1.22

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

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

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

4 Ways to Characterize Beta

Investors always measure a portfolio’s beta against a benchmark index, which they give a value of 1. Stocks that have a beta higher than one are more volatile than the overall market, and those with a beta of less than one are less volatile than the overall market.

Understanding beta is part of fundamental stock analysis. Once you know the beta of your portfolio, you can make changes in order to increase or decrease its risk based on your overall investment strategy by changing your asset allocation.

There are four ways to characterize beta:

High Beta

A high beta stock — one that tends to rise and fall along with the market often — has a value of greater than 1. So if a stock has a beta of 1.2 and is benchmarked to the S&P 500, it is 20% more volatile than the broader measure.

If the S&P 500 rises or falls 10%, then the stock would conversely rise or fall 12%. The same would be true for portfolio beta. While there’s more downside risk with high-beta stocks, they can also generate bigger returns when the market rallies – a principle of Modern Portfolio Theory.

Low Beta

A low beta stock with a beta of 0.5 would be half as volatile as the market. So if the S&P 500 moved 1%, the stock would post a 0.5% swing. Such a stock may have less volatility, but it also may have less potential to post large gains as well.

Still, investors often prefer lower volatility securities. Low beta investment strategies have shown strong risk-adjusted returns over time, too.

Negative Beta

Stocks or portfolios with a negative beta value inversely correlate with the rest of the market. So when the S&P 500 rises, shares of these companies would go down or vice versa.

Gold, for instance, often moves in the opposite direction as stocks, since investors tend to turn to the metal as a haven during stock volatility. Therefore, a portfolio of gold-mining companies could have a negative beta.

So-called defensive stocks like utility companies also sometimes have negative beta, as investors buy their shares when seeking assets less tied to the health of the economy. A downside to negative beta is that expected returns on negative beta securities tend to be weak – even less than the risk-free interest rate.

Zero Beta

A stock or portfolio can also have a beta of zero, which means it’s uncorrelated with the market. Some hedge funds seek a market-neutral strategy. Being market-neutral means attempting to perform completely indifferent to how an index like the S&P 500 behaves.

💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

How to Calculate an Individual Stock’s Beta

For investors, calculating the beta of all their stock holdings can be time consuming, and typically, financial data or brokerage firms offer beta values for stocks.

But if you wanted to calculate beta for an individual stock, you’d divide a measure of a stock’s returns relative to the broader market over a given time frame by a measure of the market’s return by its mean, also over a specific time frame. Here is the formula:

Beta = covariance/variance

Covariance is a measure of a security’s returns relative to the market’s returns.

Variance is a measure of the market’s return relative to its mean or average.

Alpha vs Beta vs Smart Beta

Beta is one of the Option Greeks, terminology frequently used by traders to refer to characteristics of specific securities or derivatives in the market. Another commonly used Greek term is Alpha. While beta refers to an asset’s volatility relative to the broader market, Alpha is a measure of outperformance relative to the rest of the market.

Beta also comes up a lot in the exchange-traded fund or ETF industry. Smart Beta ETFs are funds that incorporate rules- or factor-based strategies.

What Impacts Beta?

A variety of factors impact an asset’s beta. In general, stocks seen as riskier than average typically feature higher betas. Stock-specific factors such as debt levels, aggressive management, bold projects, volatile cash flows, and even ESG factors can influence a stock’s idiosyncratic risk. Higher business risk, while stock-specific, can lead to a more volatile stock price than the overall market, hence a higher beta.

Higher betas often appear in particular sectors. There are even investment fund strategies that play on beta – you can buy funds that exclusively own high beta or low beta stocks. A stock’s sector, industry, geographic location, and market cap size all impact a stock’s volatility and beta.

Cyclical and growth sectors like energy, industrials, information technology, and consumer discretionary often feature high betas. Utilities, consumer staples, real estate, and much of the healthcare sector typically have low beta.

Small caps and stocks domiciled in emerging-market economies also often have a higher beta (compared to the U.S. large-cap S&P 500).

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Important Things to Know About Beta

1.    A stock’s beta may change over time. Because beta relies on historical price data, it is subject to change.

2.    Beta is not a complete measure of risk. It can be a useful way for investors to estimate short-term risk but it’s less helpful when it comes to considering a long-term investment because the macroeconomic environment and company’s fundamentals may change. In some cases, beta is not the best measure of a stock or a portfolio’s risk.

3.    Beta is an input when investors are using the Capital Asset Pricing Model (CAPM) — a way to measure the expected return of assets taking into account systematic risk. It’s a method that also looks at the cost of capital for investors.

4.    The estimated beta of a stock will be less helpful for companies that do not trade as frequently. Thin liquidity for a stock may bias its beta value since there is less robust historical price data.

5.    Beta does not offer a complete picture of a stock’s risk profile as it’s linked to systematic risk. Investors must also consider stock-specific risk when managing their portfolios.

The Takeaway

As discussed, beta is a popular metric that investors use to measure a portfolio’s risk, or its sensitivity to price swings in the broader market. Knowing stock holdings’ betas can be important information when you’re building your portfolios.

You can calculate their portfolio beta using simple math as long as you’re able to obtain the individual betas for your stock holdings. While beta is a helpful tool to try to gauge potential volatility in a portfolio, its reliance on historical data makes it limited in measuring the complete risk profile of an asset or portfolio.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

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

FAQ

What is a good beta for a portfolio?

In a general sense, a good beta for a portfolio would be 1. That’s only a general guideline or rule of thumb, however, as it means that a portfolio’s value is roughly as volatile as the market overall.

What does a beta of 1.3 mean?

A beta of 1.3 means that a portfolio’s value is 30% more volatile than the overall market, which means its value will swing more wildly than the market.

Why is market portfolio beta 1?

Beta measures a portfolio or asset’s sensitivity relative to the overall market. If a portfolio’s beta is 1, it is equally as volatile as the market, not more or less so.

How do I reduce my portfolio beta?

Perhaps the simplest way to reduce your overall portfolio’s beta is to replace higher-beta assets within the portfolio with assets that have lower associated beta.

Is it possible to have zero beta portfolio?

It is possible, and would amount to a zero-beta portfolio, which means the portfolio itself has no systemic risk whatsoever. In other words, this portfolio would have no relationship to the overall movements of the market, and likely have low returns.

What is the difference between stock beta and portfolio beta?

A stock beta is a measure of an individual stock’s volatility, while portfolio beta is a measure of an overall investment portfolio’s volatility.

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.

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.
[cd_ETFs]
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.

SOIN0124081

Read more

CATEGORIES

  • All
  • No categories
Close modal

See what SoFi can do for you and your finances.

Select a product below and get your rate in just minutes.

Student Loan
Refinancing

Personal
Loans

Online
Investments

Other

Terms and conditions apply. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or other eligible status, be residing in the U.S., and meet SoFi's underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates reserved for the most creditworthy borrowers. If approved, your actual rate will be within the range of rates at the time of application and will depend on a variety of factors, including term of loan, evaluation of your creditworthiness, income, and other factors. If SoFi is unable to offer you a loan but matches you for a loan with a participating bank, then your rate may be outside the range of rates listed above. Rates and Terms are subject to change at any time without notice. SoFi Personal Loans can be used for any lawful personal, family, or household purposes and may not be used for post-secondary education expenses. Minimum loan amount is $5,000. The average of SoFi Personal Loans funded in 2023 was around $33K. Information current as of 2/26/24. SoFi Personal Loans originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org). See SoFi.com/legal for state-specific license details. See SoFi.com/eligibility for details and state restrictions.

✝ To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

©2024 Social Finance, LLC All rights reserved.
TLS 1.2 Encrypted
Equal Housing Lender