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When an investor places a stop-loss order, sometimes referred to as a stop order, they order their broker to buy or sell a stock once shares reach a certain price. This price is called a “stop price.” Placing a stop-loss order can potentially help keep people from losing money.
There are several types of stop-loss orders, too, that investors can use to increase their chances of retaining any applicable returns. Knowing what they are, and how to use them, can be beneficial to many investors.
A stop-loss order is a market order type that automatically executes a transaction once certain parameters are met — those parameters being set by the investor. In effect, a stop-loss order limits an investor’s potential losses, by “locking in” their profit or gain in relation to a given position.
It may be helpful to think of stop-loss orders as a set of instructions given to your brokerage or investment platform that will automatically execute a trade once a security reaches a given price.
💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.
Stop-loss orders work by executing a predetermined order or set of instructions set by an investor or trader. Effectively, an investor can decide that if the value of one of their stocks falls below a certain threshold, they’ll want to sell it, thereby preserving the gain or profit they’ve made on the stock’s appreciation over time.
So, if the stock’s value starts to fall, and hits the threshold decided upon by the investor, an automatic sell order will execute, and the investor’s position will be vacated – or, their stocks will be sold automatically. This way, if the stock continues to lose value, the investor’s already cashed out, and they won’t lose any more value if they had held onto their stocks.
There are a few key types of stop-loss orders investors should know about:
A sell-stop order is an order to sell a stock when shares hit a certain price. Let’s look at two examples. The first shows how sell-stop orders can help investors limit their losses.
Daniel buys 10 shares of Stock X at $150 each. He knows he could lose money, but he wouldn’t be comfortable losing more than 10% of what he initially invests.
To ensure he doesn’t lose more than 10%, Daniel sets up a sell-stop order for $135, which is 10% less than he originally paid for his shares of Stock X. If Stock X shares drop to $135, his broker will immediately sell them, so he only loses 10%.
By setting up a sell-stop order, Daniel has limited his losses. (Remember, 10% is just an example, not a suggestion. Everyone has different preferences when investing.)
Now let’s look at an example of how a sell-stop order can lock in profits. This time, Daniel buys 10 shares of Stock Y for $100 each. Six months later, shares have increased to $150 each.
Daniel doesn’t want to lose any of his unrealized gains. “Unrealized gains” are the gains investors make when share prices increase, but they haven’t sold their shares, so they haven’t collected any of the money yet.
Daniel’s Stock Y shares have increased by $50, or $500 total. If the share price drops below the original $100, he could lose all those unrecognized gains.
But Daniel isn’t ready to sell his Stock Y shares yet, either. If the share price continues to increase, he wants to keep earning money. So, he sets up a sell-stop order.
Now that the Stock Y share price is $150, Daniel might set up a sell-stop order for, say, $130. If shares drop to $130, his broker automatically sells them.
Although Daniel wouldn’t be able to keep the full $500 he could have earned had he sold his shares at $150, he would still pocket $30 per share, or $300 total.
In the example of Daniel’s Stock X shares, he prevented losses. With his Stock Y shares, he’s locked in gains. When trading, you’ll probably hear the term “market order” pop up frequently. Know that a stop-loss order is not the same as a market order. When people place market orders, they buy or sell stocks at the current market price, whatever that may be. With a stop-loss order, people “schedule” a market order that is triggered once a predetermined price has been hit.
So once a stock hits its stop price, the stop-loss order becomes a market order. The stop price isn’t necessarily the same price that the shares will be sold at.
For example, Daniel’s stop price for his Stock Y shares is $130, but by the time they sell, they may have dropped to $125.
As a result, he loses more money than he’d anticipated. Or the share price could increase to $135 when they sell, so Daniel only loses $15 per share, even though he was prepared to lose $20.
Knowing what a sell-stop order is, a buy-stop order is similarly exactly what it sounds like. Investors set up a buy-stop order to purchase a stock once shares hit a price higher than the current market price.
Buy-stop orders are placed under the assumption that once a stock starts to increase, it will gain momentum and continue to rise.
If Daniel knows that Stock S shares generally sell for between $20 and $25, he might set up a buy-stop order to purchase 10 shares once they reach $26. The computer system would buy 10 shares on his behalf, and he’d hope Stock S share prices would continue to rise.
Regular sell-stop orders and buy-stop orders are set at a specific dollar amount. Trailing stop-loss orders are different.
When someone sets a sell trailing-stop order for a certain amount, it tracks (or “trails”) the stock and sells shares once they decrease by that amount. A buy trailing-stop order “trails” the stock and buys shares once they increase by that amount.
Let’s look at an example with real numbers to break it down.
Let’s say Daniel buys shares of Stock A for $40 each. He sets a sell trailing stop-loss order for $1. As long as the stock increases, he’ll hold onto his shares. But as soon as the share price dips by $1, Daniel’s broker will sell his shares of Stock A.
If Stock A’s share price drops from $40 to $39, Daniel’s broker will sell his shares. And if the share price gradually increases to $44 but then drops to $43, a sell trailing-stop order for $1 will cause his broker to sell shares at a stop price of $43. (But remember, because a stop-loss order turns into a market order, shares might be at a price other than $43 by the time they sell.)
Trailing-stop orders are useful for locking in gains. As long as share prices increase, investors keep their shares. Once it decreases by a predetermined amount, the stock is sold.
Stop-loss orders have a couple of primary advantages: Limiting losses, and locking in profits or gains.
The most obvious advantage of a stop-loss order is that it keeps people from losing too much money in the market. In the first example of Daniel’s shares of Roku, he set a sell-stop order so that even if he did lose money, he didn’t lose more than he was comfortable with or could afford.
Stop-loss orders aren’t just for preventing losses, though. People can also use them to secure a capital gain.
With Daniel’s stop-loss order for Stock Y, his shares increased from $100 to $150, and he set up a sell-stop order for $130 so that if the stock started to dip, he would pocket at least $30 per share, or $300 total.
If Daniel hadn’t set that sell-stop order for his Stock Y investment, he could have incurred a net loss. Hypothetically, let’s say the share price continued to drop to $90 before he finally sold. He would have lost $10 per share, or $100, rather than gained $300.
Stop-loss orders can also lock in profits. That can lead to some peace of mind for some investors.
In other words, a stop-loss order can make the investment process less stressful. People don’t have to check in on their stocks three times per day, five days per week to track share prices and decide whether they want to buy or sell.
Stop-loss orders help remove other emotions from the process, too. It can be easy to make irrational or rash decisions when trading stocks.
Daniel might get emotionally attached to his Stock Y shares, so he holds onto it even when it becomes a bad investment. Or he tells himself he’ll sell once Stock Y shares drop 10%, but he has a hard time pulling the trigger.
Some people are the type to “set it and forget it.” They buy stocks and forget to check in on them at all. Daniel might say he’ll sell his Stock Y shares when the price decreases 10%, but he simply forgets to check the market for three months. Stock Y’s share price continues to drop, and he loses significant money.
Stop-loss orders can be ideal for investors who want to “set it and forget it” and they have the potential to reduce portfolio risk if used appropriately.
Stop-loss orders can have some drawbacks, too, just as they have potential advantages.
Stop-loss orders can work against investors when there’s a short-term drop in the share price, or drawback.
Consider this: Maybe Daniel buys 20 shares of Stock B for $30 per share. He sets a sell-stop order for $28.Monday, shares are at $30, but they fall to $28 on Tuesday, so his broker automatically sells all 20 shares. By Friday, shares have jumped up to $33, so Daniel has lost $60 in just a few days because there was a short-term dip.
It’s helpful to research how much a stock tends to fluctuate in a given amount of time to avoid these types of problems. Maybe Stock B’s share price regularly fluctuates by a few dollars at a time, so Daniel should have set his stop-loss order at a lower price.
If investors understand their stocks’ trends, they can probably set up stop-loss orders more strategically. However, research goes out the window when there is a “flash crash.” This is a sudden, aggressive drop in stock prices — but prices can jump back up just as quickly.
Flash crashes aren’t common, but they occasionally occur.
In this case, Daniel’s Stock B shares could drop from $30 to $15 in the morning, and because he set up a sell-stop order, they automatically sell. But the share price jumps to $32 by the time the closing bell sounds, and Daniel loses out on those gains because he had a sell-stop order.
Another drawback to consider is that once a stock hits its stop price, the stop-loss order becomes a market order, or an order to sell a stock at the current market price. When a stop-loss order becomes a market order, shares sell for the next available price — or, what’s often called a price gap.
If the difference between an investor’s stop price and the next available price is a few cents, it might not be a big deal. But if the market is volatile that day and the market price is several dollars below the stop price, someone could end up losing quite a bit of cash — especially in the case of a flash crash.
Granted, a stop-loss order turning into a market order could be either a pro or a con, depending on whether a share price increases or decreases. Regardless, some investors might consider it a disadvantage to not know what to expect.
Investors can choose to use stop-loss orders in a variety of scenarios, but they can likely be most beneficial if an investor feels that a security’s price is likely to fall in the near future, or if they’re particularly risk-averse and want to lock in their gains.
With that in mind, there may not necessarily be an ideal scenario in which a stop-loss order is best used or deployed — it’ll depend on the individual investor’s goals and concerns. Again, if they’re particularly risk-averse or at a point in their life where they can’t wait for the market to rebound, and want to lock in their gains, it may be a good idea to use one. If not, a stop-loss order may be less useful.
It may be a good idea to talk to a financial professional, too, about when or if using a stop-loss order is a good idea at a given point in time.
If you’re uncomfortable with the risks that come with stop-loss orders, you may choose not to use them. But know that a huge purpose of stop-loss orders is to minimize risk, and depending on market conditions, they may help ease your anxiety. Even so, it might be helpful to think about the trade-offs and whether the pros outweigh the cons, in your particular financial situation.
💡 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).
While each and every investor will have different considerations to make when setting stop-loss order levels, there are some things to broadly keep in mind.
There’s no exact science when determining price levels for stop-loss orders. It really comes down to an investor’s risk threshold — or, how much loss they’re willing to stomach before they want to bail on a position. Again, that will vary from investor to investor.
It may be helpful to think of that threshold in terms of a percentage. For instance, if a stock’s value declines by 10%, would you want to sell? How about 20%? These can be broad, general markers that many investors can utilize. But there are more advanced methods, too, like using moving averages to determine an acceptable stop-loss placement.
You could even use support and resistance levels to work as guidelines, too. It depends on how thorough or exact you’d like to be.
Stop-loss orders are a type of market order that can be helpful to investors who want to preserve their gains, or who may want to limit their risk. There’s no exact science as to when and how to use them, but they can be an important and powerful tool in any investor’s kit — though there’s no obligation to ever necessarily use them.
If you’re unsure of whether you should start incorporating stop-loss orders into your strategy, it may be helpful to talk about it with a financial professional. Again, these are just one tool of many, and if you’re particularly risk-averse, they may be worth investigating further.
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The main difference between a limit stop-loss order and a limit order is that limit orders guarantee trades execute at a specified price, whereas stop orders can be used to limit potential losses. Limit orders specify the maximum price an investor is willing to pay, where a stop-loss order specifies the threshold at which an investor wishes to sell.
Stop-loss orders do not always work, as there can be glitches within a trading platform’s system, low market liquidity, trading stoppages, and market gaps that can throw an investor’s plans out the window.
A stop-loss order is not necessarily better than a stop-limit order, as they’re two different things that can or could be used together as a part of an overall investment strategy.
Using stop-loss orders may be a good strategy for certain investors, but it’ll depend on the specific investor’s overall strategy, goals, and risk tolerance. What’s good for one investor may not necessarily be good for another.
Stop-loss rules are specified by investors when inputting a stop-loss order. These rules specify the price at which an investor will want to vacate a position or sell their holdings — it’s a threshold at which they want to sell and maintain their gains.
There are many strategies and tactics that investors can use to set up stop-loss orders, which might help them maintain profit and value. Some investors, for example, use a percentage as a guideline, while others might use moving averages to determine stop-loss limits, and others could use support and resistance levels.
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.
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.
SOIN1023173
Value investing is an investment philosophy that takes an analytical approach to selecting stocks based on a company’s fundamentals — such as earnings growth, dividends, cash flow, book value, and intrinsic value. Value investors don’t follow the herd when it comes to buying and selling, which means they tend to ignore tips and rumors they hear from coworkers and talking heads on TV.
Instead, they look for stocks that seem to be trading for less than they should be, perhaps because of a negative quarterly report, management scandal, product recall, or simply because they didn’t meet some investors’ high expectations.
A value investor’s goal is to find stocks that the market may be undervaluing. And after conducting their own analysis, an investor then decides whether they think the targeted stocks have potential to accrue value over time, and to invest.
In effect, value investing is an investment strategy that involves looking for “deals” in the market, and taking portfolio positions accordingly.
Value investing has been championed and used by some of the most storied investors in history. For example, Warren Buffett, the CEO of Berkshire Hathaway, also known as the “Oracle of Omaha,” is probably the most famous (and most quoted) value investor of all time.
From 1965 to 2017, Buffett’s shares in Berkshire Hathaway had annual returns of 20.9% compared to the S&P 500’s 9.9% return.
Buffett’s mentor was Benjamin Graham, his teacher at Columbia Business School and later his employer, who is known as “the father of value investing.” Columbia professor David Dodd, another Graham protegee and colleague, is recognized for helping him further develop several popular value investing theories.
Billionaire Charlie Munger, vice chairman of Berkshire Hathaway Corp., was another super-investor who followed Graham and Dodd’s approach. And billionaire investor Seth Klarman , chief executive and portfolio manager of the Baupost Group, is a longtime proponent.
Joel Greenblatt, who ran Gotham Capital for over two decades and is now a professor at Columbia Business School, is the co-founder of the Value Investors Club.
The main goal of value investing is to buy a security at a price that is near or less than its intrinsic value. That is, the investor is not paying a premium or markup on the stock — they’re getting a “deal” when they invest in it. There can be many elements at play when determining a value stock, including intrinsic value, margin of safety, and market inefficiencies.
Intrinsic value refers to a stock’s “true” value, which may differ from its “market” value. It can be a difficult concept to wrap your head around, but at its core, determining a stock’s intrinsic value can help an investor determine whether they’re actually finding a value stock, or if they’d potentially be overpaying for a stock. That’s why the concept of intrinsic value is critical to value investors.
Similarly, investors need to incorporate a “margin of safety,” which accounts for some wiggle room when they’re trying to determine a stock’s intrinsic value. In other words: Investors can be wrong or off in their calculations, and calculating a margin of safety can give them some margin of error when making determinations.
Value investors also tend to believe that the market is rife with inefficiencies. That means that the market isn’t perfect, and doesn’t automatically price all stocks at their intrinsic values — opening up room to make value investments. If you, conversely, believe that the market is perfectly efficient, then there wouldn’t be any stocks that are priced below their intrinsic value.
💡 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.
Value investing isn’t about finding a big discount on a stock and hoping for the best, or making a quick buck on a market trend.
Value investors seek companies that have strong underlying business models, and they aren’t distracted by daily price fluctuations. Their decisions are based on research, and their questions might include:
• What is the potential for growth?
• Is the company well managed?
• Does the company pay consistent dividends?
• What is the company doing about unprofitable products, projects, or divisions?
• What are the company’s competitors doing differently?
• How much do I know about this company or the business it’s in?
Investors who are familiar with an industry or the products it sells (either because they’ve worked in that business or they use those goods or services) can tap that knowledge and experience when they’re analyzing certain stocks.
The same line of thought can be applied to companies that sell products or services that are in high demand. That brand might be expected to remain in demand into the future because the company has a reputation for evolving as times (and challenges) change.
Identifying undervalued stocks requires time, patience, and some good, old-fashioned analysis. That mostly includes fundamental analysis, which is a method of evaluating securities by looking at its underlying financial health. That typically involves digging into financial statements and records.
Investors who are time-crunched or still learning the basics might find the homework daunting. Deep diving into earnings reports, balance sheets, and income statements, and pondering what the future might hold isn’t for everyone.
Doing what feels right on a personal level instead of going with the flow is a big part of value investing. And it isn’t always easy.
If everyone around you is talking about a particular stock, that enthusiasm can be contagious. Which is why a typical investor’s decision making is often heavily influenced by relatives, co-workers, friends, and acquaintances.
For an investor who believes the pursuit of market-beating performance is more about randomness than research, emotions (fear, greed, FOMO) can be their worst enemy. Behavioral biases can lead to knee-jerk reactions, which can result in investing mistakes. It takes patience and discipline to stick with a value investing strategy.
This is all to say that investors should do their best to get a handle on overarching market dynamics, rather than investing emotionally or going with the crowd.
Value investors don’t follow the herd. They eschew the efficient market hypothesis, which states that stock prices already reflect all known information about a security (market inefficiencies!).
Value investors take the opposite approach. If a well-known company’s stock price drops, they look for the reasons why the company might be undervalued. And if there are strong signs the company could recover and even grow in the future, they consider investing.
Value investing is often discussed alongside growth investing. Value versus growth stocks represent different investment styles or approaches.
In a general sense, value stocks are stocks that have fallen out of favor in the market, and that may be undervalued. Growth stocks, on the other hand, are shares of companies that demonstrate a strong potential to increase revenue or earnings thereby ramping up their stock price.
In terms of performance value stocks may not be seeing much price growth, whereas growth stocks may be experiencing rapid price appreciation.
Both value and growth investing have their pros and cons.
Value investing, for instance, may see investors experience lowering volatility when investing, and also getting more dividends from their investments. But their portfolio might accrue value more slowly — if at all. Conversely, growth investing may see investors accrue more gains more quickly, but also with higher levels of volatility and risk.
As noted, value investing is a type of investing strategy, but it’s similar to how a value shopper might operate when hoping to buy a certain brand of a smartwatch for the lowest price possible. If that shopper suddenly saw the watch advertised at half the price, it would make them happy, but it also might make them wonder: Is there a new version of the watch coming out that’s better than this one? Is there something wrong with the watch I want that I don’t know about? Is this just a really good deal, or am I missing something?
Also as discussed, their first step would likely be to go online and do some research. And if the watch was still worth what they thought, and the price was a good discount from a reliable seller, they’d probably go ahead and snap it up.
Investing in stocks can work in much the same way. The price of a share can fluctuate for various reasons, even if the company is still sound. And a value investor, who isn’t looking for explosive, immediate returns but consistency year after year, may see a drop in price as an opportunity.
Value investors are always on the lookout to buy stocks that trade below their intrinsic value (an asset’s worth based on tangible and intangible factors). Of course, that can be tricky. From day to day, stocks are worth only what investors are willing to pay for them. And there doesn’t have to be a good reason for the market to change its mind, for better or worse, about a stock’s value.
But over the long run, earnings, revenues, and other factors — including intangibles such as trademarks and branding, management stability, and research projects — do matter.
Value investors use several metrics to determine a stock’s intrinsic value. A few of the factors they might look at (and compare to other stocks or the S&P 500) include:
This ratio is calculated by dividing a stock’s price by the earnings per share. For value investors, the lower the P/E, the better; it tells you how much you’re paying for each dollar of earnings.
The PEG ratio can help determine if a stock is undervalued or overvalued in comparison to another company’s stock. If the PEG ratio is higher, the market has overvalued the stock. If the PEG ratio is lower, the market has undervalued the stock. The PEG ratio is calculated by taking the P/E ratio and dividing it by the earnings growth rate.
A company’s book value is equal to its assets minus its liabilities. The book value per share can be found by dividing the book value by the number of outstanding shares.
The price-to-book ratio is calculated by dividing the company’s stock price by the book value per share. A ratio of less than one is considered good from a value investor’s perspective.
The debt-to-equity ratio measures a company’s capital structure and can be used to determine the risk that a business will be unable to repay its financial obligations. This ratio can be found by dividing the company’s total liabilities by its equity. Value investors typically look for a ratio of less than one.
This is the cash remaining after expenses have been paid (cash flow from operations minus capital expenditures equals free cash flow).
If a company is in good shape, it should have enough money to pay off debts, pay dividends, and invest in future growth. It can be useful to watch the ups and downs of free cash flow over a period of a few years, rather than a single year or quarter.
Over time, each value investor may develop their own formula for a successful stock search. That search might start with something as simple as an observation — a positive customer experience with a certain product or company, or noticing how brisk business is at a certain restaurant chain.
But research is an important next step. Investors also may wish to settle on a personal “margin of safety,” based on their individual risk tolerance. This can protect them from bad decisions, bad market conditions, or bad luck.
An important thing to remember when it comes to value investing is that investors are likely on the hook for the long term. Many value stocks are probably not going to see huge value increases over short periods of time. They’re fundamentally unsexy, in many respects. For that reason, investors may do well to remember to be patient.
As with any investment strategy, value investing does have its risks. It tends to be a less-risky strategy than others, but it has its risks nonetheless.
For one, investors can mislead themselves by making faulty or erroneous judgments about certain stocks. That can happen if they misunderstand financial statements, or make inaccurate calculations when engaging in fundamental analysis. In other words, investors can make some mistakes and bad judgments.
Investors can also buy stocks that are overvalued – or, at least overvalued compared to what the investor was hoping to purchase it for. There are also concerns to be aware of as it relates to diversification in your overall portfolio (you don’t want a portfolio overloaded with value stocks, or any other specific type of security).
💡 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.
Value investing is a type of investment strategy or philosophy that involves buying stocks or securities that are “undervalued.” In effect, an investor determines that a stock is worth more than the market has valued it, and purchases it hoping that it will accrue value over time. While it’s a strategy that has its risks, it’s been used by many high-profile investors in the past, such as Warren Buffett.
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).
Pros of value investing include that it tends to be a less risky investing strategy, and that value stocks may experience less volatility. Some of the cons are that value stocks may not see sizable value increases over short periods of time, and that it’s possible investors can make a mistake and purchase an overvalued stock, rather than an undervalued one.
Value investing is generally considered to be a lower-risk investment strategy, as investors tend to buy securities that they perceive to be undervalued, rather than overvalued.
Yes, investors can make money utilizing a value investing strategy. Many of the most successful investors in history, such as Warren Buffett, used a value investing strategy to great success.
Value investing involves purchasing stocks or other securities that an investor has determined to be “undervalued” by the market. Investors purchase those securities, with the hope that they’ll accrue value over time.
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.
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.
SOIN1023172
Investing in foreign currency involves purchasing money, or currency, in another country. The market for foreign currency investing is the largest and most liquid in the world. There are some differences between investing in foreign currency and investing in stocks or bonds, though, that investors should be aware of.
Further, foreign currency investing can be somewhat confusing to new investors, and it also entails its own unique risks. For that reason, it can be beneficial to learn the basics before folding it into an investment strategy.
As noted, investing in foreign currency means purchasing another country’s currency, or money, as a means of investment. You’re not planning on spending it, in other words, and are hoping that it accrues value to generate a return. It’s also different from exchanging foreign currency, though it may feel similar.
Foreign currency investment is often, or typically done via “forex” trading. Forex is short for “foreign exchange market,” and refers to trading fiat currencies, or those that are backed by the government that uses them. For example, an investor could trade their United States dollars (USD) for Euros. Or, they can trade their Japanese yen for New Zealand dollars.
Forex trades can happen at any time throughout the day, since there’s always a foreign currency market open somewhere in the world. Foreign currency investors are typically institutional investors, although it is possible for individual investors to participate.
Investors should also know that currencies tend to trade in pairs — more on that below.
Like other types of investments, forex trading, or investing in foreign currencies, can offer up some benefits.
For one, investing in foreign currencies can add a degree of diversification to an investor’s portfolio. That means that while an investor may have built a portfolio with a number of other investments, such as stocks, bonds, and ETFs, foreign currency can be another element in the mix. Note, though, that it’s likely foreign currency should only comprise a small portion of a portfolio’s overall holdings.
The forex markets operate 24 hours per day, 365 days per year, unlike the standard stock exchanges. So, for investors who want to trade around the clock, the markets are almost always accessible.
There are four major forex trading sessions in a 24-hour period, split up by international region:
• Sydney (Australia)
• Tokyo (Asia)
• London (Europe)
• New York (The Americas)
There are minor sessions, too, but these are the four major sessions, and markets can be busy (when the Americas’ session overlaps with Europe’s), or less busy, depending on the time of day, and how many people are actively trading.
It’s possible that while a domestic currency is losing value due to inflation, foreign currencies could retain their value at the same time. That would, theoretically, provide investors with a hedge against inflation — but there’s no guarantee prevailing market forces would work to an investor’s advantage in such a scenario.
💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
Foreign currency investment doesn’t typically involve using physical money, so you’ll have to find something else to do with the foreign currency left over from your last international vacation. There are several ways to get started in currency exchange investment.
First, you can work with a foreign exchange brokerage to trade the currency you’re holding (such as U.S. dollars) for another currency (Euros, Yen, etc.). The goal is that the currency you’re trading for, or buying, will increase in value relative to the currency you’re trading away, or selling.
So, if you buy, or trade U.S. dollars for Euros, you’re hoping that in the future, you’d be able to trade the Euros back for more U.S. dollars than you originally used to make the purchase. You’re looking to make a profit, in other words.
While the goal is straightforward, the process can get more complicated. For instance, there are a few ways traders can execute trades, such as spot trading, forward trading, and future trading. Spot trading is an instant trade, whereas forward and future trading may involve settling on terms at a time in the future (similar to trading options).
Further, investors should understand the concept of the spread, which represents the difference between a trader’s cost and the dealer’s profits.
Beyond that, investors should also have a working knowledge of currency pairs, which is how much of the forex market trades. More on that below.
Investors can also look into foreign currency CDs (certificates of deposit), which work more or less like traditional CDs but might offer higher yields. Foreign savings accounts are another potential option, and can serve as investment vehicles by accruing interest and currency appreciation, though nothing is guaranteed.
Investors can look at the possibility of purchasing foreign bonds, which are issued in other countries by foreign governments or foreign companies. There are many types of foreign bond investment types, so investors would do well to do a bit of research to figure out if it’d be a good addition to their portfolio.
As mentioned, investors may want to look at currency ETFs. These ETFs are similar to foreign bond funds, there are also foreign currency ETFs on the market, which offer many of the same advantages of domestic or traditional ETFs, but can give investors exposure to the forex market. Likewise, exchange-traded notes, or ETNs, which are similar to bonds, are another potential investment investors can check out.
💡 Looking for other alternatives to invest in? Check out: 10 Types of Alternative Investments
Foreign currency investment isn’t without risk, and in fact, can introduce some types of risk that investors may not otherwise encounter — such as political and interest rate risks.
Since forex markets are so active, prices can change quickly, which means it’s a fairly volatile asset class. The news cycle (including economic, political, or social news) can cause sudden and drastic changes to prices. That means it may be a better fit for investors with a relatively high risk tolerance than those who are more risk averse.
Political risk is something to consider, too, as currencies are backed by governments. If a foreign government is unstable or otherwise involved in some sort of political drama, it can affect the price of a currency. That can pose a risk to investors.
Some investments incur interest rate risk, which is when an investment loses value due to a fluctuation in interest rates. Foreign currencies may be subject to such risk, though interest rate risk is more commonly associated with bonds.
There may also be additional costs associated with currency trading and investing, including currency conversion and transfer costs. These may not always be applicable, but are something that investors should at least be aware of in the event that they do encounter them.
💡 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.
In order to invest in foreign currency investing as safely as possible — remember, no investment is completely safe or risk-free — investors should brush up on the mechanics of the forex market, and know what they’re getting into.
A couple of things investors should also know about are “pips,” and the use of leverage in forex trading.
A “pip” is a unit of measure that represents the smallest unit of value in a currency quote. Using the above quote as an example, the difference between the “bid” (1.2100) and the “ask” (1.2104) is four pips.
Why does this matter? Because currency values fluctuate very slightly during the trading day, perhaps only several pips. That means that to make a significant return, traders deal with large quantities of currencies.
And as for leverage? To get to those large quantities, traders often use leverage. For example, you may give your broker $100 to trade with $10,000 on the markets (using, or borrowing the broker’s $9,900 to make trades is called “margin”). Most forex trading is done this way, using leverage and margin in order to generate returns.
That, of course, has its risks, since traders may incur losses, and end up owing money to their brokers. For beginners, it may be best to use lower margins for that very reason.
Also noted previously, the bid-ask spread is another important concept to know and incorporate if you’re trading or investing in foreign currency. Effectively, the spread refers to the difference between a trader’s cost and the dealer’s profits. There’s a slight difference in what you’re willing to pay, and what a seller is willing to sell for. In forex trading, the spread can be important to calculating overall potential returns.
Above all, it’s critical that investors keep their own personal risk tolerances in mind, and weigh that against the potential gains they could see from foreign currency investing. It may not be a good fit for everyone’s investment strategy.
Forex trading is different from other types of investing or trading. Generally, investing in or trading foreign currency involves pairs of currencies. That’s because two different currencies are quoted based on their relative value to each other. On an exchange, that may appear as “USD/EUR,” or something similar, while a pairing of Japanese yen and Euros, it may be represented as such: “JPY/EUR.”
Some currencies are more widely traded than others and are “paired” with one another or grouped as “major” currencies:
• U.S. dollars
• Euros
• Japanese yen
• British pounds
• Swiss francs
• Australian dollars
• Canadian dollars
• New Zealand dollars
There are also “minor” and “exotic” currency pairs. These are not traded as widely as the majors, but are still often swapped on exchanges. They may include pairings with the Hong Kong dollar, the Mexican peso, the Singapore dollar, or the Norwegian krone, among others.
Additionally, investors should know about foreign currency quotes. These quotes are similar to stock quotes, which list the current value, or price of a stock. Forex quotes display the bid and ask prices for a currency pair, since one currency’s value is relative to another currency. Here’s an example of a quote for a common pairing, Euros and U.S. dollars:
EUR/USD = 1.2100
In this example, Euros are the “base” currency, and U.S. dollars are the “quote” currency. What does the quote say, exactly? That a single Euro is equal to 1.21 U.S. dollars. Or, €1 = $1.21.
So, in terms of a basic trading strategy for a beginner? It may be best to choose a pair and stick to it — at least for a while, until you get the gist of it. After that, you can look at other, more in-depth trading strategies.
As mentioned, investors may want to look at currency ETFs. These ETFs are similar to foreign bond funds, there are also foreign currency ETFs on the market, which offer many of the same advantages of domestic or traditional ETFs, but can give investors exposure to the forex market. Likewise, exchange-traded notes, or ETNs, which are similar to bonds, are another potential investment investors can check out.
While investors can trade currency itself, they can also look at more advanced ways of investing in the forex markets. That can include trading futures and options, or other types of relevant derivatives.
First and foremost, investors should be aware of the unique risks that financial derivatives can introduce into their portfolios. Trading options contracts is a whole different beast from choosing stocks, so before you dive headfirst into forex options, it may be worth it to speak to a financial professional.
But at their core, currency options are derivatives, with currency itself as their underlying asset. There are calls, puts, and futures — if you’re not familiar with traditional options, it may be a good idea to review the basics before looking at forex options.
In effect, though, these options allow investors to hedge against unfavorable fluctuations of foreign currencies, or to speculate on volatility in the forex market. Again, it’s fairly high-level stuff, so if you feel like it’s over your head, it may be best to bone up on your investment knowledge before including options trading in your overall strategy.
Trading or investing in foreign currency is yet another avenue that investors can explore in an attempt to generate returns. As discussed, it involves actually purchasing money with money — foreign currencies — with the hopes that the price differences will work in the investors’ favor, and they’ll generate returns. Foreign currency markets are also extremely liquid, which is another potential upside for some traders.
As always, though, there are risks to consider, and learning the ropes of the foreign currency markets may be tricky. If investors feel like they want to get their feet wet in the market, though, without diving straight in, it may be worthwhile to discuss their plans with a financial professional.
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For those who are at or getting close to retirement age and are looking for ways to rev up their cash flow, a reverse mortgage may seem like a wise move. After all, the TV ads make them look like a simple solution to pump up the money in one’s checking account.
A reverse mortgage can be a way to translate your home equity into cash, but, you guessed it: There are downsides along with the benefits. Whether or not to take out a reverse mortgage requires careful thought and research.
Here, you’ll learn the pros and cons to these loans, so you can decide if it’s the right move for you and your financial situation.
There are many different types of mortgages out there. Here are the basics of how reverse mortgages work.
• A reverse mortgage is a loan offered to people who are 62 or older and own their principal residence outright or have paid off a significant amount of their mortgage. You usually need to have at least 50% equity in your home, and typically can borrow up to 60% (or more, but not 100%) of the home’s appraised value.
• The lender uses your home as collateral in order to offer you the loan, although you retain the title. The loan and interest do not have to be repaid until the last surviving borrower moves out permanently or dies. A nonborrowing spouse may be able to remain in the home after the borrower moves into a health care facility for more than 12 consecutive months or dies.
• Here’s another aspect of how reverse mortgages work: Fees and interest on the loan mean that over time, the loan balance increases and home equity decreases.
• You may see reverse mortgages referred to as HECMs, which stands for Home Equity Conversion Mortgage. This is a popular, federally insured option.
💡 Quick Tip: Buying a home shouldn’t be aggravating. SoFi’s online mortgage application is quick and simple, with dedicated Mortgage Loan Officers to guide you through the process.
A reverse mortgage offers older Americans the opportunity to turn what may be their largest asset — their home — into spendable cash. There are a variety of ways in which this can be attractive.
Many seniors find themselves with a fair amount of their net worth rolled up in their home but without many income streams. A reverse mortgage is a relatively accessible way to cover living expenses in retirement.
While you have to have some of your home loan paid down in order to qualify for a reverse mortgage, any remaining mortgage balance is paid off with reverse mortgage proceeds. This, in turn, can free up more cash for other expenses.
Those who take out reverse mortgages are allowed to remain in their homes and keep the title to their home the entire time. For established seniors who aren’t eager to pick up and move somewhere new — or downsize — to lower expenses, this feature can be a major benefit.
While most forms of retirement funding, like money from a traditional 401(k) or IRA, are considered income by the IRS, and are thus taxable, money you receive from a reverse mortgage is considered a loan advance, which means it’s not.
Heirs can sell the home, buy the home, or turn the home over to the lender. If they choose to keep the home, under HECM rules, they will have to either repay the full loan balance or 95% of the home’s appraised value, whichever is less.
Thanks to FHA backing, if the home ends up being worth less than the remaining balance, heirs are not required to pay back the difference, though they’d lose the house unless they chose to pay off the reverse mortgage or refinance the home.
Recommended: Guide to Cost of Living by State
As attractive as all of that may sound, reverse mortgages carry risks, some of which are pretty serious.
While heirs may not be forced to pay the shortfall of an upside-down reverse mortgage, inheriting a home in that scenario could come as an unpleasant surprise. Keeping a home in the family is an accessible way to build generational wealth and ensure that heirs have a home base for the future. Therefore, the potential for them to lose — or have to refinance — the house can be painful.
Unfortunately, losing your house with a reverse mortgage is a possibility. You’ll still be required to pay property taxes, any HOA fees, homeowners insurance, and for all repairs, along with your regular living expenses, and if you can’t, even with the reverse mortgage proceeds, the house can go into foreclosure.
As you probably realize this far into an article explaining the pros and cons of reverse mortgages, these loans aren’t exactly simple. Even if you understand the basics, there may be caveats or exceptions written into the documentation.
Before applying for an HECM, you must meet with a counselor from a HUD-approved housing counseling agency. The counselor is required to explain the loan’s costs and options to an HECM, such as nonprofit programs, or a single-purpose reverse mortgage (whose proceeds fund a single, lender-approved purpose) or proprietary reverse mortgages (private loans, whose proceeds can be used for any purpose).
Although your reverse mortgage “income” stream isn’t taxable, it may affect Medicaid or Supplemental Security Income benefits, because those are needs-based programs. (Proceeds do not affect Social Security or Medicare, which are non-means-tested programs.)
Like just about every other loan product out there, reverse mortgages come at a cost. You’ll pay:
• A lender origination fee
• An initial and annual mortgage insurance premium charged by your lender and paid to the FHA, guaranteeing that you will receive your expected loan advances.
These can be rolled into the loan, but doing so will lower the amount of money you’ll get in the reverse mortgage.
Not everyone is eligible to take out a reverse mortgage. While specific requirements vary by lender, generally speaking, you must meet the following:
• You must be 62 or older
• You must own your home outright (or have paid down a considerable amount of your primary mortgage)
• You must stay current on property expenses such as property taxes and homeowners insurance
• You must pass eligibility screening, including a credit check and other financial qualifications
Recommended: How Homeownership Can Help Build Generational Wealth
While everyone interested in a reverse mortgage needs to weigh the pros and cons for themselves, there are some instances when this type of loan might work well for you:
• The value of your home has increased significantly over time. If you’ve built a lot of equity in your home, you probably have more wiggle room than others to take out a reverse mortgage and still have some equity left over for heirs.
• You don’t plan to move. With the costs associated with initiating a reverse mortgage, it probably doesn’t make sense to take one out if you plan to leave your home in the next few years.
• You’re able to comfortably afford the rest of your required living expenses. As discussed, if you fall delinquent on your homeowners insurance, flood insurance, HOA fees, or property taxes, you could lose your home to foreclosure under a reverse mortgage.
There are options to consider. They include a cash-out refinance, home equity loan, home equity line of credit, and downsizing to pocket some cash.
A reverse mortgage may be a way to turn your home equity into spendable cash if you’re a qualified older American, but there are important risks to consider before taking one out. While reverse mortgages can free up funds, they are complicated, can involve fees, and can wind up putting your home into foreclosure if you can’t keep up with payments.
Reverse mortgages are just one of many different mortgage types out there — all of which can be useful under the right circumstances. SoFi doesn’t offer reverse mortgages at this time but has an array of home loan products that may meet your needs.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
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*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.
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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
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Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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.
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