Nov
22
2023
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Capital Appreciation on Investments

By | Growing Wealth, invest, Investing | Comments Off on Capital Appreciation on Investments

The term capital appreciation refers to an investment’s value rising over time. Theoretically, capital, meaning money or funds, appreciates, or goes up (as opposed to depreciates) after an investor initially purchases it, and that rise in value is what’s referred to as capital appreciation.

Of course, capital can also depreciate, but investors aren’t usually looking for negative returns. This is an important concept for investors to grasp, too, as capital appreciation is likely the main goal of most investors’ overall strategies.

Key Points

•   Capital appreciation refers to the increase in an investment’s value over time.

•   Calculating capital appreciation involves comparing the current market price of an asset to its original purchase price.

•   Factors such as company performance, economic conditions, and monetary policy can influence capital appreciation.

•   Assets like stocks, real estate, mutual funds, ETFs, and commodities are commonly associated with capital appreciation.

•   Capital appreciation is an important component of long-term wealth-building strategies, along with income from dividends and interest.

What Is Capital Appreciation?

As noted, capital appreciation refers to a rise in the price of an investment. Essentially, it is how much the value of an asset has increased since an investor purchased it. Analysts calculate capital appreciation by comparing the asset’s current market price and the original purchase price, also called the cost basis.

Example of Capital Appreciation

Capital appreciation can be understood by analyzing an example from stock market investing.

If an investor purchases 100 shares of Company A for $10 a share, they are buying $1,000 worth of stock. If the price of this investment increases to $12 per share, the initial 100 share investment is now worth $1,200. In this example, the capital appreciation would be $200, or a 20% increase above the initial investment.


💡 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.

What Causes Capital Appreciation?

The value of assets can rise and fall for various reasons. These include factors specific to individual investments and those affecting the economy and financial world as a whole.

Asset Fundamentals

In the most traditional sense, the price of an asset will increase because of a rise in the fundamental value of the underlying investment. When investors see that a company is doing well and expect it to keep doing well, they will invest in the company’s stock. This activity pushes the stock price up, resulting in capital appreciation if an investor holds shares in the company.

For a real estate asset, the value of a property could go up after a homeowner or landlord renovates a structure. This capital improvement increases the property’s market value.

Macroeconomic Factors

When the economy is booming, it can buoy all kinds of financial assets. In a strong economy, people typically have good jobs and can afford to spend money. This helps many companies’ bottom lines, which causes investors to put money into shares of the company. The opposite of this scenario is also true. When the economy endures a downturn, asset prices may fall.

Recommended: Understanding Economic Indicators

Monetary Policy

Central banks like the Federal Reserve play a significant role in how the financial markets operate. Because of this, the monetary policy set by central banks can play a prominent role in capital appreciation.

For example, when a central bank cuts interest rates, corporations can usually borrow money at a lower cost. Businesses often use this injection of cheap money to invest in and grow their business, which may cause investors to pour into the stock market and push share prices higher. Additionally, companies may take advantage of lower interest loans to borrow money to buy shares of their stock, known as a stock buyback. These moves may push share prices higher, further leading to capital appreciation.

Another monetary policy tool is quantitative easing (QE), which refers to a method of central bank intervention where central banks purchase long-term securities to increase the supply of money and encourage investment and lending. Like a low interest rate policy, this method can lead to rising asset prices because more money is being added to the economy — money that flows into assets, bidding their prices higher.

Speculation

Another potential cause of capital appreciation is speculation. Speculation occurs when many investors perceive the value of a particular asset as being higher than it is and start buying the asset in anticipation of a higher price. This activity may lead to the price of an asset being pushed higher. After a frenzy, the price of the asset eventually drops as investors sell in a panic when they realize there’s no fundamental reason to keep holding the asset. This type of speculation is fueled by investors’ emotions, rather than financial fundamentals.

Assets Designed for Capital Appreciation

There are several categories of assets that are designed for returns through price appreciation. Investors generally hold these investments for the long term hoping that prices will rise. This isn’t an exhaustive list, but it provides a good overview.

Stocks

Stocks are a type of financial security that represents equity ownership in a corporation. They can be thought of as little pieces of a publicly-traded company that investors can purchase on an exchange, with hopes that the price of the shares will go up.

Real Estate

Real estate is a piece of land and anything attached to that land. Many people build wealth through homeownership and capital appreciation, buying a house at a specific price with an expectation that it will appreciate in value by the time they are ready to sell.

Residential real estate is just one area of real estate investment. Investors may also look to put money into commercial, industrial, and agricultural real estate activities. Investors can invest in various real estate investment trusts (REITs) to get exposure to returns on real estate.

Mutual Funds

A mutual fund consists of a pool of money from many investors. The fund might invest in various assets, including stocks, bonds, commodities, or anything else. In the context of a mutual fund, capital appreciation occurs when the value of the assets in the fund rises.

ETFs

Similar to mutual funds, exchange-traded funds (ETFs) are investment vehicles that contain a group of different stocks, bonds, or commodities. ETFs can track stocks in one particular industry, e.g., gold mining stocks, or track all the stocks in an entire index such as the S&P 500. As the name suggests, ETFs are bought and sold on exchanges just like stocks.

Commodities

Commodities are an investment that has a tangible economic value. This means that the market values these raw materials because of their different use cases. For example, commodities like oil and wheat are desired because they can power automobiles and be used for food, respectively. Commodities markets can be highly volatile, but many investors take advantage of the volatility to see the capital appreciation on both a short-term and long-term time horizon.


💡 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.

Capital Appreciation Bonds

Capital appreciation bonds are municipal securities backed by local government agencies. With these bonds, investors hope to receive a significant return in the future by investing a small amount upfront.

Like all bonds, capital appreciation bonds yield interest, which is a primary reason that investors buy them. But instead of paying out interest annually, the interest gets compounded regularly until maturity. This gives the investor one lump sum payout at the end of the bond’s lifetime.

Unlike other assets that experience capital appreciation, the price of the capital appreciation bond does not rise. Instead, capital appreciation refers to the compounded interest paid out to the bondholder at maturity.

Capital Appreciation vs Capital Gains

Though the terms are sometimes used interchangeably, there is a difference between capital appreciation and capital gains.

Capital appreciation occurs when the value of an investment rises above the purchase price while the investor owns the asset. In contrast, capital gains are the profit made once an investment is sold. Appreciation is, in effect, an “unrealized” gain. It becomes “realized” once the investment is sold for a profit.

Capital appreciation alone does not have tax implications; an investor doesn’t have to pay taxes on the price growth of an investment when they own it. But when an investor sells an investment and realizes a profit, they must pay capital gains taxes on the windfall.

Capital Appreciation vs Income

Capital appreciation is one piece of the puzzle in an investment strategy. Another critical component to build wealth is investing in assets that pay out dividends, interest, and other income sources.

A dividend is a portion of a company’s earnings paid out to the shareholders. For every share of stock an investor owns, they get paid a portion of the company’s profits.

Interest income is typically earned by investing in bonds, otherwise known as fixed-income investments. The interest payment is determined by the bond’s yield or interest rate. Investors can also be paid interest by putting money into savings accounts or certificates of deposit (CDs).

For real estate investors, rents paid by tenants can also act as a regular income payout.

Investing in assets that pay out regular income can supplement capital appreciation. The combination of capital appreciation with income returns is the total return of an investment.

Risks Associated With This Type of Investment

Assets intended for capital appreciation tend to be riskier than those intended for capital preservation, like many types of bonds.

Investing in stocks for capital appreciation alone is also known as growth investing. This strategy is typically focused on investing in young or small companies that are expected to increase at an above-average rate compared to the overall market.

The returns with a growth investing strategy can be high, but the risk involved is also high. Because they don’t have a long track record, these small and young companies can struggle to grow their business and lead to bankruptcy.

The Takeaway

Capital appreciation refers to the rise in value, or price, of an investment in an investor’s portfolio. It’s paramount to the whole concept of investing, as most investors invest in an effort to generate returns, or appreciation, on their money.

Capital appreciation is one part of a long-term wealth-building strategy. Along with income from dividends, interest, and rent, capital appreciation is part of the total return of an investment that investors need to consider.

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 the difference between capital growth and capital appreciation?

The difference between the terms capital growth and capital appreciation is merely semantics. Both terms refer to an increase in value of an investment over time, and effectively mean the same thing.

How much tax do you pay on capital appreciation?

Investors do not pay taxes on capital appreciation, as an investment gaining value does not trigger a taxable event. They do pay taxes on capital gains, which are realized when an investor sells an asset.

What is the difference between dividend and capital appreciation?

A dividend is a payout to shareholders from a company’s profits. Capital appreciation is the rise in market value of an investment or asset, so they are two completely different things.

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.

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Nov
22
2023
Wash Trading: What Is It? Is It Legal?

Wash Trading: What Is It and How Does It Work?

By | Growing Wealth, invest, Investing | Comments Off on Wash Trading: What Is It and How Does It Work?

Wash trading is a practice which involves entering into securities transactions for the express purpose of giving the appearance that a trade has taken place although their portfolio has not substantially changed. Also referred to as round-trip trading, wash trading is a prohibited activity under the Commodity Exchange Act (CEA) and the Securities Exchange Act of 1934.

In some cases, wash trading is a direct attempt at market manipulation. In others, wash trading may result from a lack of investor knowledge. This may be the case with wash sales, in which an investor sells one financial instrument then replaces it with a similar one right away. It’s important to understand the implications of making a wash trade and what one looks like in action.

Key Points

•   Wash trading involves investors engaging in the simultaneous buying and selling of securities to create the illusion of trading activity.

•   Wash trading involves the simultaneous buying and selling of the same or similar securities.

•   This practice can be a form of market manipulation or result from a lack of investor knowledge.

•   The goal of wash trading is to influence pricing or trading activity, often through collaboration between investors and brokers.

•   Wash trading is illegal and can result in penalties, including the disallowance of tax deductions for losses.

What Is Wash Trading?

Wash trading occurs when an investor buys and sells the same or a similar security investment at the same time. The Internal Revenue Service (IRS) also refers to this as a wash sale, since buying the same security cancels out the sale of that security. It’s also called round-trip trading, since you’re essentially ending where you began — with shares of the same security in your portfolio.

Wash trades can be used as a form of market manipulation. Investors can buy and sell the same securities in an attempt to influence pricing or trading activity. The goal may be to spur buying activity to send prices up or encourage selling to drive prices down.

Investors and brokers might work together to influence trading volume, usually for the financial benefit of both sides. The broker, for example, may benefit from collecting commissions from other investors who want to purchase a stock being targeted for wash trading. The investor, on the other hand, may realize gains from the sale of securities through price manipulation.

Wash trading can be a subset of insider trading, which requires the parties involved to have some special knowledge about a security that the general public doesn’t. If an investor or broker possesses insider knowledge they can use it to complete wash trades.

How Does Wash Trading Work?

On the surface level, a wash trade means an investor is buying and selling shares of the same security at the same time. But the definition of wash trades goes one step further and takes the investor’s intent (and that of the broker they may be working with) into account. There are generally two conditions that must be met for a wash trade to exist:

•   Intent. The intent of the parties involved in a wash trade (i.e. the broker or the investor) must be that at least one individual involved in the transaction must have entered into it specifically for that purpose.

•   Result. The result of the transaction must be a wash trade, meaning the investors bought and sold the same asset was bought and sold at the same time or within a relatively short time span for accounts with the same or common beneficial ownership.

Beneficial ownership means accounts that are owned by the same individual or entity. Trades made between accounts with common beneficial ownership may draw the eye of financial regulators, as they can suggest wash trading activity is at work.

A telling indicator of wash trading activity is the level of risk conveyed to the investor. If a trade doesn’t change their overall market position in the security or expose them to any type of market risk, then it could be considered a wash.

Wash trades don’t necessarily have to involve actual trades, however. They can also happen if investors and traders appear to make a trade on paper without any assets changing hands.

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

Example of a Wash Trade

Here’s a simple wash trade example:

Say an investor who’s actively involved in day trading owns 100 shares of ABC stock and sells those shares at a $5,000 loss on September 1. On September 5, they purchase 100 shares of the same stock, then resell them for a $10,000 gain. This could be considered a wash trade if the investor engaged in the trading activity with the intent to manipulate the market or to unfairly claim a tax deduction for the loss.

Is Wash Trading Illegal?

Yes. The Commodity Exchange Act prohibits wash trading. Prior to the passage of the Act, traders commonly used wash trading to manipulate markets and stock prices. The Commodity Futures Trade Commission (CFTC) also enforces regulations regarding wash trading, including guidelines that bar brokers from profiting from wash trade activity.

The IRS has rules of its own regarding wash trades. The rules disallow investors from deducting capital losses on their taxes from sales or trades of stocks or other securities that are the result of a wash sale. Under the IRS rules, a wash sale occurs when you sell or trade stocks at a loss and within 30 days before or after the sale you:

•   Purchase substantially identical stock or securities

•   Acquire substantially identical stock or securities in a fully taxable trade

•   Acquire a contract or option to buy substantially identical stock or securities, or

•   Acquire substantially identical stock for your individual retirement arrangement (IRA) or Roth IRA

Wash sale rules also apply if you sell stock and your spouse or a corporation you control buys substantially identical stock. When a wash sale occurs, you’re no longer able to claim a tax deduction for those losses.

So, in short, yes, wash trading is illegal.

Difference Between Wash Trading & Market Making

Market making and wash trading are not the same thing. A market maker is a firm or individual that buys or sells securities at publicly quoted prices on-demand, and a market maker provides liquidity and facilitates trades between buyers and sellers. For example, if you’re trading through an online broker you’re using a market maker to complete the sale or purchase of securities.

Recommended: What Is a Brokerage Account?

Market making is not market manipulation. A market maker is, effectively, a middleman between investors and the markets. While they do profit from their role by maintaining spreads on the stocks they cover, this is secondary to fulfilling their purpose of keeping shares and capital moving. Without market makers, trades would take longer to execute and the markets could become sluggish.

How to Detect & Avoid Wash Trading

The simplest way to avoid wash trading as an investor is to be aware of what constitutes a wash trade or sale. Again, this can mean the intent to manipulate the markets by placing similar trades within a short time frame, or it can mean inadvertently executing a wash sale because you’re not familiar with the rules.

In the latter case, you can avoid wash trading or wash sales by being mindful of the securities you’re buying and selling and the time frame in which those transactions are completed. So selling XYZ stock at a loss, then buying it again 10 days later to sell it for a profit would likely constitute a wash sale, if you executed the trade in an attempt to be able to deduct the initial loss.

It’s also important to understand how the 30 days period works for timing wash sales. The 30 day rule extends to the 30 days prior to the sale and 30 days after the sale. So effectively, you could avoid the wash sale rule by waiting 61 days to replace assets that you sold in your portfolio to be on the safe side.

💡 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.

Wash Trading in Crypto Trading

Cryptocurrency can be a target for wash-trading activity. In the EOS case, wash trades were suspected of being used as a means of driving up investor interest surrounding the cryptocurrency during its initial offering. High-frequency trading has also been a target of scrutiny, as some believe it enables wash trading in the crypto markets. Whether wash trading rules and regulations specifically apply to crypto, however, is a bit murky.

The Takeaway

Wash trading involves selling certain securities and then replacing them in a portfolio with identical or very similar securities within a certain time period. This is done so as to avoid making substantial changes in your portfolio. Wash trading is illegal in practice but it’s also avoidable if you’re investing consciously and with a strategy in place.

Understanding when wash sale rules apply can help you to stay out of trouble with the IRS. If you’re unclear about it, you can consult 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.

Photo credit: iStock/mapodile

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.

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Nov
21
2023
index card money sign

Financial Index Card: All You Need for Your Money Management

By | Budgeting & Goals, Financial Independence, Terminology | No Comments
    Money management can be complex, but what if the best, smartest advice could fit on one little index card? That’s the idea behind the financial index card. It’s a concept that the researcher who popularized the idea that the most effective strategies could be summarized on a small piece of paper, whether you pin that to your fridge, carry it in your pocket, or keep it next to your laptop.

    Here, you’ll learn the story of that financial index card and what exactly is written on it. The advice written on it could help build your money smarts and build your wealth.

    The Story Behind the Financial Index Card

    The financial index card got its start In 2013, when Harold Pollack, PhD, a social scientist at the University of Chicago, posted a photo of an index card online. On the card, he said, was the only financial advice anyone ever needed to know.

    He created the card after interviewing personal finance writer Helaine Olen. During their talk, Pollack jokingly claimed that all the necessary info about good money management could fit on an index card.

    Pollack’s off-the-cuff comment — at the time he hadn’t actually produced this index card — generated a lot of audience commentary with investors wondering what his advice would be. Pollack grabbed an index card, wrote down nine tips, snapped a photo, and posted it online.

    The nine simple tips on the card resonated with the public and the photo went viral. In fact, the concept was so popular that Pollack teamed up with Olen to write a book, The Index Card: Why Personal Advice Doesn’t Have to Be Complicated.

    The Financial Index Card’s Advice

    Here is a rundown of the nine tips Pollack offered on the original card and an explanation of what each one means to help you better understand the value of the financial index card.

    1. Max Out Your 401(k) or Other Employee Contribution

    A traditional 401(k) is a retirement plan that offers various investment options and is often offered via your employer – but note that not all employers offer 401(k)s as a benefit. Sometimes your employer will make matching contributions to your 401(k) as well.

    What makes 401(k)s particularly useful are the tax advantages that they offer. You can fund 401(k)s with pretax money.

    Contributions can be taken straight from your paycheck before you pay any income tax, which in turn lowers your taxable income and potentially your tax bill that year. Keep in mind that when you later make withdrawals from your 401(k), you will owe income tax.

    But once in the 401(k), your money grows tax-deferred. Your employer will likely offer a number of investment options for you to choose from, such as mutual funds or target-date funds.

    The more money you can put into your 401(k), the more money you have at work for you. If your employer offers matching funds, aim to at least save the minimum amount to max out the match if you can.

    Saving for your future merits a spot on the financial index card because it’s such a vital part of planning ahead, achieving your money goals, and building your net worth. What’s more, stashing away cash for tomorrow can also help reduce money stress.

    2. Buy Inexpensive, Well-Diversified Mutual Funds

    Here’s the next bit of advice from the financial index card: It’s about buying mutual funds. A mutual fund takes a pool of money from investors and buys a basket of securities such as stocks or bonds. They are an important tool investors can use to diversify their portfolios.

    Diversification is a way to help reduce risk in your portfolio. Imagine that you had a portfolio that was only invested in one stock. If that company does poorly, your entire portfolio may suffer. Now imagine that you invested in 100 stocks. If one of the stocks does poorly, its effect on the portfolio as a whole will likely be much smaller.

    Investors may choose to invest in a target date fund, which holds a diverse selection of stocks and bonds. Investors may use these funds to work toward a goal a number of years down the line.

    Say you will retire in 2050, you may choose a target date fund with a provider called the 2050 Fund. As the target date approaches — aka the date at which you’ll likely need your money — the asset allocation inside the fund will typically shift to become more conservative.

    Mutual funds typically charge fees to pay for management costs. The fees may take a bite out of your eventual return. Consider looking for target funds that charge lower fees to minimize the amount that you’ll end up paying.

    This investing advice can help you grow your wealth and meet your long-term financial goals.

    3. Don’t Buy or Sell an Individual Security

    Buying and selling individual stocks can be tricky. It’s difficult to know how an individual stock will behave, and choosing stocks can take a lot of time and research. It may be easier for investors to use mutual funds, exchange-traded funds (ETFs), or index funds to gain exposure to many different stocks.

    Investors who are interested in adding individual stocks when managing their portfolio may want to consider their overall asset allocation and diversification strategy to be sure that the stock is the right fit.

    4. Save 20% of Your Money

    Here’s the next bit of advice on the financial index card: Save 20% of your earnings. This saving tip from Pollack dovetails nicely with the popular 50/30/20 budget rule. This rule states:

    •  50% of your income should be used to cover your needs, such as car payments, groceries, housing, and utilities.

    •  30% of your spending should be used to cover your wants, such as eating out, vacations, or hobbies.

    •  20% is the money you save, which can go toward paying down debts, building an emergency fund, or stashing cash for retirement.

    Another formula for saving that some experts recommend:

    •  Put 12% to 15% toward retirement

    •  The remaining 5% to 8% goes toward paying off debt and building an emergency fund.

    You can keep track of your savings with various mobile and online savings and budgeting tools. (Check with your bank; they may offer some.)

    If it’s not possible for you to save 20% of your income (perhaps you live in a place with a very high cost of living), then save as much as you are able.


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

    5. Pay Your Credit Card Balance in Full Every Month

    Credit cards can be extremely convenient, whether you’re renting a car or buying a new refrigerator with all the bells and whistles which you couldn’t otherwise afford.

    However, if you start to carry a credit card balance from month to month, your credit card debt may quickly spiral out of control. The average annual percentage rate, or APR, for credit cards currently tops 20%. This rate represents that amount of interest that you’ll pay on the balance of your credit card.

    What’s more, many credit cards only require that you make a minimum payment each month — less than the balance you’re carrying. But think twice before making these minimal payments. You can continue to accrue interest, and the time required to pay off the entire amount of debt can be lengthy.

    To avoid being sucked into this spiral of revolving credit, follow the financial index card’s advice. You might consider trying to spend only what you can truly afford each month on your credit card and paying off your balance in full, if possible.

    6. Maximize Tax-Advantaged Savings Vehicles like Roth, SEP, and 529 Accounts

    A 401(k) is not your only option for tax-advantaged accounts. If you’ve earned income — and even if you already have a 401(k) — you can take advantage of setting up an IRA account. Here are some details:

    •  Contributions to traditional IRAs are made pretax and then grow tax-deferred. Contributions to Roth IRAs are made after-tax and grow without being taxed.

    •  Withdrawals from Roth accounts, when meeting specific criteria, are not subject to income tax.

    •  Small business or self-employed workers can take advantage of SEP IRAs, which allow employers to make contributions in an employee’s name.

    •  A 529 plan is a tax-advantaged account that helps people save to cover qualified education expenses, such as college tuition. These plans are sponsored by states, state agencies, and educational institutions. Contributions to 529 plans are made with after-tax money.

    However, savings inside the account grow without being taxed and qualified withdrawals are not subject to tax. Contributions are not federally deductible, but some states allow deductions on state income tax.

    Like 401(k)s, these tax-advantaged accounts allow you to supercharge your savings and can make your money work harder for you.

    7. Pay Attention to Fees and Avoid Actively Managed Funds

    The next point on the financial index card focuses on investing decisions. Actively-managed funds are run by portfolio managers who are trying to find ways to beat market returns. This requires time and manpower, both of which can be expensive.

    Actively-managed funds pass this expense on to investors in the form of fees. Investors do have an alternative in index funds, which try to match the returns of an index, such as the S&P 500. They do so by buying all or nearly all of the securities included in the index.

    Managing this type of fund takes less time and effort and is therefore typically cheaper than active management. As a result, index funds often have lower fees than actively-managed funds.

    The potential to outperform the market may make actively managed funds sound pretty tempting. With an index fund you’re likely not going to do better than the market; the funds are actually aiming to mirror the market.

    Understanding this difference can help you assess whether paying fees to go after better-than-the-market results is worthwhile for your financial management.

    8. Make Financial Advisors Commit to the Fiduciary Standard

    To understand this strategy on the financial index card, it’s helpful to first understand your terms. A fiduciary standard refers to the duty of financial advisors to always work in their customers’ best interests. That may seem like a no-brainer. Wouldn’t all financial advisors do that? Yet, there are myriad opportunities for conflicts of interest to arise in relationships between financial advisors and investors.

    For example, advisors may be paid a commission when their clients invest in certain funds. If advisors don’t disclose that information, clients can’t be sure the advisor is suggesting investments because they’re the right fit for their portfolio or because the advisor is paid to use them. Advisors adhering to a fiduciary standard disclose conflicts of interest or avoid them altogether.

    Since Pollack’s index card made waves in 2013, the U.S. Department of Labor has tried to issue regulations that all financial advisors maintain a fiduciary standard when overseeing retirement accounts.

    The Fifth Circuit Court decided that this ruling was an overreach and shot it down in 2018. In 2023, the DOL put forth a proposal to revive the rule, but as of writing, no changes have been implemented. However, until it is (if ever), investors can ask their advisors whether they adhere to a fiduciary standard, and if they don’t, ask them to commit to doing so.

    Another option: Investors may turn to fee-only vs. fee-based advisors, who accept fees from their clients as their only form of compensation. Fee-only advisors by definition operate under a fiduciary standard.

    9. Promote Social Insurance Programs to Help People When Things Go Wrong

    A rising tide lifts all ships. This final tip on the financial index card is about supporting social programs like Social Security, Medicare, and the Supplemental Nutrition Assistance Program, which help keep the population healthy as a whole — financially and literally.

    You likely already pay into programs like these through Social Security and Medicare taxes. These are taken straight out of your paycheck if you’re employed, or if you’re self-employed, you pay them yourself. (And even the savviest of investors may need to fall back on government support.)

    The Next Financial Index Card

    In 2017, Pollack acknowledged his financial tips were directed toward people of at least middle class means, so he came up with a second index card. This time, he focused more on the needs of those who had a lower income or more financial obligations.

    The second financial index card included these points:

    •  Set and pursue financial goals that excite you.

    •  Follow a budget and track your spending.

    •  Pay cash or by check rather than by credit card or payment plan whenever possible.

    •  Save consistently, and build a financial reserve.

    •  Make sure you are receiving all pertinent public benefits.

    •  Make good use of your tax refund and/or your EITC.

    •  Don’t buy any financial service/product endorsed by any celebrity.

    •  By cheap index funds rather than individual stocks.

    •  Invest in your 401(k) if you have access to one.

    •  Work with a financial coach.

    •  Protect yourself from fraud and abuse.

    •  Look into a credit union, even if you have been unbanked.

    Start Investing With SoFi

    The financial index card is a simple concept, but it can be helpful to many people. Although Pollack’s advice covers a lot, there’s only so much you can fit on an index card. Tips like setting specific financial goals, simplifying your finances, keeping track of your spending (not just your savings), and setting a realistic budget, are also helpful in establishing and maintaining financial wellness.

    As always, if you’re struggling to manage your finances, it may be a good idea to speak with a financial professional. A financial index card can help, but marshaling additional resources may not be a bad idea.

    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.


    SoFi Invest®

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

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

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

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21
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What Is Discretionary Income?

Discretionary Income Definition and Explanation

By | Budgeting & Goals, Financial Independence, money | Comments Off on Discretionary Income Definition and Explanation

Discretionary income is defined as the cash you have available to spend after your necessary payments are covered. Those necessities are typically made up of basic living expenses, such as housing, utilities, food, healthcare, and insurance costs. (In some cases, minimum payments toward debt may be included as well.)

So what does discretionary income equal in daily life? It’s the post-tax money you can put toward things like eating out, entertainment, travel, clothing, electronics, and gym memberships. You might think of discretionary income as paying for the wants in life vs. the needs.

In this guide, you’ll learn more about the definition of discretionary income, read examples of this type of income and how to use it, and understand how to calculate this money in your budget. It can be an important number to know, as you’ll see, especially if you’re repaying student loans.

Key Points

•   Discretionary income is the money left after paying for necessary expenses like housing, utilities, food, healthcare, and insurance.

•   It can be used for non-essential expenses like eating out, entertainment, travel, clothing, and electronics.

•   Discretionary income is important for budgeting and can be used to pay down debt or save for goals like vacations or home improvements.

•   Some people may not have discretionary income if they struggle to cover essential expenses or have variable income.

•   Calculating discretionary income involves subtracting necessary expenses from take-home pay; it’s important to have a budget to manage that money effectively.

What Is Discretionary Income?

Discretionary income is the amount of post-tax income that is left over after you have paid for all the essentials of daily life. These expenses include your mortgage or rent, utilities, and car payments or bills, as well as food, healthcare, and occasionally clothing (if it is needed, not just wanted). To phrase it another way, no, a Netflix subscription or your AM latte isn’t a “necessity.”

It’s worth noting that not everyone has discretionary income; some people struggle just to cover the “essentials” when it comes to paying their bills.

•  Gig, seasonal, and part-time workers: The concept of discretionary income can get a little more complicated if you aren’t a person who gets a steady paycheck. If you have a variable income due to the nature of your work (maybe you’re a gig worker or freelancer), you’ll need to make sure you have enough money set aside in savings if you have a shortfall.

If your income dips and you can’t pay for the basics in life, let alone have some discretionary income, that could mean you’ll get hit with overdraft or late fees or wind up with excessive credit card debt to pay off.

•  Discretionary income and savings: Also worth noting (warning, buzzkill ahead): Discretionary income isn’t just to be spent on cool stuff and fun experiences. It’s wise to put a portion of it toward savings. Some people will include debt payments as part of the “necessities” bucket of your budget; others will say that a portion of discretionary income is what goes toward debt.

One key kind of debt to consider in this scenario: student loans. There are four programs for repaying federal educational loans in which your discretionary income can be a factor. It’s vital to make sure you have the right income-driven repayment plan (IDR) that works for your financial situation when it comes to paying down federal student loans.

What if despite your best efforts to pay back your loans, you are still feeling the financial pinch? It’s a common situation as basic bills and student loans conspire to vacuum up all your moolah. Refinancing your student loans to a lower rate can help free up additional discretionary income each month.

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7 Examples of Discretionary Income and Expenses

Now that you know what discretionary income is, it’s worth mentioning that the phrase is sometimes used interchangeably with discretionary expenses. To be clear, discretionary income is what is spent on discretionary expenses.

And what are discretionary expense examples? Here are several:

1. Entertainment and Eating Out


This category includes such expenses as dining out, getting drinks, splurge-y takeout food (pizza delivery, we’re looking at you!), and fancy coffees. In terms of entertainment, the following would be considered discretionary: Concert, play, and movie tickets; museum admission; books, magazines, and streaming services; and similar costs.

2. Vacations and Travel


Taking a vacation, whether you go to the other side of the planet or an hour’s drive away, is not a necessity, despite how you may feel about it.

3. Luxury Items


These expenses could be anything from a pricey sportscar to designer clothes to jewelry to wine. While clothing and a car may be necessities in life, when you pay extra for top-notch prestige brands, you enter the realm of discretionary expenses.

4. Memberships and Hobbies

Yes, joining a gym or taking up a musical instrument are admirable things. But they are not vital to your survival. For this reason, things like yoga or Pilates classes, crafting supplies, and similar expenses are considered discretionary.

5. Personal Care


A basic haircut or bottle of shampoo may not be discretionary, but pricey blowouts, manicures, massages, skincare items, and the like are.

6. Upgrading Items

If your current phone is functional but you get the latest one, that’s a discretionary expense. The same holds true for being bored with your couch and getting a new one or remodeling your bathroom just because.

7. Gifts


Of course you want to show you care for your loved ones. But buying presents for others isn’t vital to survival, so this should be earmarked as a discretionary expense.

Recommended: How to Save on Streaming Services

Income vs Disposable Income

If you are wondering how income vs. disposable income stacks up, here’s the difference. Income refers to all the funds you have coming in, whether from your salary, any side hustles, interest or dividends, and other sources.

Disposable income, however, is what is left of your post-tax money after you have paid for your necessities, as described above. If, say, you follow the popular 50/30/20 budget rule, 50% of your money goes toward needs (necessities), 30% would go toward wants (discretionary expenses), and 20% toward saving. Together, those account for all of your after-tax money, aka your disposable income.

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How Is Discretionary Income Used?

Discretionary income can be used for a number of fun things, from buying the latest mobile phone to taking a pal out for their birthday to spending a day at a theme park with the kids. You could also use discretionary income to make a future dream come true. You could, say, contribute to a fund for your next vacation or the down payment on a house. Another way to allocate discretionary income is to use it for home improvement projects, especially ones that could increase the value of your home. Heck, you could even save it in your bank account, plain and simple, if you wanted.

Also, it’s wise to recognize the fact that some people may need to use their discretionary money for an income-based repayment plan to pay down student loan debt. There may not be a lot of wiggle room there. Others must put this money toward paying down their credit card bills; those high-interest debts can grow over time and do damage to your credit score.

(One tip for those who get paid every other week: When you get an “extra” paycheck that doesn’t need to go to bills, consider it discretionary income that you could put toward an extra payment on debts or to toss into savings.)

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How to Calculate Discretionary Income

One way to calculate your discretionary income is to calculate your take-home pay each month and subtract your “fixed” or “necessary expenses” from that. The money you have left over is your discretionary income which can be used for the kinds of expenses we highlighted above.

What if, when you tally your discretionary income, you wound up with a negative number? This means you do not have any earnings left over to address discretionary expenses. In this situation, it’s important to keep spending under control and look for ways to free up funds.

One other angle to consider about this topic: If you have student loans to pay off, discretionary income can be used for an income-based repayment plan.The federal government offers income-based plans, and each one has its own discretionary income requirements.

These programs often put your student loan payments notably under what you might otherwise pay. Some of the factors taken into consideration are income and family size; you also must meet certain requirements to qualify for these repayment plans. You can see how the options stack up by plugging your details into the federal government’s loan simulator tool.

What Is A Good Amount of Discretionary Income?

When you’re considering how much discretionary income you should have, you might want to consult a discretionary income calculator. Many options for these calculators are available online.

Hopefully you have some money left each month after you’ve paid your basic living expenses. As you look at your overall budget and discretionary income, you might benefit from exploring the 50/30/20 rule, as noted above.

Example of Using 50/30/20 Rule to Calculate Discretionary Income

If your monthly net (take-home) income was $5,000, $2,500 would be siphoned off for your “needs,” $1,500 would be allotted for discretionary income, and $1,000 would go toward savings and investments. This can be a really helpful way to understand how to “bucket” your money and keep your finances healthy.

As you think about discretionary income and related concepts, you’ll probably realize how important it is to have a budget; this will inform where your money has to go as well as what’s left after those bills have been paid. It will help keep you on track for your discretionary income, reining in excessive spending and guiding you toward saving well and staying out of debt. There are a variety of different budget methods; try a couple and see which works best for you.

💡 Quick Tip: When you overdraft your checking account, you’ll likely pay a non-sufficient fund fee of, say, $35. Look into linking a savings account to your checking account as a backup to avoid that, or shop around for a bank that doesn’t charge you for overdrafting.

Discretionary vs. Disposable Income

The phrases “discretionary income” and “disposable income” might be used interchangeably in conversations among your friends, but — sorry — that’s not necessarily correct.

•  Disposable income is how much money you have left from your earnings after tax withholdings are taken out but before deductions are also removed. That’s likely going to be a much higher number than your discretionary income.

•  Discretionary income is the amount left after your taxes and deductions (like health insurance, retirement contributions, etc.) are taken out, and then you’ve paid all of your essential living expenses (home, utilities, food, car).

It’s important to be aware that these definitions may be used differently in some circumstances, like if a court is going to garnish your wages or back-owed tax payments during a bankruptcy consideration. These are distressing circumstances, yes, but they happen every day to regular people, so it’s good to have the vocabulary down if you ever face these situations.

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FAQ

What is the meaning of discretionary income?

Discretionary income is defined as the cash you have available to spend after your taxes are deducted and necessary payments are covered.

What is an example of discretionary income?

Here’s an example of discretionary income: If your post-tax earnings were $100K and you spent $50K on necessities and $20K went into your retirement savings, the remaining $30K would be discretionary income.

What is the difference between discretionary and disposable income?

Discretionary income is the money that you spend on non-essential items, or the wants in your life vs. needs. Disposable income, however, is your total after-tax income.

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

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

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

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

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

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

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Nov
21
2023

Guide to Liquid Net Worth

By | Budgeting & Goals, Financial Independence, Growing Wealth, money, Terminology | Comments Off on Guide to Liquid Net Worth

If you’re wondering how your financial health is tracking, you may want to figure out your net worth and your liquid net worth. These two numbers reflect what your assets (what you have) vs. what you owe, helping you see how your personal wealth is evolving.

While totaling up your net worth offers a more big-picture view of your total assets with your total liabilities subtracted, liquid net worth is a slice of that. It focuses on solely the amount you own in liquid assets minus your total liabilities.

This reflects how much cash you truly have access to or could quickly raise if for some reason you needed to.

Here’s a guide to determining your liquid net worth and ways to improve it.

Key Points

•   Net worth is the value of your assets minus your liabilities, while liquid net worth focuses on easily accessible assets.

•   Liquid net worth includes cash, checking and savings accounts, stocks, bonds, and other assets that can be quickly converted to cash.

•   Non-liquid assets like real estate and retirement accounts are not included in liquid net worth calculations.

•   Liquid net worth is important for financial stability and emergency preparedness.

•   Strategies for improving liquid net worth include building an emergency fund, reducing expenses, paying off high-interest debt, and increasing investments.

What Is Liquid Net Worth?

First, know that net worth is the amount of assets you have minus your liabilities, or what you owe. When it comes to income vs. net worth, you see that your worth is more than just what you earn; it’s also what you keep and how you invest and grow your money.

For instance, if you have a high income but spend it all because your cost of living is very high, your net worth could be very low despite your healthy salary.

Now, what is liquid net worth’s meaning? That’s the same calculation as net worth, but only looking at assets that could easily be tapped. So, you would exclude the value of, say, the home you are living in or your retirement accounts which you can’t touch until decades from now.

Liquid net worth reflects assets you could draw upon right now if you had to, without putting your home on the market or pulling money out of an IRA. Net worth vs. liquid net worth, on the other hand, represents all your assets, whether easily tapped or not.

What Counts for Liquid Net Worth Calculations?

Here are some assets that can count when calculating liquid net worth:

•   Cash

•   Money in a checking account

•   Money in a savings, CD, or money market account

•   Mutual funds, stocks, and bonds

•   Possibly jewelry and watches that could be quickly sold, if need be.

Typically, you do not include real estate or retirement savings when calculating liquid net worth as these can’t be cashed in on the spot if that was your goal.

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Net Worth vs Liquid Net Worth

As briefly mentioned above, your total net worth includes all of your assets (what you own) and liabilities (what you owe). When you determine your net worth, you add up all your assets, including non-liquid assets, such as your house, car, and retirement accounts, and then subtract all of your liabilities. The resulting number is your total net worth.

•   Your liquid net worth is the amount of money you have in cash or cash equivalents (assets that can be easily converted into cash) after you’ve deducted all of your liabilities.

It’s very similar to net worth, except that it doesn’t account for non-liquid assets such as real estate or retirement accounts.

•   Your total net worth gives you a picture of your overall financial strength and balance sheet, while liquid net worth shows how much money you have available that is quickly accessible in case of emergency or other financial hardship.

•   Both measures of net worth can give you a useful snapshot of your financial wellness, since they consider both assets and debts. Looking at your assets without considering your debts can give you a false picture of your financial situation.

•   Knowing and tracking these numbers can also tell you if you are moving in the right or wrong financial direction. If your net worth or liquid net worth is in negative territory or the numbers are declining over time, it can be a sign you need to make some changes and/or may want to put off making a major purchase such as a home or a car.

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Why Liquid Net Worth Matters

Your liquid net worth is a measure of your ability to weather a financial storm. Imagine you need money for something important — a major home or car repair, a trip to the ER, or getting laid off and deciding to start a new business.

You need it now… or, at least, within the next few weeks or months. Where are you going to get the money?

You might not want to look at cashing in things like your home, your car, your retirement savings, your baseball card collection, or Grandma’s wedding ring unless it’s absolutely necessary.

Those kinds of assets can be difficult to convert to cash in a hurry — and there could be consequences if you did decide to go that route.

Instead, it may be easier to tap your more liquid assets, such as cash from a checking, savings, or money market account, or cash equivalents, like stocks and bonds, mutual funds, or money market funds.

Liquid net worth is often considered a true measure of how financially stable you are because it tells you what you can rely on to cover expenses. In addition, your liquid net worth acts as an overall emergency fund.

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Calculating Your Liquid Net Worth

The difference in calculating net worth and liquid net worth is understanding which of your financial assets are liquid assets.

Liquid assets are cash and assets that could be converted to cash quickly. The following are considered liquid assets.

•   Cash: This includes the money that is in your wallet, as well as the cash you have in any savings, checking, and money market accounts.

•   Stocks: Any equity in a brokerage account, such as stocks, index funds, mutual funds, and ETFs, is considered a liquid asset. While you might have to pay taxes and other fees if you sell equities to convert to cash, you could liquidate these assets fairly quickly.

•   Bonds: Like equities, any bonds or bond funds are also liquid assets. Again, you may have to pay taxes on your profits when you sell, but the translation is relatively quick.

Non-liquid assets include anything that cannot be converted to cash quickly or for their full value, such as:

•   Retirement accounts, such as 401(k)s and IRAs.

•   A house or other real estate holding (which could take a while to sell and the actual sales price is not known).

•   Cars (while you may be able to liquidate a car relatively quickly, cars generally don’t hold their original value; they depreciate).

Liquid Net Worth Formula

For a liquid net worth calculation, here are the steps to follow:

•   List all of your liquid assets: The cash and cash equivalents you could easily and quickly get your hands on if you need money.

•   Next, list your current liabilities, including credit card debt, student loan balance, unsecured loans, medical debt, a car loan, and any other debt.

•   Subtract your liabilities from your liquid assets. The result is your liquid net worth.

4 Tips for Improving Liquid Net Worth

If your liquid net worth is too low to cover at least three to six months’ worth of living expenses or is in negative territory, you may want to take some steps to bolster this number. Here are some strategies that can help boost liquid net worth.

1. Building an Emergency Fund

If you don’t already have a solid contingency fund set aside in a liquid account, you may want to start building one. Having enough cash on hand to cover three to six months’ worth of expenses can be a great place to start building your liquid net worth.

An emergency fund can help keep you from getting behind on your bills and running up high interest credit card debt in the event of an unexpected expense, job loss, or reduction in work hours.

It’s fine to build towards this slowly. Automating your savings to deposit, say, $25 per paycheck into an emergency fund can be a good starting point if money is tight.

2. Reducing Expenses

For every dollar you save each month, you are potentially increasing your liquid net worth by that amount. One way to cut spending is to take a close look at your monthly expenses and to then try to find places where you may be able to cut back, such as saving on streaming services, lowering your food bills, or shopping around for a better deal on home and car insurance.

3. Lowering High-Interest Debt

Debts add to your liabilities and therefore lower your liquid net worth. Expensive debt also increases your monthly expenses in the form of interest. This gives you less money to put in the bank each month, making it harder to build your liquid net worth.

If you’re carrying credit card debt, you may want to start a debt reduction plan (such as the “debt snowball” or “debt avalanche” method) to get it paid down faster.

4. Increasing Investments

Investing money in the market for long-term savings goals, such as a child’s education, can increase your liquid net worth. While there is risk involved, you’ll have more time to ride out the ups and downs of the securities markets when saving for the longer term.

Recommended: Average Net Worth by Age

The Takeaway

Liquid net worth is the amount of money you have in cash or cash equivalents after you’ve deducted your liabilities from your liquid assets. It doesn’t account for non-liquid assets, such as real estate or retirement accounts.

Your liquid net worth can be a valuable measure of your financial health and stability because it shows how prepared you are to handle a change in plans, an unexpected expense, or a true emergency.

One easy way to boost your liquid net worth is to start building an emergency fund. If you’re looking for a good place to start saving, you may want to consider opening a high-interest bank account.

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


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

FAQ

Does a 401(k) count as liquid net worth?

When calculating liquid net worth, you typically do not include retirement accounts nor real estate. Liquid net worth’s meaning involves assets you can quickly tap without paying a large penalty.

How do you calculate liquid net worth?

To calculate your liquid net worth, add up your liquid assets (cash, money in the bank, stocks, bonds, and the like) and subtract your liabilities (credit card debt, student loans, car loan, etc.). When adding up your assets, do not include real estate or retirement accounts.

What is the average liquid net worth by age?

Figures for average liquid net worth are hard to come by. Rather, total net worth is what is typically tracked, which was recently found to be approximately $76,300 for those under age 35, $436,200 for those 35 to 44; $833,200 for those 45 to 54, and $1,175,900 for those 55 yo 64. It may be helpful to also consider the media values for these age brackets, which are significantly lower than the average.

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

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

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

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

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

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

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

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