Nov
18
2024
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Guide to Yield to Maturity (YTM)

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Guide to Yield to Maturity (YTM)

When investors evaluate which bonds to buy, they often take a look at yield to maturity (YTM), the total rate of return a bond will earn over its life, assuming it has made all interest payments and repaid the principal.

Calculating YTM can be complicated. Doing so takes into account a bond’s face value, current price, number of years to maturity and coupon, or interest payments. It also assumes that all interest payments are reinvested at a constant rate of return. With these figures in hand, they will be better equipped to understand the bond market and which bonds will offer the greatest yield if held to maturity.

Key Points

•   Yield to Maturity (YTM) represents the total return expected from holding a bond until it matures, factoring in interest payments and principal repayment.

•   Calculating YTM involves the bond’s coupon rate, face value, current market price, and the time to maturity, making it a complex formula.

•   YTM is useful for comparing bonds with different characteristics, helping investors anticipate returns and understand interest rate risks associated with bond investments.

•   Limitations of YTM include assumptions about reinvestment of interest payments and the neglect of taxes, which can significantly affect actual returns.

•   Investors can utilize YTM as a tool for decision-making but should consider diversifying their portfolios and possibly consulting financial professionals for guidance.

What Is Yield to Maturity (YTM)?

The yield to maturity (YTM) is the estimated rate investors earn when holding a bond until it reaches maturity or full value. The YTM is stated as an annual rate and can differ from the stated coupon rate.

The calculations in the yield to maturity formula include the following factors:

•   Coupon rate: Also known as a bond’s interest rate, the coupon rate is the regular payment issuers pay bondholders for the right to borrow their money. The higher the coupon rate, the higher the yield.

•   Face value: A bond’s face value, or par value, is the amount paid to a bondholder at its maturity date.

•   Market price: A bond’s market price refers to how much an investor would have to pay for a bond on the open market currently. The price buyers pay on the secondary market may be higher or lower than a bond’s face value. The higher the price of the bond, the lower the yield.

•   Maturity date: The date when the issuer repays the principal is known as the maturity date.

The YTM formula assumes all coupon payments are made as scheduled, and most calculations assume interest will be reinvested.

💡 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.

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How to Calculate Yield to Maturity

Calculating yield to maturity can be done by following a formula — but fair warning, it’s not simple arithmetic!

Yield to Maturity (YTM) Formula

To calculate yield to maturity, investors can use the following YTM formula:

yield to maturity formula

In this calculation:

C = Interest or coupon payment
FV = Face value of the investment
PV = Present value or current price of the investment
t = Years it takes the investment to reach the full value or maturity

Example of YTM Calculation

Here’s an example of how to use the YTM formula.

Suppose there’s a bond with a market price of $800, a face value of $1,000, and a coupon value of $150. The bond will reach maturity in 10 years, with a coupon rate of about 14%.

By using this formula, the estimated yield to maturity would calculate as follows:

example of yield to maturity formula

The Importance of Yield to Maturity

Knowing a bond’s YTM can help investors compare bonds with various maturity and coupon rates, and ultimately, what their dividend yield could look like. For example, consider two bonds of varying maturity: a five-year bond with a 3% YTM and a 10-year bond with a 2.5% YTM. Investor’s can easily see that the five-year bond is more valuable.

YTM is particularly useful when attempting to compare older bonds sold in a secondary market, which can be priced at a premium or discounted — meaning they cost more or less than the bond’s face value. Understanding the YTM formula also helps investors understand how market conditions can impact their portfolio based on the investment they select. Since yields rise when prices drop (and vice versa) as seen on a yield curve, investors can forecast how their investment will perform.

Additionally, YTM can help investors understand how likely they are to be affected by interest rate risk — the danger that the value of a bond may be adversely affected due to the changes in interest rate. Current YTM is inversely proportional to interest rate risk. That means, the higher the YTM, the less bond prices will be affected should interest rates change, in theory.

Yield to Maturity vs Yield to Call

With a callable, or redeemable bond, issuers can choose to repay the principal amount before the maturity date, halting interest payments early. This throws a bit of a wrench into the YTM calculation. Instead, investors may want to use a yield to call (YTC) calculation. To do so, they can use the YTM calculation, substituting the maturity date for the soonest possible call date.

Typically a bond issuer will call a bond only if it will result in a financial gain. For example, if the interest rate drops below a coupon rate, the issuer may decide to recall the bond to borrow funds at a lower rate. This situation is similar to when interest rates drop and homeowners refinance their home loans.

For investors that use callable bonds for income, yield to call is significant. Suppose the issuer decides to call the bond when the interest rates are lower than when the investor purchases it. If an investor decides to reinvest their payout, they may have a tough time finding a comparable bond that offers the yield they need to support their lifestyle. They may feel it necessary to take on more risk, looking to high-yield bonds.

💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

Yield to Maturity vs Coupon Rate

While a bond’s coupon rate is another important piece of information that investors need to keep in mind, it’s not the same as yield to maturity. The coupon rate tells investors the annual amount of interest that a bond’s owner is set to receive — the two may be the same when a bond is initially purchased, but will likely diverge over time due to changing economic and market conditions.

Limitations of Yield to Maturity

The yield to maturity calculation does have limitations.

Taxes

It’s important to note that YTM calculations exclude taxes. While some bonds, like municipal bonds and U.S. Treasury bonds, may be tax exempt on a federal and state level, most other bonds are taxable. In some cases, a tax-exempt bond may have a lower interest rate but ultimately offer a higher yield once taxes are factored in.

As an investor, it can be especially helpful to consider the after-tax yield rate of return. For example, suppose an investor in the 35% federal tax bracket who doesn’t pay state income taxes is considering investing in either Bond X or Bond Y. Bond X is a tax-exempt bond and pays a 4% interest rate, while Bond Y is taxable and pays 6% interest.

While the 4% yield for Bond X remains the same, the after-tax yield for Bond Y is 3.8%. While it seemed like the less lucrative of the two options up front, Bond X should ultimately yield a higher return after taxes.

Presuppositions

Another YTM limitation is that it makes assumptions about the future that may not necessarily come to fruition. Specifically, it assumes that a bondholder will hang on to the bond until its maturity date, which may or may not actually happen. It also assumes that profits from the investment will be reinvested in a uniform manner — again, that may or may not be the case.

The Takeaway

Using the yield to maturity formula can help investors compare bond options with different coupon and maturity rates, market and par values, and determine which one offers the potential for a higher yield. But calculating the YTM is not an exact science, especially when you’re gauging the return on a callable bond, say, or adding the impact of taxes to the mix.

YTM is just one tool investors can use to determine which bond may best serve their financial needs and goals. One alternative to choosing individual bonds is to invest in bond mutual funds or bond exchange-traded funds (ETFs). Investors can also speak with a financial professional for guidance.

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

What is a bond’s yield to maturity (YTM)?

A bond’s yield to maturity is the total return an investor can anticipate receiving if the bond is held to its maturity date. YTM calculations assume that all interest payments will be made by the issuer and reinvested by the bondholder at a constant rate of interest.

What is the difference between a bond’s coupon rate and its YTM?

A bond’s coupon, or interest, rate is fixed from the moment an investor buys it. However, the same bond’s YTM can fluctuate over time depending on the price paid for it and other interest prices available on the market. If YTM is lower than the coupon rate, it may indicate that the bond is being sold at a premium to its face value. If it’s lower, it may be that the bond is priced at a discount to face value.

What is yield to maturity and how is it calculated?

Yield to maturity refers to the total return an investor can expect or anticipate from a bond if they hold it to maturity. It’s calculated using variables including the time to maturity, a bond’s face value, its current price, and its coupon rate.

Why is yield to maturity important?

The yield to maturity formula can give investors an idea of what they can expect in terms of returns from their bond holdings. But again, there are some assumptions the calculation takes into account, so an investor’s mileage may vary.

Is a higher YTM better?

A higher YTM may be better under certain circumstances. For example, since a higher YTM may indicate a bond is being sold for less than its face value, it may represent a valuable opportunity to invest. However, if the bond is discounted because the company that offered it is in trouble or interest rates offered by other investments are more appealing, then a high YTM might not be such a good thing. Investors must research investments carefully and understand the full story before they buy.

SoFi Invest®

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

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

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

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

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Portfolio Diversification: What It Is and Why It’s Important

By | Growing Wealth, invest, Investing | No Comments

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

Taking portfolio diversification to the next step — further differentiating the investments you have within asset classes (for example, holding small-, medium-, and large-cap stocks, or a variety of bonds) — may also be beneficial.

Building a diversified portfolio is only one of many financial tools that can help mitigate investment risk and improve performance. But there is a lot of research behind this strategy, so it’s a good idea to understand how it works and how it might benefit your financial plan.

Key Points

•   Portfolio diversification involves spreading investments across various asset classes, which can help reduce risk over time.

•   Understanding the difference between systemic and unsystematic risk is crucial, as diversification primarily mitigates unsystematic risk associated with specific companies or sectors.

•   A diversified portfolio can include a mix of equities, fixed income assets, real estate, and alternative investments, tailored to individual risk tolerance and investment goals.

•   Regularly reviewing and adjusting a portfolio’s asset allocation based on life stages and financial objectives is essential to maintain a suitable level of diversification.

What Is Portfolio Diversification?

Portfolio diversification refers to spreading a portfolio’s investments across asset classes, industries, sectors, geographies, and more, in an effort to reduce investment risk, as noted.

When you invest in stocks and other securities, you may be tempted to invest your money in a handful of sectors or companies where you feel comfortable. You might justify this approach because you’ve done your due diligence, and you feel confident about those sectors or companies. But rather than protecting your money, limiting your portfolio like this could make you more vulnerable to losses.

To understand this important aspect of portfolio management, it helps to know about the two main types of risk: Systemic risk, and unsystematic risk.

•   Systematic risk, or market risk, is caused by widespread events like inflation, geopolitical instability, interest rate changes, or even public health crises. You can’t manage systematic risk through diversification, though; it’s part of the investing landscape.

•   Unsystematic risk is unique or idiosyncratic to a particular company, industry, or place. Let’s say, for example, a CEO is implicated in a corruption scandal, sending their company’s stock plummeting; or extreme weather threatens a particular crop, putting a drag on prices in that sector. This is what may be referred to as unsystematic risk.

While investors may not be able to do much about systematic risk, portfolio diversification may help mitigate unsystematic risk. That’s because even if one investment is hit by a certain negative event, another holding could remain relatively stable. So while you might see a dip in part of your portfolio, other sectors can act as ballast to keep returns steady.

This is why diversification matters.

You can’t protect against the possibility of loss completely — after all, risk is inherent in investing. But building a portfolio that’s well diversified helps reduce your risk exposure because your money is distributed across areas that aren’t likely to react in the same way to the same occurrence.

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💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

What Should a Diversified Portfolio Look Like?

60:40 stock bond split returns 1977-2023

A fairly basic example of a relatively diversified portfolio may concern the 60-40 rule, which is a basic rule-of-thumb for asset allocation: You invest 60% of your portfolio in equities and 40% in fixed income and cash.

But that’s just one example. A portfolio can contain a broader mix of assets that includes stocks, bonds, alternative assets, real estate, and much more.

The mix you choose will likely be determined by factors such as your age, investment objectives, and/or risk tolerance. But this model reflects the basic principles of diversification: By investing part of your portfolio in equities and part in bonds/fixed income, you can manage some of the risk that can come with being invested in equities.

Stocks

You can fill your portfolio with stocks, and that would have some upsides and downsides. Most prominently, perhaps, is that stocks, compared to fixed-income assets, offer the potential for higher returns in exchange for higher risk.

If you’re invested 100% in equities, you’re more vulnerable to a market downturn that’s due to systematic risk, as well as shocks that come from unsystematic risk. By balancing your portfolio with bonds, say, which usually react differently than stocks to market volatility, you can offset part of that downside.

Of course, that also means that when the market goes up, you likely wouldn’t see the same gains as you would if your portfolio were 100% in equities.

Bonds

By the same token, if your portfolio is invested 100% in bonds offering a fixed rate of return, you might be shielded to a certain extent from market volatility and other risk factors associated with equities, but you likely wouldn’t get as much growth either.

Other Investments

As noted, you can also add other types of investments to the mix. While a typical portfolio may mostly comprise stocks and bonds, a smaller portion — maybe 10%-20%, just as an example — could hold real estate, or even cryptocurrencies. But again, there would ideally be a mixture of different types of those assets, too, in a diversified portfolio.

Again, a 60-40 portfolio is an example of simple diversification (sometimes called naive diversification) — which means investing in a range of asset classes. Proper diversification would have you go deeper, and invest in several different stocks (domestic, international, tech, health care, and so on), as well as an assortment of fixed income instruments.

Diversification Considerations for Different Stages

It’s also important to take your stage of life into account when considering how to diversify your portfolio and what asset allocation may be right for you.. Broadly speaking, the younger you are, the more risk you may be willing to take with your specific mix of investments (likely more stocks). While stocks may be more volatile and risky in the short-term, they tend to perform better than other lower-risk assets over the long-term.

The older you are, and the closer you are to retiring or needing to liquidate the equity in your portfolio, the less risk you may be willing to take.

Again, this will depend on the individual’s goals and risk tolerance, but consider the stage of your life and investing journey when deciding on your allocation and diversification strategy.

It may be a good idea to regularly review your allocation and change up your asset mix every few years, or work with a financial professional to make sure that your portfolio is aligned with your goals.

6 Ways to Diversify Your Portfolio

To attain a diversified portfolio, it’s important to think through your asset allocation, based on your available capital and risk tolerance. It’s also important to spread investments out within each asset class.

There can be a number of ways to diversify your portfolio, including (but not necessarily limited to) the following strategies.

Invest in a Range of Stocks or Index Funds

Diversifying a stock portfolio requires thinking about a number of factors, including quantity, sector, the risk profile of different companies, and so on.

•   Quantity. Instead of owning shares of just one company, a portfolio may have a margin of protection when it’s invested in many stocks (perhaps dozens or even hundreds).

•   Sector. You may want to think about a range of sectors, e.g. consumer goods, sustainable energy, agriculture, energy, and so on.

•   Variety. Variety is the spice of life, as they say, and variety in the types of stocks you are selecting is also an important factor. A mix of small-, mid-, and large-cap companies may offer diversification. Small-cap stocks, which might include startups, for example, have the potential to offer substantially higher returns than more stable large-cap companies, but they also come with greater risk.

You can further diversify by style. Some investors may opt for a mix of cyclical versus defensive companies, those closely tied to economic growth cycles versus ones that aren’t. Some investors may prefer value vs. growth stocks, companies that are underpriced rather than those that demonstrate faster revenue or earnings growth.

One common way to diversify a stock portfolio is to avoid picking individual stocks and invest instead in a mutual fund or exchange-traded fund (ETF) that offers exposure to dozens of companies or more. This is known as passive investing, as opposed to active. But it can be an effective way to diversify.

Invest in Fixed Income Assets, Such as Bonds

Investing in bonds is a good way to diversify your portfolio because they tend to perform very differently from stocks. Bonds offer a set interest rate, and though bond yields can be lower than the return on some stocks, you can generally predict the income you’ll get from bond investments.

Bonds tend to be less risky than stocks, but they aren’t risk free. They can be subject to default risk or call risk — and can also be subject to market volatility, especially when rates rise or fall. But bonds generally move in the opposite direction from stocks, and so can serve to counterbalance the risk associated with a stock portfolio.

You can diversify your mix of bonds, as well. High-yield bonds offer higher interest rates, but have a greater risk of default from the borrower. Short-term Treasury bonds, on the other hand, tend to be safer, but the return on investment isn’t as high.

You may also consider specific types of bonds, such as green bonds, which typically invest in sustainable organizations or municipal projects, or municipal bonds, which can offer tax benefits. And you can expand your options, and create more diversification, when you invest in bond mutual funds, or exchange-traded bond funds.

Consider Investing in Real Estate

Real estate may provide a hedge against inflation and tends to have a low correlation with stocks, so it can also provide diversification. The housing market and equity market can influence each other — case in point: the 2008 recession, when widespread troubles in real estate led to a stock market crash. But they don’t always have such a strong relationship. When stocks or bonds drop, real estate prices can take much longer to follow.

Conversely, when the markets improve, housing can take a while to catch up. Also, every real estate market is different. Location-specific factors that have nothing to do with the broader economy can cause prices to soar or plummet. Real estate can also be unpredictable and comes with risk, such as illiquidity and changing property values, which is something to keep in mind.

These are all factors to consider when investing in real estate. In addition, there are different types of investments, like Real Estate Investment Trusts (REITs), which can provide exposure to different types of properties without you having to own them.

Alternative Investments

While stocks, bonds, and cash equivalents are among the most common investments, you can diversify your portfolio by putting money into alternative investments, such as commodities, private credit, private equity, foreign currencies, and real estate, mentioned above. Alternatives can also include collectibles, such as art, wine, cars, or even non-fungible tokens (NFTs).

Alternatives have a low correlation with conventional assets, and have the potential to offer investors higher returns. Of course, knowing something about the area you want to invest in, or doing a bit of research, is likely a good idea before you get started.

However, alternative investments can be particularly risky compared to other types of assets. Their values may be particularly volatile and subject to a variety of factors, and it’s possible that some investors may even find themselves being targeted as a part of a scam — which is common, for instance, in the crypto space. Remember that though alternative investments may offer the opportunity to secure high returns, they can also subject investors to high potential losses.

Short-term Investments and Cash

Another possibility is to opt for low-risk short-term investments, such as certificates of deposit (CDs). A CD is a savings account that requires you to keep your funds locked up for a set amount of time (typically a few months to a few years). In exchange it pays you a fixed interest rate that may be higher than a traditional savings account.

A diversification strategy can also involve holding some funds in cash, just in case the bottom falls out on other investments.

International Investments

Another strategy for diversification is to invest in both U.S. and foreign stocks. Spreading out your investments geographically might protect you from market volatility concentrated in one area. When one region is in recession, you may still have holdings in places that are booming. Also, emerging and developed markets have different dynamics, so investing in both can potentially leave you with less overall risk.

Why Is Portfolio Diversification Important?

Diversification is important mainly because it can help investors mitigate risk. Although creating a well-diversified portfolio may help improve performance, risk minimization is the true end of diversification efforts.

Of course past performance is no guarantee that outcomes of those portfolio allocations will be the same in the future. But the research is interesting in that it suggests certain strategies might be effective in mitigating risk.

Introducing greater diversification, by way of bonds and fixed income instruments, actually may create a portfolio with similar returns, but lower volatility over time.

💡 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.

Pros and Cons of Diversification

As with any investment strategy, diversification has its pros and cons.

Pros

The clearest benefit, or pro, to diversification is that it may help reduce risk in a portfolio. That can create a smoother ride, so to speak, for investors during times of high market volatility, and there is also evidence, as discussed, that diversified portfolios can provide equal or better returns over time.

Cons

The drawbacks to diversification include the fact that short-term gains may be limited by a more risk-averse approach. It can also take more time and energy to manage your portfolio, or to check in and consider your allocation — although that will depend on your specific strategy.

The Takeaway

Portfolio diversification is one of the key tenets of long-term investing. Instead of putting all your money into one investment or a single asset class like stocks or bonds, diversification spreads your money out across a range of securities. Investors should make sure they vary their investments in a way that matches their goals and tolerance for risk.

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

What is an example of a well-diversified portfolio?

An hypothetical example of a well-diversified portfolio could be one used by hedge fund founder Ray Dalio, who constructed an example portfolio that includes 30% stocks, 40% bonds, 15% U.S. bonds, 7.5% gold, and 7.5% other commodities. Again, this is just one example, and this particular mix is likely not ideal for many investors.

What are the dangers of over-diversifying your portfolio?

The main risk associated with over-diversification is that you stymie your portfolio’s potential gains while seeing diminishing returns in terms of risk mitigation. In other words, you cost yourself potential gains while not meaningfully reducing risk.

When should you diversify your portfolio?

It may be a good idea to diversify your portfolio as soon as you start investing. Further, you can repeatedly check your allocation at regular intervals, to ensure you’re properly diversified in accordance with your risk tolerance, age, and goals.

SoFi Invest®

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

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

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


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

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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2024
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When Is the Stock Market Closed?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on When Is the Stock Market Closed?

The stock market is closed on weekends and many holidays. Accordingly, in a general sense, investors can buy and sell stocks Monday through Friday between 9:30am-4pm ET, but the exact schedule can vary based on time zone, market, and holiday season. Additionally, the major stock exchanges may close or stop trading unexpectedly due to several reasons, like natural disasters or technical glitches. It’s all a part of how the stock markets work.

While a person can always access stock market data, the stock exchanges have strict operating hours during a typical work week. Knowing the stock market schedule and when the stock market is closed may help investors make better investment decisions.

Key Points

•   The stock market operates Monday through Friday, with core trading hours from 9:30 AM to 4 PM ET, and is closed on weekends and holidays.

•   Major U.S. holidays when the stock market is closed include New Year’s Day, Independence Day, Thanksgiving, and Christmas, among others.

•   The stock market may also close unexpectedly due to crises, technical issues, or to honor significant events, such as the passing of notable figures.

•   Trading curbs, which temporarily halt trading, are triggered by significant drops in the S&P 500 Index, with varying levels based on the severity of the decline.

•   Extended trading hours are available for premarket and after-hours trading, but these periods carry higher risks due to lower liquidity and increased volatility.

U.S. Stock Market Holidays

Even with standard operating hours, stock markets will close their markets completely for certain holidays. The New York Stock Exchange and Nasdaq recognize the following holidays:

•   New Year’s Day

•   Martin Luther King, Jr. Day

•   Washington’s Birthday

•   Good Friday

•   Memorial Day

•   Juneteenth National Independence Day

•   Independence Day

•   Labor Day

•   Thanksgiving Day

•   Christmas Day

Additionally, the stock market closes early (at 1pm ET) on the following dates:

•   Black Friday

•   Christmas Eve, if the holiday falls on a weekday

Stock exchanges in other countries might have different national holidays and operating schedules. Investors can buy and sell stocks or other securities during open market hours outside of these major holidays.

Is the Market Closed the Following Monday After a Holiday?

For holidays with a fixed date, like Juneteenth (June 19), Independence Day (July 4), and Christmas (Dec. 25), the stock market will be closed on the preceding Friday if the holiday falls on a Saturday or the following Monday if the holiday falls on a Sunday.

However, if New Year’s Day (Jan. 1) falls on Saturday, the holiday is not observed; the stock market will be open on the preceding Friday and the following Monday.

Other Times the Stock Market Closes or Is Halted

In addition to planned holidays, historically, the stock market has closed trading in times of crisis or technical challenges.

For example, at the beginning of the Covid-19 pandemic in early 2020, markets were halted multiple times due to unprecedented drops in the market. Called trading curbs or circuit breakers, these are temporary pauses mandated by the Securities and Exchange Commission in 2012. Each level follows different criteria:

•   Level 1: A 7% drop in the S&P 500 Index compared to closing the day before will trigger the market to be paused for at least 15 minutes.

•   Level 2: A 13% drop in the S&P 500 compared to closing the day before will trigger at least a 15-minute pause in the market.

•   Level 3: A 20% drop in the S&P 500 compared to closing the day before will trigger a premature close on trading for the rest of the day.

Trading curbs can occur for a single stock and a whole market. It’s more common for the curb to be tripped on a single stock, but unprecedented events can spark a whole market pause. Covid-19 caused three trading curbs in just over a week.

The stock market may also close unexpectedly due to unprecedented events. For example, the terrorist attacks of Sept. 11, 2001, caused the NYSE to close for a week, while Superstorm Sandy forced the NYSE to close for two days in Oct. 2012.

Additionally, the markets may close down to honor the death of a world figure, as was the case with George H.W. Bush and Martin Luther King Jr.

The market has also closed unexpectedly due to technical glitches and cybersecurity threats; in July 2015, the NYSE temporarily stopped trading because of a technical issue on the floor.

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Stock Market Operating Hours

In the United States, the major stock exchanges are generally open Monday through Friday, with core trading hours between 9:30am-4pm ET. The stock market does not operate during the weekend.

Because the different stock exchanges operate on eastern time, these trading hours are different throughout the U.S., depending on time zones and daylight savings time.

However, with so many global stock exchanges, a market may always open if an investor is interested in trading in foreign markets. Most markets operate during their time zone’s business hours.

Recommended: Pros & Cons of Global Investments

Why Does the Stock Market Close Each Day?

The stock market closes each day for several reasons, notably because it allows for the settlement of all trades that have occurred. The close gives market professionals time to calculate the day’s trading results and prepare for the next day.

Additionally, the stock market close is helpful for investment brokers and traders to catch up on paperwork and other administrative tasks.

While the stock market closes each day at 4pm in the United States, other markets, like cryptocurrency and foreign exchange markets, offer trading 24 hours a day.

Recommended: Is 24/7 Stock Trading Available?

When Does the Market Open for Premarket Trading?

The market opens for premarket trading at 4 am ET and operates until 9:30 am ET.

While most stock trading occurs during the normal 9:30am-4pm ET operating hours, investors can also take advantage of extended-hours trading. Investors may be interested in trading during the premarket because of the release of economic data, company earnings reports, and other major news events.

Investors must use an alternative trading system known as electronic communication networks (ECNs) to make trades during premarket trading.

However, investors must be aware of the risks associated with premarket trading. Because fewer buyers and sellers operate during the early hours, there is lower liquidity and higher volatility.

Premarket trading probably isn’t for a beginner investor; if you don’t need to buy or sell a stock immediately, you might prefer to wait until regular trading hours.

After-Hours Trading

The closing bell for the major U.S. stock exchanges might ring promptly at 4 pm ET, but there’s still after-hours trading: it’s possible to buy, sell, and trade stocks between 4pm-8pm ET. Electronic trading tools like ECNs mentioned above make it possible to conduct business after hours, but making moves during after-hours trading comes with its own risks, just like during premarket trading.

The Takeaway

Investors should be aware that the stock market is closed on weekends, designated holidays, and for world events and other disruptive circumstances. When the stock market is open, the exchanges generally operate on a 9:30am-4pm ET schedule, Monday through Friday.

Knowing when the stock market is open and closed can allow investors to strategize the best time to make trades and investments.

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

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

Is the stock market closed on holidays?

The stock market is generally closed on New Year’s Day, Martin Luther King Jr. Day, Presidents’ Day, Good Friday, Memorial Day, Juneteenth National Independence Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.

When is the stock market closed and opened?

The stock market in the United States is closed on weekends and some holidays. The stock market is generally open Monday through Friday from 9:30am-4pm ET.

Is the stock market open for extended hours?

The stock market is open for extended hours, from 4am-9:30am ET for premarket trading and 4pm-8pm for after-hours trading. However, trading during this period can be risky.

SoFi Invest®

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

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

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

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

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18
2024
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What To do With an Inheritance: A Comprehensive Guide

By | Growing Wealth, Investing | No Comments

Getting an inheritance can usher in a wide range of emotions.

On one hand, you’ve just lost someone close to you, and that can be very difficult to process and deal with. On the other hand, inheritance money can change lives for the better. Who hasn’t dreamed of getting a chunk of change to put toward their financial dreams?

But receiving a sudden windfall can also be unexpectedly stressful. If you mismanage an inheritance, it could leave you back where you started financially, or even create new financial problems for you.

It’s crucial to think carefully about what to do with an inheritance, and to consider all your options before you act. From paying off debt to buying a home to investing the inheritance, there are many ways to use your inheritance that may help you get ahead financially.

Here are some ideas for what to do with an inheritance, including how to think about this new money and how to invest your inheritance in your financial goals.

Key Points

•   Receiving an inheritance can be emotionally complex, requiring time to grieve before making any immediate financial decisions regarding the funds.

•   Strategically considering how to honor the loved one’s legacy while managing the inheritance can provide meaningful guidance in financial planning.

•   Consulting financial professionals such as advisors or accountants is advisable to navigate the complexities of managing inherited wealth effectively.

•   Different strategies exist for utilizing inheritance funds, including saving for emergencies, paying off debts, or investing in retirement and education.

•   Understanding potential tax implications associated with inherited assets, such as capital gains taxes and estate taxes, is crucial for effective financial management.

First Steps After Receiving an Inheritance

If you receive an inheritance, first take a breath and just sit with the news for a bit. Don’t do anything rash or you might end up regretting it.

The Importance of Slowing Down

It’s wise to take it easy right now. You’ve just lost someone close to you and you are still dealing emotionally with that. Give yourself time to grieve before making any major decisions about what to do with an inheritance. In most cases, you don’t have to do anything about the inheritance immediately, so don’t feel pressured to act right away. Instead, take your time and be strategic.

For instance, you could put the money in a high-yield savings account for the time being. Then, when you’re ready, you can start mapping out a plan for the funds.

Paying Tribute: Honoring Their Legacy in Your Decisions

Your loved one worked hard to earn or accumulate the money you’ve inherited. Take some time to feel gratitude toward them and what they’ve done for you.

Think about how they might want you to spend the money. Would they want you to put it toward your retirement savings? Buy a house so you can finally stop renting? Keeping your loved one top of mind as you plan what to do with the money, might help give you purpose and hold you accountable so that you don’t spend the inheritance frivolously.

Building Your Support Team: Financial Advisors, Lawyers, and Accountants

Inheriting money can be confusing since you probably aren’t quite sure how the process works. And you may not know the best thing to do with the funds. That’s why having some support, such as estate lawyers, accountants, or financial advisors, might be wise, especially if you’re inheriting a large sum.

But be an active participant in the process. Ask these professionals for their input and suggestions and then carefully weigh the different options. You need to make the decisions that are best for you and your situation.


💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Managing a Cash Inheritance

Receiving a cash inheritance is a great reason to sit down and review your financial situation and assess your current needs and priorities. Looking at your financial statements — including your income, expenses, assets, and liabilities — might be the easiest way to start.

Taking some time to think about your short-term and long-term financial goals may help define your values and guide you as you determine the best course of action for saving and investing the money. How you ultimately invest an inheritance will depend on your financial goals.

Strategies for Small, Medium, and Large Sums

What you do with your inheritance may depend on how much you inherit. If it’s a small sum, you may want to put it toward a downpayment on a house, for example. Or you could use it to build up an emergency fund.

If you inherit a medium-size sum, you may want to earmark it for your children’s college education. Or you could put it toward your own retirement savings.

And finally, if you inherit a large sum, you may want to do several different things with the money. For instance, you may decide to invest a chunk of it for your future. And you might use another portion if it to pay off your mortgage or other debts you have. Perhaps you want to donate some to charity. You could even use some of the money to take the vacation you’ve always dreamed of.

Balancing Savings, Debt Repayment, and Investments

It could be wise to make several financial moves with your inheritance to help secure your future. That way you can balance your different priorities.

Some of the money could go into your emergency savings fund so that you have a robust financial cushion in case you need it.

Another portion might go toward paying off debt, such as credit card or student loan debt. This can help free up your cash flow and even help you save more money for your future.

And you could invest the rest for retirement. You can explore the different types of retirement accounts that you may be eligible for to find the right options for you.

Retirement, Education, and Emergency Fund Priorities

Saving and investing for retirement could be an excellent use of inheritance money. As mentioned above, the first step is determining which type of account to open.

Because inherited money is not earned income, you cannot put it directly into a retirement account like a traditional or Roth IRA. However, you could open a brokerage account and build an investment portfolio for retirement. You may want to consider stocks, mutual funds, exchange-traded funds (ETFs), or a mix of all three in your portfolio.

Another priority for your inheritance might be your children’s college education. You could consider using your inherited money to fund a college savings account or invest towards your child’s future educational costs.

This can be done through a 529 plan, a prepaid tuition plan, or a Coverdell education savings account. A 529 plan allows for tax-free investment growth when the money is used for higher education expenses.

Each state has its own 529 plan, but you’re not required to use the plan for the state for which you live. Some states may offer a state income tax deduction if you use their state’s plan, so check with the plan (or your tax advisor) to be sure.

Another way you may want to use inherited money is building up an emergency fund. Just like it sounds, an emergency fund is cash, typically held in a savings account, that’s available in the event of an emergency, such as a sudden, unexpected expense like a car accident or a root canal. Having the cash available to cover such an expense may help you avoid going into credit card or other debt in the future.

While it’s ultimately up to you to determine how much money to keep in an emergency fund, you may want to consider having the recommended three to six months’ worth of expenses in the bank. This amount may help cover you in the event you are laid off from your job and need time to find a new opportunity.

Investment Opportunities for Inherited Wealth

Once you’ve paid off any debts you owe and allocated money to an emergency fund and possibly to your children’s college funds, you may want to invest the rest for your future financial goals.

Diversifying Investments: Stocks, Bonds, and Funds

Building a diversified, balanced portfolio with investments that have different degrees of risk is one strategy to consider. Diversification may help mitigate risk, though it’s important to remember that there is still risk involved with investing. Some investments with different levels of risk to explore are stocks, bonds, and mutual funds. Stocks are considered more volatile — they may potentially offer higher growth but also have higher risk — while bonds typically have lower risk and smaller returns. Mutual funds typically include a mix of stocks and bonds.

Tax-Advantaged Accounts and Minimizing Tax Burden

Inheritances are not considered taxable income for federal taxes. However, any earnings on your inherited assets are generally taxable.

Some of the most popular types of accounts that may offer tax advantages include IRAs and 401(k)s. Inheritance money per se cannot be invested in these accounts (because it’s not earned income). However, the additional money you get from an inheritance might give you the flexibility to use your income to open an IRA or contribute more to your 401(k) at work.

Here’s how: If you use inheritance money to pay down debt or pay bills, such as your mortgage, you may be able to afford to invest more of your earned income in a retirement account. Because some of these accounts are tax deferred, including traditional IRAs and 401(k)s, they may also help reduce your tax burden.

Real Estate Investments: Pros, Cons, and Considerations

If you’re thinking about investing your inheritance in real estate, you might want to consider a real estate investment trust (REIT). A REIT is a company that owns or operates properties that generate income. With a REIT, you can invest in real estate properties without having to buy actual properties and manage them yourself.

But REITS do come with risks. For instance, REITs tend to be very sensitive to changes in interest rates. When rates rise, the value of a REIT can fall. Also, commercial properties can be affected by trends. For instance, if a REIT focuses on a type of store that suddenly becomes less popular with consumers, your investment could take a hit.


💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

How to Handle Inherited Properties and Valuables

Part of your inheritance might include a house, a car, antiques, or jewelry. These can all be financially beneficial, depending on their value. But they can also pose challenges since you will need to decide what to do with them.

Decisions for an Inherited House: Sell, Rent, or Move In?

If you inherit a house, for instance, the big decision you’ll face is whether to move into it, rent it, or sell it.

Selling the house will provide you with a profit. You could then use that money to pay debt or invest for the future. There may also be a tax benefit. That’s because inherited homes have a step-up tax basis. That means you don’t pay taxes on the full amount of the home, but only on any amount it sold for that’s more than what the home was worth on the date your loved one died. So if the house was worth $300,000 at the time your relative died, and you sell it for $375,000, you only pay taxes on $75,000.

Just remember that you’ll have to empty out the house and get it ready to sell. You’ll also need to pay the utilities, mortgage, taxes, etc. until the house sells.

You can rent out the home instead, which could potentially give you steady rental income. However, you will need to manage the property and take care of maintenance and repairs. This could be tricky if you don’t live nearby. And even if you do, it can be time consuming. You’ll also need to figure out the tax implications of renting out the house, which may be complicated.

Finally, you may choose to move into the house. This might be a good option for you if you haven’t been able to afford buying a home of your own previously. Just remember that while you won’t have to pay a mortgage, you will have to pay such ongoing expenses as real estate taxes and homeowner’s insurance.

Inherited Vehicles and Heirlooms: Assessing Value and Sentiment

If you inherit a vehicle like a car, you’ll need to decide whether to keep it or sell it. Your decision will likely depend on the age of the vehicle and the shape it’s in. It will also hinge on whether you need or want a new car. You might be perfectly happy with your own current vehicle. In that case, you could sell the inherited car and make a profit from it.

Deciding what to do with inherited items that have sentimental value as well as monetary value — such as jewelry, antiques, or a relative’s prized collection — can be more difficult. You may feel an attachment to these items. Wait a bit before making a decision about them and give yourself time to think through the best course of action. For instance, you might want to hold onto a few items that have special meaning to you and sell the rest. Or perhaps you’ll decide you’re not ready to part with them and you’ll keep them all. Do what feels right to you.

Tax Implications of an Inheritance

There are two types of taxes related to an inheritance: estate taxes and inheritance taxes.

Estate and Inheritance Taxes: What You Need to Know

The federal government does not impose an inheritance tax. That means you won’t have to pay federal taxes on your inheritance. But keep in mind that any earnings you make from your inheritance are subject to taxes.

Some states have inheritance taxes that you may need to pay. To find out if your state is one of them, check with the state department of taxation. You might also want to consult a tax professional.

Estate taxes are a different matter. These taxes are not levied against you, the person inheriting money. Instead, they are levied against the estate of the deceased person. However, unless the estate is extremely large ($12.92 million or more in 2023, and $13.61 in 2024), the estate won’t have to pay federal estate taxes.

Capital Gains Tax: How It Affects Your Inherited Assets

Capital gains taxes are something you typically pay when you sell inheritance assets and make money on them. Thanks to what’s known as a step-up in basis, the value of the item you inherit is adjusted to its value on the date of your loved one’s death.

For example, if you inherit a house your mother bought for $100,000 and the house is worth $500,000 on her date of death, the value of the house is adjusted to $500,000. If you sell the house for that amount, there are no capital gains. If you sell the house for more than $500,000 you pay capital gains on anything over that amount.

In addition to real estate, this rule also generally applies to other things you inherit, such as stocks, mutual funds, bonds, and collectibles.

Capital gains taxes can be quite complicated, so you may want to consult a tax professional to make sure you report and pay these taxes properly.

Leveraging Professional Financial Advice

Dealing with an inheritance and all it involves can be overwhelming. A trusted advisor could help you decide what to do with the money in order to make the most of it.

Choosing the Right Advisor for Your Inheritance Needs

You may want to begin your search for an advisor with the person or people associated with the estate before it was passed along, such as the estate’s executor or a trustee.

That said, you’ll want to be certain that this person is a “fiduciary,” which means that they always act in your best financial interest.

Another option is to directly hire a financial advisor. When choosing a financial advisor, you can start by asking family, friends, and colleagues for recommendations. You can also consult industry associations such as the National Association of Personal Financial Advisors or the Financial Planning Association

The Role of Financial Planning in Estate Inheritance

A financial planner can help you create a financial plan for your inheritance based on your financial goals and your current situation.

A good financial plan can help you make the most of your money. It can allocate money to help you pay down debt and to create an emergency fund. It can also help you manage your inheritance assets. For instance, you might choose to put some of the money in investments to help reach future financial goals such as buying a house or saving for retirement.

Inheriting money requires careful decision making. That’s why having a solid financial plan in place can be so useful. It can help you stay on track to meet your goals.

Avoiding Common Mistakes with Inherited Wealth

When you receive an inheritance, it’s wise to take some time to decide the best course of action to take. This can help prevent you from doing something you may regret later. These are some common mistakes to avoid:

Failing to put together a solid financial plan. A good plan lays out your financial goals and priorities. It can help you pay off debt now and save money for your future. Without such a plan, you might end up frittering away a chunk of your inheritance before you realize it.

Making emotional decisions. Dealing with the loss of a loved one is difficult, and emotions could cloud your judgment about what to do with your inheritance. Don’t make rash decisions. Instead, put the money someplace safe for the time being, like a high-yield savings account, and give yourself time to grieve before making major decisions.

Spending too much. You may be tempted to use your windfall to purchase a boat or buy a luxury car. While these purchases are fun, they won’t help you in the long-term the way paying off debt or saving for your retirement will. Plus, cars and boats require ongoing maintenance — and even storage in the case of the boat — that you’ll need to keep paying for.

If you’re not careful, you could end up burning through your entire inheritance and not have a lot to show for it. Instead, create a financial plan as outlined above. In your plan you can set aside a small part of your inheritance for fun spending. For instance, maybe you dedicate 5% or 10% of the amount you inherited to taking that trip to Italy you’ve always dreamed of. That way you’ll be able to enjoy some of the money now and save and invest the rest for the future.

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

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


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

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18
2024

How Are IPO Prices Set?

By | Growing Wealth, invest, Investing | Comments Off on How Are IPO Prices Set?

Before listing a stock for sale on a public exchange, companies undergo a rigorous process of preparation and compliance — which includes a suggested starting price for the shares they plan to sell in their initial public offering (IPO).

This price then creates an IPO valuation for the company.

Companies and their bankers use a variety of factors and steps to determine the IPO price. Here’s a closer look at the IPO valuation process.

Key Points

•   The IPO process involves a rigorous preparation phase, where companies set a suggested starting price for shares before going public.

•   Investment banks analyze various factors like market conditions and growth potential to establish the IPO price, which is aimed at attracting investors.

•   Companies typically go public to raise capital, enhance visibility, and provide liquidity for early investors, though they may face new challenges post-IPO.

•   The initial public offering price is distinct from the opening price; the latter may fluctuate based on market demand once trading begins.

•   Investing in IPOs can be risky due to potential volatility, making it crucial for investors to assess their financial goals and risk tolerance before participating.

What Is IPO Price?

An IPO price is the price at which a company’s stock is sold to accredited and institutional investors right before the stock trades on a public exchange. The purpose of the public offering price is to attract investors to buy the shares.

IPO stocks are considered high-risk investments, and while some companies may present an opportunity for growth, there are no guarantees. Like investing in any other type of stock, it’s essential for investors to do their due diligence.

The investment banks that underwrite a company’s public offering set the IPO price, using several variables including an analysis of the company’s growth potential, a comparison to related firms, and a determination of market demand conditions.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

Initial Public Offerings 101

When privately owned companies, such as unicorn companies, begin to sell shares of stock to the public, they hold an initial public offering, or IPO. Before an IPO, companies are usually owned by the founders, employees, and early investors, such as venture capital firms and angel investors. The process of selling shares to investors is called going public. Typically the initial offering is limited, and there are a number of people eligible for those shares first.

For this reason, it can be difficult for individual investors to buy IPO stock when it’s first issued. In most cases, individuals can trade IPO shares on the secondary market through their brokerage. In some cases, a brokerage may set certain requirements in order for individual investors to buy shares.

An IPO can help a company raise significant capital. It can also be a source of publicity. However, the IPO process is also time-consuming and expensive. Once a company has gone public, it faces new challenges such as regulatory scrutiny and an increased need to please shareholders.

Recommended: What Is an IPO and How Does it Work?

Why Do Companies Go Public?

The main reason companies choose to go public is to raise money. Holding an IPO can create significant value for a company and its management. In some cases, IPOs raise millions and even billions of dollars for the company, but some companies also face losses after an IPO.

Bringing in public investment benefits the business, but it also benefits early investors. These initial investors, who have invested time and money in a company, can sell their shares following an IPO, unlocking shareholder value.

An IPO can also benefit employees of the company. That’s because when an individual joins a company, sometimes they are granted employee stock options. Companies will often give early employees the options over several months or years — a process called vesting. Usually, employees must wait to sell their vested stock until the end of a lock-up period — a period after an IPO during which employees have to wait before selling their shares.

Other reasons companies go public are to gain media attention, grow a broad base of financial supporters, and create a windfall for venture capital firms that helped fund the company in its early stages.

The number of publicly traded, exchange-listed companies in the U.S. has decreased from the peak in the mid-to-late 1990s when it reached about 8,000. In 2021, the figure was closer to 6,000 companies that traded on different stock exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq.

Steps in IPO Valuation

When a company decides to hold an IPO, they work with an investment bank to determine the company’s IPO valuation. The process of investment bankers handling an IPO is called underwriting.

How Underwriting Works in IPOs

Each underwriting process can be slightly different, but investment bankers’ factors in determining IPO prices and valuations are essentially the same. Some questions include:

•   Why has the company decided to go public?

•   What is the current status of the market?

•   Who are the company’s competitors?

•   What are the company’s assets?

•   How much has been invested in the company and by whom?

•   What is the history of the company and its team?

•   What are the company’s prospects for growth?

Recommended: What Is IPO Due Diligence?

Process of Determining IPO Prices

The rules of supply and demand apply to how the company and its underwriters will set an IPO price. Essentially, the underwriters must determine the demand for the shares based on the supply of shares that will be offered and sold to investors. These underwriters try to figure out what investors are willing to pay for each share of a company when it decides to go public.

To create a balance in this tradeoff that makes both existing and new investors happy, the company must decide how many new shares to issue and the estimated IPO price they plan to sell each share. The company’s executives and their investment bank determine the number of new shares by deciding how much money they hope to raise and how much ownership they are willing to give up.

Institutional Investors in IPO Process

Once executives and bankers decide on the number of new shares to issue, they reach out to institutional investors to start asking them how many shares they are interested in buying. Institutional investors include hedge funds, mutual funds, high net worth individuals, and pension funds in good standing with the investment bank.

Days before the IPO, the institutional investors place requests for how many shares they actually want to purchase. The company and its investment bankers then set the price for the IPO, and they know how much money they will raise.

The underwriting investment bank goes through the complex process of selling and allocating all the newly public shares to the institutional investors. They want to create a balance of different types of investors.

Retail Investors in IPO Process

Unfortunately for the at-home retail investor, it can be difficult to buy a stock at its IPO price. However, some brokerage platforms, like SoFi, have started to offer IPO Investing services that allow individuals to buy closer to the IPO price.

Determining Opening Price Point

Before the first day of trading, the stock exchanges on which the company decides to list look at all the incoming orders for the newly issued stock, which may be either buy or sell orders, and report the predominant price.

They then go through a process of price discovery to determine what the opening price will be. The goal is to have the maximum number of trades be executed from all the placed orders. At Nasdaq, this is done electronically, while human traders are involved at the NYSE.

Following this price discovery period, the opening price point is set, and the trading day continues. The stock is open for public trading.


💡 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.

Post-IPO Trading

In an ideal situation for the company and the underwriters, the stock’s closing price is relatively close to the opening price on opening day. This means the shares were priced accurately for what investors are willing to pay and the company had an appropriate valuation.

However, the IPO price isn’t necessarily a good indicator of the value of a stock. Broader market interest in the stock is impossible to plan for, and IPO conditions differ from the company’s long-term presence in the market.

IPO Price vs Opening Price: Similarities & Differences

Many analysts use the terms IPO price and opening price interchangeably when discussing a newly public company. However, there is a distinction between the two price points.

The IPO price is the price at which a company’s shares are first offered to institutional and accredited investors. The underwriters of the IPO sell the newly issued public share to these investors and clients at the initial public offering price.

In contrast, the opening price is the price at which the stock trades when it first begins trading on the stock market. The two prices are usually very close, but the opening price may be higher or lower than the IPO price.

Do IPO Stocks Always Rise?

IPO stocks don’t always rise in price once they are available for public trading. Many highly talked-about IPOs have disappointed in their opening weeks. This may be because investors feel these companies are overvalued and don’t want to risk putting money into them when they haven’t yet shown a profit.

It can take time for a stock to increase following an IPO, so the initial sale isn’t necessarily an indicator of long-term success or failure. The initial stock offering doesn’t always result in an immediate rise, but the influx of new capital can allow the company to grow.

Many stocks experienced tumultuous action for months before seeing a steadier climb. As an investor, looking for companies with a solid team and business plan, rather than just hype and a high valuation, can result in long-term portfolio growth.

How to Invest in IPOs

You can expose yourself to IPO stocks through an exchange-traded fund (ETF). Certain ETFs offer a weighted balance of newly public stocks and are adjusted over time. By diversifying your portfolio, you benefit from any gains while avoiding steep losses.

Also, some online brokerages, like SoFi, offer IPO investing for retail investors.

But, as mentioned above, IPOs can be very volatile. Although there is potential for significant returns, investors can also see severe losses in the weeks and months after a company goes public.

Rather than investing immediately, you can wait a quarter or six months to see how a company’s stock fluctuates following the IPO and then decide whether to invest. Stocks can often fall to form a base price before beginning to rise again.

Recommended: How to Find Upcoming IPO Stocks Before Listing Day

The Takeaway

It’s exciting when a company opens up to public investment. Although the IPO price is set as part of the lengthy IPO process, once the stock goes public all bets are off. Now the market determines the stock price, and the valuation of the company itself.

That’s one reason it can be challenging for most investors to know when and how to add new IPO stocks to their portfolios. Ultimately, investing in newly public stocks can be risky; the decision should be based on financial goals, time horizon, and risk tolerance.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

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

FAQ

Is it good to buy at IPO price?

Like all investments, there is risk in buying a stock when it goes public. IPOs can be suitable investments if the stock price increases after the IPO, but there is also a risk that the stock price could decrease. When buying a stock at an IPO price, investors don’t have the benefit of history to help analyze the stock.

How is an IPO price determined?

The IPO price is the initial public offering price of a stock. The IPO price is the price the underwriters will sell stock to institutional and accredited investors. The investment bank that works with the company going public determines the IPO price.

Can you lose money on an IPO?

Yes. An investor can lose money on an IPO if the company’s stock price falls below the price at which the investor bought the shares.

SoFi Invest®

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

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

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.

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