Nov
18
2024
Why Is It Risky to Invest in Commodities?
Why is it risky to invest in a commodity — and why is it a good idea? In this article, we’ll give you a crash course on commodity risk and trading.
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SoFi
Student Loan Consolidation and Refinancing
Nov
18
2024
Commodities Trading Guide for Beginners
Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Commodities trading — e.g. agricultural products, energy, and metals — can be profitable if you understand how the commodity markets work. Commodities trading is generally viewed as high risk, since the commodities markets can fluctuate dramatically owing to factors that are difficult to foresee (like weather) but influence supply and demand.
Nonetheless, commodity trading can be useful for diversification because commodities tend to have a low or even a negative correlation with asset classes like stocks and bonds. Commodities fall firmly in the category of alternative investments, and thus they may be better suited to some investors than others. Getting familiar with commodity trading basics can help investors manage risk vs. reward.
Key Points
• Commodities trading involves buying and selling raw materials like agricultural products, energy, and metals, which can be profitable with proper understanding of the markets.
• The commodities market is driven primarily by supply and demand, making it susceptible to volatility from unpredictable factors such as weather and global economic changes.
• Investors can engage in commodities trading through various methods, including futures contracts, stocks in related companies, ETFs, mutual funds, and index funds.
• The advantages of commodity trading include portfolio diversification and potential hedging against inflation, while the main disadvantage is the high risk associated with price volatility.
• Understanding personal risk tolerance is essential before investing in commodities, which may be more suitable for those comfortable with higher risk strategies.
What Is Commodities Trading?
Commodities trading simply means buying and selling a commodity on the open market. Commodities are raw materials that have a tangible economic value. For example, agricultural commodities include products like soybeans, wheat, and cotton. These, along with gold, silver, and other precious metals, are examples of physical commodities.
There are different ways commodity trading can work. Investing in commodities can involve trading futures, options trading, or investing in commodity-related stocks, exchange-traded funds (ETFs), mutual funds, or index funds. Different investments offer different strategies, risks, and potential costs that investors need to weigh before deciding how to invest in commodities.
Unique Traits of the Commodities Market
The commodities market is unique in that market prices are driven largely by supply and demand, less by market forces or events in the news. When supply for a particular commodity such as soybeans is low — perhaps owing to a drought — and demand for it is high, that typically results in upward price movements.
And when there’s an oversupply of a commodity such as oil, for example, and low demand owing to a warmer winter in some areas, that might send oil prices down.
Likewise, global economic development and technological innovations can cause a sudden shift in the demand for certain commodities like steel or gas or even certain agricultural products like sugar.
Thus, investing in commodities can be riskier because they’re susceptible to volatility based on factors that can be hard to anticipate. For example, a change in weather patterns can impact crop yields, or sudden demand for a new consumer product can drive up the price of a certain metal required to make that product.
Even a relatively stable commodity such as gold can be affected by rising or falling interest rates, or changes in the value of the U.S. dollar.
In the case of any commodity, it’s important to remember that you’re often dealing with tangible, raw materials that typically don’t behave the way other investments or markets tend to.
Commodity vs Stock Trading
The main difference in stock trading vs commodity trading lies in what’s being traded. When trading stocks, you’re trading ownership shares in a particular company. If you’re trading commodities, you’re trading the physical goods that those companies may use.
There’s also a difference in where you trade commodities vs. stocks. Stocks are traded on a stock exchange, such as the New York Stock Exchange (NYSE) or Nasdaq. Commodities and commodities futures are traded on a commodities exchange, such as the New York Mercantile Exchange (NYME) or the Chicago Mercantile Exchange (CME).
That said, and we’ll explore this more later in this guide, it’s possible to invest in commodities via certain stocks in companies that are active in those industries.
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Start trading funds that include commodities, private credit, real estate, venture capital, and more.
Types of Commodities
Commodities are grouped together as an asset class but there are different types of commodities you may choose to invest in. There are two main categories of commodities: Hard commodities and soft commodities. Hard commodities are typically extracted from natural resources while soft commodities are grown or produced.
Agricultural Commodities
Agricultural commodities are soft commodities that are typically produced by farmers. Examples of agricultural commodities include rice, wheat, barley, oats, oranges, coffee beans, cotton, sugar, and cocoa. Lumber can also be included in the agricultural commodities category.
Needless to say, this sector is heavily dependent on seasonal changes, weather patterns, and climate conditions. Other factors may also come into play, like a virus that impacts cattle or pork. Population growth or decline in a certain area can likewise influence investment opportunities, if demand for certain products rises or falls.
Recommended: How to Invest in Agriculture
Livestock and Meat Commodities
Livestock and meat are given their own category in the commodity market. Examples of livestock and meat commodities include pork bellies, live cattle, poultry, live hogs, and feeder cattle. These are also considered soft commodities.
You may not think that seasonal factors or weather patterns could affect this market, but livestock and the steady production of meat requires the steady consumption of feed, typically based on corn or grain. Thus, this is another sector that can be vulnerable in unexpected ways.
Energy Commodities
Energy commodities are hard commodities. Examples of energy commodities include crude oil, natural gas, heating oil or propane, and products manufactured from petroleum, such as gasoline.
Here, investors need to be aware of certain economic and political factors that could influence oil and gas production, like a change in policy from OPEC (the Organization of the Petroleum Exporting Countries). New technology that supports alternative or green energy sources can also have a big impact on commodity prices in the energy sector.
Precious Metals and Industrial Metals
Metals commodities are also hard commodities. Types of metal commodities include precious metals such as gold, silver, and platinum. Industrial metals such as steel, copper, zinc, iron, and lead would also fit into this category.
Investors should be aware of factors like inflation, which might push people to buy precious metals as a hedge.
How to Trade Commodities
If you’re interested in how to trade commodities, there are different ways to go about it. It’s important to understand the risk involved, as well as your objectives. You can use that as a guideline for determining how much of your portfolio to dedicate to commodity trading, and which of the following strategies to consider.
Recommended: What Is Asset Allocation?
Trading Stocks in Commodities
If you’re already familiar with stock trading, purchasing shares of companies that have a commodities connection could be the simplest way to start investing.
For example, if you’re interested in gaining exposure to agricultural commodities or livestock and meat commodities, you may buy shares in companies that belong to the biotech, pesticide, or meat production industries.
Or, you might consider purchasing oil stocks or mining stocks if you’re more interested in the energy stocks and precious or industrial metals commodities markets.
Trading commodities stocks is the same as trading shares of any other stock. The difference is that you’re specifically targeting companies that are related to the commodities markets in some way. This requires understanding both the potential of the company, as well as the potential impact of fluctuations in the underlying commodity.
You can trade commodities stocks on margin for even more purchasing power. This means borrowing money from your brokerage to trade, which you must repay. This could result in bigger profits, though a drop in stock prices could trigger a margin call.
Futures Trading in Commodities
A futures contract represents an agreement to buy or sell a certain commodity at a specific price at a future date. The producers of raw materials make commodities futures contracts available for trade to investors.
So, for example, an orange grower might sell a futures contract agreeing to sell a certain amount of their crop for a set price. A company that sells orange juice could then buy that contract to purchase those oranges for production at that price.
This type of futures trading involves the exchange of physical commodities or raw materials. For the everyday investor, futures trading in commodities typically doesn’t mean you plan to take delivery of two tons of coffee beans or 4,000 bushels of corn. Instead, you buy a futures contract with the intention of selling it before it expires.
Futures trading in commodities is speculative, as investors are making educated guesses about which way a commodity’s price will move at some point in the future. Similar to trading commodities stocks, commodities futures can also be traded on margin. But again, this could mean taking more risk if the price of a commodity doesn’t move the way you expect it to.
Trading ETFs in Commodities
Commodity ETFs (or exchange-traded funds) can simplify commodities trading. When you purchase a commodity ETF you’re buying a basket of securities. These can target a picture type of commodities, such as metals or energy, or offer exposure to a broad cross-section of the commodities market.
A commodity ETF can offer simplified diversification though it’s important to understand what you own. For example, a commodities ETF that includes options or commodities futures contracts may carry a higher degree of risk compared to an ETF that includes commodities companies, such as oil and gas companies, or food producers.
Recommended: How to Trade ETFs
Investing in Mutual and Index Funds in Commodities
Mutual funds and index funds offer another entry point to commodities investing. Like ETFs, mutual funds and index funds can allow you to own a basket of commodities securities for easier diversification. But actively managed mutual funds offer investors access to very different strategies compared with index funds.
Actively managed funds follow an active management strategy, typically led by a portfolio manager who selects individual securities for the fund. So investing in a commodities mutual fund that’s focused on water or corn, for example, could give you exposure to different companies that build technologies or equipment related to water sustainability or corn production.
By contrast, index mutual funds are passive, and simply mirror the performance of a market index.
Even though these funds allow you to invest in a portfolio of different securities, remember that commodities mutual funds and index funds are still speculative, so it’s important to understand the risk profile of the fund’s underlying holdings.
Commodity Pools
A commodity pool is a private pool of money contributed by multiple investors for the purpose of speculating in futures trading, swaps, or options trading. A commodity pool operator (CPO) is the gatekeeper: The CPO is responsible for soliciting investors to join the pool and managing the money that’s invested.
Trading through a commodity pool could give you more purchasing power since multiple investors contribute funds. Investors share in both the profits and the losses, so your ability to make money this way can hinge on the skills and expertise of the CPO. For that reason, it’s important to do the appropriate due diligence. Most CPOs should be registered with the National Futures Association (NFA). You can check a CPO’s registration status and background using the NFA website.
💡 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.
Advantages and Disadvantages of Commodity Trading
Investing in commodities has its pros and cons like anything else, and they’re not necessarily right for every investor. If you’ve never traded commodities before it’s important to understand what’s good — and potentially not so good — about this market.
Advantages of Commodity Trading
Commodities can add diversification to a portfolio which can help with risk management. Since commodities have low correlation to the price movements of traditional asset classes like stocks and bonds they may be more insulated from the stock volatility that can affect those markets.
Supply and demand, not market conditions, drive commodities prices which can help make them resilient throughout a changing business cycle.
Trading commodities can also help investors hedge against rising inflation. Commodity prices and inflation move together. So if consumer prices are rising commodity prices follow suit. If you invest in commodities, that can help your returns keep pace with inflation so there’s less erosion of your purchasing power.
Disadvantages of Commodity Trading
The biggest downside associated with commodities trading is that it’s high risk. Changes in supply and demand can dramatically affect pricing in the commodity market which can directly impact your returns. That means commodities that only seem to go up and up in price can also come crashing back down in a relatively short time frame.
There is also a risk inherent to commodities trading, which is the possibility of ending up with a delivery of the physical commodity itself if you don’t close out the position. You could also be on the hook to sell the commodity.
Aside from that, commodities don’t offer any benefits in terms of dividend or interest payments. While you could generate dividend income with stocks or interest income from bonds, your ability to make money with commodities is based solely on buying them low and selling high.
The Takeaway
Commodities trading could be lucrative but it’s important to understand what kind of risk it entails. Commodities trading is a high-risk strategy so it may work better for investors who have a greater comfort with risk, versus those who are more conservative. Thinking through your risk tolerance, risk capacity, and timeline for investing can help you decide whether it makes sense to invest in commodities.
Fortunately, there are a number of ways to invest in commodities, including futures and options (which are a bit more complex), as well as stocks, ETFs, mutual and index funds — securities that may be more familiar.
Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.
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Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
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SOIN1023182
Nov
18
2024
How to Calculate the Debt-to-Equity Ratio
The debt-to-equity ratio (D/E) is one of many financial metrics that helps investors determine potential risks when looking to invest in certain stocks.
Companies also use debt, also known as leverage, to help them accomplish business goals and finance operating costs. Calculating a company’s debt-to-income ratio requires a relatively simple formula investors can use on their own or with a spreadsheet.
Key Points
• The debt-to-equity ratio (D/E) is a financial metric that compares a company’s total liabilities to its shareholder equity, indicating its reliance on debt for financing.
• Calculating the D/E ratio involves dividing total liabilities by shareholder equity, with the resulting figure helping investors assess potential risks associated with a company’s financial structure.
• A high D/E ratio may suggest a company is overleveraged, making it riskier for investors, while a low ratio could indicate underutilization of debt for growth opportunities.
• Different industries have varying acceptable D/E ratios, with capital-intensive sectors often operating with higher ratios due to their borrowing needs for growth.
• The D/E ratio is just one of many indicators investors should consider, as it should be contextualized within industry standards and accompanied by a broader analysis of a company’s financial health.
What Is the Debt-to-Equity Ratio?
The debt-to-equity ratio is one of several metrics that investors can use to evaluate individual stocks. At its simplest, the debt-to-equity ratio is a quick way to assess a company’s total liabilities vs. total shareholder equity, to gauge the company’s reliance on debt.
In other words, the D/E ratio compares a company’s equity — how much value is locked up in its shares — to its debts. Among other things, knowing this figure can help investors gauge a company’s ability to cover its debts. For example, if a company were to liquidate its assets, would it be able to cover its debt? How much money would be left over for shareholders?
Investors often use the debt-to-equity ratio to determine how much risk a company has taken on, and in return, how risky it may be to invest in that company. After all, if a company goes under and can’t cover its debts, its shares could wind up worthless.
💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.
What Is Leverage?
To understand the debt-to-equity ratio, it’s helpful to understand the concept of leverage. A business has two options when it comes to paying for operating costs: It can either use equity, or it can use debt, a.k.a. leverage.
The company can use the funds they borrow to buy equipment, inventory, or other assets — or to fund new projects or acquisitions. The money can also serve as working capital in cyclical businesses during the periods when cash flow is low.
While it’s potentially risky to use leverage — a company might have to declare bankruptcy if it can’t pay its debt — borrowed funds can also help a company grow beyond the limitation of its equity at critical junctures.
The term “leverage” reflects the hope that the company will be able to use a relatively small amount of debt to boost its growth and earnings. Wise use of debt can help companies build a good reputation with creditors, which, in turn, will allow them to borrow more money for potential future growth.
Understanding Different Types of Debt
Not all debt is considered equally risky, however, and investors may want to consider a company’s long-term versus short-term liabilities. Generally speaking, short-term liabilities (e.g. accounts payable, wages, etc.) that would be paid within a year are considered less risky.
A company’s ability to cover its long-term obligations is more uncertain, and is subject to a variety of factors including interest rates (more on that below).
The Debt-to-Equity Ratio Formula
Calculating the debt-to-equity ratio is fairly straightforward. You can find the numbers you need on a listed company’s balance sheet.
To calculate the D/E ratio, take the company’s total liabilities and divide it by shareholder equity. Here’s what the debt to equity ratio formula looks like:
D/E = Total Liabilities / Shareholder Equity
How to Calculate the Debt-to-Equity Ratio
In order to calculate the debt-to-equity ratio, you need to understand both components.
Total Liabilities
This component includes a company’s current and long-term liabilities. Current liabilities are the debts that a company will typically pay off within the year, including accounts payable. Long-term liabilities are debts whose maturity extends longer than a year. Think mortgages on buildings or long-term leases.
Equity
The equity component includes two portions: shareholder equity and retained earnings. Shareholder equity is the money investors have paid in exchange for shares of the company stock. Retained earnings are profits that the company holds onto that aren’t paid out in the form of dividends to shareholders.
Excel Formula for Debt-to-Equity Ratio
Using excel or another spreadsheet to calculate the D/E is relatively straightforward. First, using the company balance sheet, pull the total debt amount and the total shareholder equity amount, and enter these numbers into adjacent cells (e.g. E2 and E3).
Then, in cell E4 enter the formula “=E2/E3”, and this will give you the D/E ratio.
Debt-to-Equity Example
To look at a simple example of a debt to equity formula, consider a company with total liabilities worth $100 million dollars and equity worth $85 million. Divide $100 million by $85 million and you’ll see that the company’s debt-to-equity ratio would be about 1.18. In other words, the company has $1.18 in debt for every dollar of equity.
When using a real-world debt to equity ratio formula, you’ll probably be able to find figures for both total liabilities and shareholder equity on a company’s balance sheet. Publicly traded companies will usually share their balance sheet along with their regular filings with the Securities and Exchange Commission (SEC).
Putting the D/E in Context
Remember that arriving at this ratio is just that: a single number that reveals a certain aspect of a company’s potential performance, but doesn’t tell the whole story. It’s essential to compare a company’s D/E ratio to that of other companies in its industry.
In addition, there are many other ways to assess a company’s fundamentals and performance — by using fundamental analysis and technical indicators. Experienced investors rarely rely on one measure to evaluate a stock.
What Is a Good Debt-to-Equity Ratio?
Once you’ve calculated a debt-to-equity ratio, how do you know whether that number is good or bad?
As a general rule of thumb, a good debt-to-equity ratio will equal about 1.0. However, the acceptable rate can vary by industry, and may depend on the overall economy. A higher debt-to-income ratio could be more risky in an economic downturn, for example, than during a boom.
Recommended: Investing During a Recession
For example, if a company, such as a manufacturer, requires a lot of capital to operate, it may need to take on a lot of debt to finance its operations. A company like this may have a debt equity ratio of about 2.0 or more.
Other companies that might have higher ratios include those that face little competition and have strong market positions, and regulated companies, like utilities, that investors consider relatively low risk.
Companies that don’t need a lot of debt to operate may have debt-to-equity ratios below 1.0. For example, the service industry requires relatively little capital.
Modifying Debt-to-Equity Ratio
As noted above, it’s also important to know which type of liabilities you’re concerned about — longer-term debt vs. short-term debt — so that you plug the right numbers into the formula.
For example, if you have two companies, each with $2.5 million in shareholder equity, and $2.5 million in debt, their D/E ratios would be the same: 1.0.
But let’s say Company A has $2 million in long-term liabilities, and $500,000 in short-term liabilities, whereas Company B has $1.5 million in long-term debt and $1 million in short term debt. The long-term D/E ratio for Company A would be 0.8 vs. 0.6 for company B, indicating a higher risk level.
Depending on the industry they were in and the D/E ratio of competitors, this may or may not be a significant difference, but it’s an important perspective to keep in mind.
What Does a Company’s Debt-to-Equity Ratio Say About It?
A debt-to-equity-ratio that’s high compared to others in a company’s given industry may indicate that that company is overleveraged and in a precarious position. Investors may want to shy away from companies that are overloaded on debt.
Not only that, companies with a high debt-to-equity ratio may have a hard time working with other lenders, partners, or even suppliers, who may be afraid they won’t be paid back.
In some cases, creditors limit the debt-to-equity ratio a company can have as part of their lending agreement. Such an agreement prevents the borrower from taking on too much new debt, which could limit the original creditor’s ability to collect.
It is possible that the debt-to-equity ratio may be considered too low, as well, which is an indicator that a company is relying too heavily on its own equity to fund operations. In that case, investors may worry that the company isn’t taking advantage of potential growth opportunities.
Ultimately, businesses must strike an appropriate balance within their industry between financing with debt and financing with equity.
What Does It Mean for a Debt-to-Equity Ratio to Be Negative?
There could be several reasons for a negative debt-to-equity ratio, including:
• Interest rates are higher than the returns
• A negative net worth (more liabilities than assets)
• A financial loss after a large dividend payout
• Dividend payments that surpass investor’s equity in the firm
So, what does this mean for investors?
Negative D/E ratios may tell investors that the company indicates investment risk and shows that the company is not financially stable. Therefore, investing in such a company may result in a loss for investors.
💡 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.
Which Industries Have High Debt-to-Equity Ratios?
The depository industry (banks and lenders) may have high debt-to-equity ratios. Because banks borrow funds to loan money to consumers, financial institutions usually have higher debt-to-equity ratios than other industries.
Other industries with high debt-to-equity ratios include:
• Non-depository credit institutions
• Insurance providers
• Hotels, rooming houses, camps, and other lodging places
• Transportation by air
• Railroad transportation
Effect of Debt-to-Equity Ratio on Stock Price
The debt-to-equity ratio can clue investors in on how stock prices may move. As a measure of leverage, debt-to-equity can show how aggressively a company is using debt to fund its growth.
The interest rates on business loans can be relatively low, and are tax deductible. That makes debt an attractive way to fund business, especially compared to the potential returns from the stock market, which can be volatile. And sometimes an aggressive strategy can pay off.
For example, if a company takes on a lot of debt and then grows very quickly, its earnings could rise quickly as well. If earnings outstrip the cost of the debt, which includes interest payments, a company’s shareholders can benefit and stock prices may go up.
The opposite may also be true. A highly leveraged company could have high business risk. If earnings don’t outpace the debt’s cost, then shareholders may lose and stock prices may fall.
Having to make high debt payments can leave companies with less cash on hand to pay for growth, which can also hurt the company and shareholders. And a high debt-to-equity ratio can limit a company’s access to borrowing, which could limit its ability to grow.
Recommended: What Every Investor Should Know About Risk
Debt-to-Equity (D/E) Ratio vs the Gearing Ratio
The debt-to-equity ratio belongs to a family of ratios that investors can use to help them evaluate companies. These ratios are collectively known as gearing ratios.
Here’s a quick look at other gearing ratios you may encounter:
Equity Ratio
This ratio compares a company’s equity to its assets, showing how much of the company’s assets are funded by equity.
Debt Ratio
This looks at the total liabilities of a company in comparison to its total assets. On the surface, this may sound like the debt ratio formula is the same as the debt-to-equity ratio formula. However, the total debt ratio formula includes short-term assets and liabilities as part of the equation, which the debt-to-equity ratio discounts. Also, this ratio looks specifically at how much of a company’s assets are financed with debt.
Time Interest Earned
This ratio helps indicate whether a company has the ability to make interest payments on its debt, dividing earnings before interest and taxes (EBIT) by total interest. Most of the information needed to calculate these ratios appears on a company’s balance sheet, save for EBIT, which appears on its profit and loss statement.
How Businesses Use Debt-to-Equity Ratios
Businesses pay as much attention to debt-to-equity as individual investors. For example, if a company wants to take on new credit, they would likely want their debt-to-equity ratio to be favorable.
Banks and other lenders keep tabs on what healthy debt-to-equity ratios look like in a given industry. A debt-to-equity ratio that seems too high, especially compared to a company’s peers, might signal to potential lenders that the company isn’t in a good position to repay the debt.
Publicly traded companies that are in the midst of repurchasing stock may also want to control their debt-to-equity ratio. That’s because share buybacks are usually counted as risk, since they reduce the value of stockholder equity. As a result the equity side of the equation looks smaller and the debt side appears bigger.
How Can the Debt-to-Equity Ratio Be Used to Measure a Company’s Risk?
While acceptable D/E ratios vary by industry, investors can still use this ratio to identify companies in which they want to invest. First, however, it’s essential to understand the scope of the industry to fully grasp how the debt-to-equity ratio plays a role in assessing the company’s risk.
Many companies borrow money to maintain business operations — making it a typical practice for many businesses. For companies with steady and consistent cash flow, repaying debt happens rapidly. Also, because they repay debt quickly, these businesses will likely have solid credit, which allows them to borrow inexpensively from lenders.
Therefore, even if such companies have high debt-to-equity ratios, it doesn’t necessarily mean they are risky. For example, companies in the utility industry must borrow large sums of cash to purchase costly assets to maintain business operations. However, since they have high cash flows, paying off debt happens quickly and does not pose a huge risk to the company.
On the other hand, companies with low debt-to-equity ratios aren’t always a safe bet, either. For example, a company may not borrow any funds to support business operations, not because it doesn’t need to but because it doesn’t have enough capital to repay it promptly. This may mean that the company doesn’t have the potential for much growth.
IPOs and Debt-to-Equity Ratios
Many startups make high use of leverage to grow, and even plan to use the proceeds of an initial public offering, or IPO, to pay down their debt. The results of their IPO will determine their debt-to-equity ratio, as investors put a value on the company’s equity.
So in the case of deciding whether to invest in IPO stock, it’s important for investors to consider debt when deciding whether they want to buy IPO stock.
The Limitations of Debt-to-Equity Ratios
Debt-to-equity ratio is just one piece of the puzzle when it comes to evaluating stocks. Whether the ratio is high or low is not the bottom line of whether one should invest in a company. A deeper dive into a company’s financial structure can paint a fuller picture.
A company’s accounting policies can change the calculation of its debt-to-equity. For example, preferred stock is sometimes included as equity, but it has certain properties that can also make it seem a lot like debt. Specifically, preferred stock with dividend payment included as part of the stock agreement can cause the stock to take on some characteristics of debt, since the company has to pay dividends in the future.
If preferred stock appears on the debt side of the equation, a company’s debt-to-equity ratio may look riskier. If it’s included on the equity side, the ratio can look more favorable.
In some cases, companies can manipulate assets and liabilities to produce debt-to-equity ratios that are more favorable. Additionally, investors may want to keep an eye on interest rates. If they’re low, it can make sense for companies to borrow more, which can inflate the debt-to-equity ratio, but may not actually be an indicator of bad tidings.
Finally, the debt-to-equity ratio does not take into account when a debt is due. A debt due in the near term could have an outsized effect on the debt-to-equity ratio.
As a result of temporary imbalances like these, investors may want to compare debt-to-equity ratios from various time periods to get an idea of a company’s normal wage, or whether fluctuations are signaling more noteworthy movement within the company.
Investing in Businesses With SoFi
Investors can use the debt-to-equity ratio to help determine potential risk before they buy a stock. As an individual investor you may choose to take an active or passive approach to investing and building a nest egg. The approach investors choose may depend on their goals and personal preferences.
Investors who want to take a more hands-on approach to investing, choosing individual stocks, may take a look at the debt-to-equity ratio to help determine whether a company is a risky bet.
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).
FAQ
What is a good debt-to-equity ratio?
Generally speaking a D/E ratio of about 1.0 doesn’t raise any red flags, but it’s important to consider the needs of the company, its industry, and its competitors, as any of these factors might justify a higher debt-to-equity ratio.
How do you interpret debt-to-equity ratio?
Taking a broader view of a company and understanding the industry its in and how it operates can help to correctly interpret its D/E ratio. For example, utility companies might be required to use leverage to purchase costly assets to maintain business operations. But utility companies have steady inflows of cash, and for that reason having a higher D/E may not spell higher risk.
What is considered a bad debt-to-equity ratio?
A D/E ratio of about 1.0 to 2.0 is considered good, depending on other factors like the industry the company is in. But a D/E ratio above 2.0 — i.e., more than $2 of debt for every dollar of equity — could be a red flag. Again, context is everything and the D/E ratio is only one indicator of a company’s health.
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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.
SOIN0723012
Read moreNov
18
2024
Sunroof vs Moonroof: How To Choose
Today, the term “sunroof” is typically used to refer to any panel or window in the roof of a vehicle that may pop up or slide open to allow air to circulate inside the cabin. A moonroof is a type of sunroof that features a stationary glass panel. There are many different sizes, shapes, and styles of sunroofs.
If you’re deciding which one to choose for a new car, we’ll share the differences and the pros and cons of each.
Key Points
• A sunroof is a panel on a car’s roof that can slide open.
• Sunroofs can be electric or manual, and may come in sliding or pop-up versions.
• Moonroofs, which have become more popular recently, have fewer mechanical issues.
• Sunroofs can add weight, reduce headroom, and increase insurance costs, but enhance ventilation and space perception.
• Moonroofs may require more AC use due to heat absorption, and repairs can be costly if they break.
What Is a Sunroof?
“Sunroof” has become a generic term for any panel or window in a car’s roof. More specifically, a sunroof is usually a panel located on the top of a vehicle that slides back to reveal a window or opening in the roof. The panel is usually opaque, matching the vehicle’s body color. It can be electric or manual.
Sunroofs can come in sliding or pop-up versions. Sometimes, a sunroof’s panel can be completely removed.
What Is a Moonroof?
“Moonroof” is a term introduced in 1973 by a marketing manager at Ford. A moonroof is a type of sunroof, made of transparent glass. It may be stationary or slide back, but can’t be removed. New cars typically have moonroofs instead of sunroofs.
A “lamella” moonroof has multiple glass panels that slide back and provide a scenic view. A panoramic moonroof has fixed glass panels that cover most of the vehicle’s roof and extend to the backseat.
Moonroof vs Sunroof Differences
As mentioned above, a sunroof is typically a painted metal panel that blends into the rest of the car roof and that slides open or can be removed. A moonroof is essentially a window in the roof, whose glass panel may or may not slide open.
Pros and Cons of a Sunroof
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Pros:
• Opening the sunroof can give motorists a sense of being in a convertible without the expense.
• A sunroof can make the interior space feel larger and keeps it well ventilated, reducing the need for air conditioning.
• The opaque panel prevents the car from overheating on sunny days.
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Cons:
• A sunroof can add weight to a vehicle and leave less headroom.
• It can also be tempting for passengers — especially children — to extend their hands or head through the roof. However, manufacturers (and common sense) caution that it’s unsafe.
• Although sunroofs can add to a car’s value, they can also cost more to insure. (You can find out how much by shopping around on online insurance sites.)
• The moving parts are vulnerable to jamming, which can lead to pricey repairs.
• Attempts to retrofit a sunroof may not be successful, with leaks being a common complaint. Factory-installed sunroofs are more reliable than ones using aftermarket parts.
Pros and Cons of a Moonroof
Because a moonroof is a type of sunroof, most of the sunroof pros and cons above also apply to moonroofs. However, there are a few additional considerations:
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Pros:
• In recent years, the moonroof has become more popular than the sunroof.
• Drivers appreciate how they allow sunlight in even when closed.
• Because there are no moving parts, a moonroof isn’t prone to mechanical problems.
• Moonroofs typically come with a sliding sunshade inside, allowing people in the car to decide how much sun protection they’d like.
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Cons:
• Because the glass absorbs heat, you may need to run your AC more on hot days.
• If a moonroof breaks, it can be expensive to fix.
Safety Considerations for Sunroofs and Moonroofs
As mentioned, it can be tempting to reach through or stand up in a vehicle with a sunroof or moonroof. For safety reasons, once the car is turned on, the driver and passengers should be seated and buckled.
Sunroofs and moonroofs also make a car more susceptible to break-ins, since there’s one more entry point for thieves to smash or pry open.
In case of a collision, there is additional risk of glass shattering, which can cause injury.
Recommended: How Much Does Car Insurance Go Up After an Accident?
Maintaining a Sunroof or Moonroof
As with any car feature, regular maintenance of your sunroof is recommended. And knowing how to DIY can help you save money on car maintenance. Mostly, that means keeping it clean. Here’s how:
1. First, use a hand brush to sweep debris off the roof.
2. Wipe down moving parts with a microfiber cloth.
3. Clean the glass with a product without ammonia or vinegar.
4. Lubricate moving parts with a lightweight automotive grease or WD-40.
How to Choose: Sunroof or Moonroof
When deciding between a moonroof and sunroof, consider your area’s climate and how much use you expect to get from the feature. It can also be helpful to ask friends or family who have experience with one or the other style for their opinions.
If money is a concern, a sunroof will cost $1,000-$1,500 more in a new car. Not having a sunroof can also help lower your auto insurance premiums.
In the end, it comes down to personal preference.
Recommended: How to Lower Car Insurance
The Takeaway
A sunroof refers to any opening or window in a car roof. A moonroof is a type of sunroof that usually features a stationary glass panel. There are many types, sizes, and styles of sunroofs, from electric to manual, pop-up to removable. Sunroofs will cost more upfront and possibly in maintenance fees and insurance. However, drivers and passengers will enjoy better light and air circulation, even without the air conditioner.
When you’re ready to shop for auto insurance, SoFi can help. Our online auto insurance comparison tool lets you see quotes from a network of top insurance providers within minutes, saving you time and hassle.
FAQ
Is a moonroof better than a sunroof?
Moonroofs do have advantages over sunroofs, including a lack of mechanical parts that require regular maintenance and can break down. Otherwise, it’s a matter of personal preference.
What are the disadvantages of a sunroof car?
A sunroof adds to the cost of the vehicle and likely to your insurance premiums. Sunroofs also make a car more vulnerable to break-ins and break-downs of mechanical parts.
Photo credit: iStock/AscentXmedia
Auto Insurance: Must have a valid driver’s license. Not available in all states.
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SoFi Insurance Agency, LLC. (“”SoFi””) is compensated by Experian for each customer who purchases a policy through the SoFi-Experian partnership.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOPRO-Q424-006
Nov
18
2024
What Does Flood Insurance Cover?
Flood insurance is designed to help homeowners, renters, and business owners cover losses caused by a flood. You can buy it to protect a building, the possessions in that building, or both.
Most standard homeowners policies don’t cover flood damage. So this separate insurance coverage is your best option for repairing or replacing property after rising water rises enters your home. In some areas, mortgage lenders can make buying flood insurance mandatory. Even if your lender doesn’t require flood insurance, you may want to consider it.
Read on for information that can help you decide if a flood policy should be part of your insurance coverage.
Key Points
• Flood insurance covers direct physical losses due to floods, including damage to the building and its contents.
• Coverage extends to foundation walls, electrical and plumbing systems, and major appliances.
• Personal property such as clothing, furniture, and electronics are also covered under flood insurance.
• The National Flood Insurance Program offers up to $250,000 for building and $100,000 for personal property damage.
• Flood insurance does not cover items outside the building, cars, or business interruption losses.
What Is Flood Insurance?
According to the Federal Emergency Management Agency (FEMA), just one inch of floodwater can cause up to $25,000 in damage. And that damage probably won’t be covered by your homeowners or renters insurance. You can, however, purchase a standalone flood insurance policy to help cover your losses.
A flood insurance policy is meant to cover losses directly caused by flooding or, as FEMA describes it, “an excess of water on land that is normally dry, affecting two or more acres of land or two or more properties.”
If your sewer backed up after heavy rainfall, or rising inland or tidal waters flooded your property, the damage would likely be covered by flood insurance. But if the backup wasn’t caused by flooding, the damage wouldn’t be covered by flood insurance. (Whether it’s covered by your homeowners insurance depends on your individual policy.)
Most people get their flood policy through the National Flood Insurance Program (NFIP), which is managed by FEMA and works with a network of insurance companies across the country. But some private insurance companies also offer their own flood policies, which are not government-backed.
Recommended: Mortgage & Homeowners Insurance Definitions
What Is Included in Standard Flood Insurance?
The NFIP offers two types of flood insurance coverage: one that covers buildings and another that covers the owner’s or renter’s personal contents.
A policy purchased through the NFIP can reimburse up to $250,000 in building damage and typically covers:
• Foundation walls, anchoring systems, and staircases
• Detached garages
• Electrical and plumbing systems
• Furnaces and water heaters
• Fuel tanks, well water tanks and pumps, and solar energy equipment
• Appliances, including refrigerators, stoves, and built-in dishwashers
• Permanently installed cabinets, paneling, and bookcases
• Permanently installed carpeting and window blinds
An NFIP policy can provide up to $100,000 in personal property damage, and typically covers:
• Personal belongings, such as clothing, furniture, and electronic equipment (TVs, computers, etc.)
• Valuables (like original artwork and furs) up to $2,500
• Portable and window air conditioners
• Washers and dryers
• Microwave ovens
• Carpets that may not be included under building coverage
• Curtains and other window coverings
What Doesn’t Flood Insurance Cover?
There are a few things NFIP flood insurance doesn’t cover, even if the damage is directly caused by flooding. Items that aren’t covered include:
• Any property that’s outside the insured building (such as a well, septic system, deck or patio, fences, seawall, hot tub or pool, and landscaping)
• Cars and most other self-propelled vehicles and their parts
• Cash, coins, precious metals, stock certificates, and other valuable paperwork
• Damage from mold or mildew that could have been prevented by the property owner
• Financial losses caused by an interruption in business
Flood insurance also doesn’t cover costs incurred if you have to live in temporary housing because of damage to your property. Unfortunately, neither will the “loss of use coverage” you may have through your homeowners policy. (Loss of use coverage pays those expenses only when the reason you’ve been displaced is covered by your homeowners policy.)
What Does Flood Insurance Cover in the Basement?
The NFIP’s coverage for flood damage in the basement is limited to some specific (usually permanent or attached) items and cleanup. Some examples of what should be covered include:
• Central air conditioners
• Fuel tanks and the fuel in them
• Furnaces and water heaters
• Sump pumps, heat pumps, and well water tanks and pumps
• Electrical outlets, switches, and junction and circuit breaker boxes
• Elevators, dumbwaiters, and related equipment
• Unfinished drywall for walls and ceilings
• Attached stairways and staircases
• Foundation elements and anchoring systems required for building support
Most personal property kept in the basement isn’t covered, including clothing, computers, TVs, and furniture.
Where Can You Get Flood Insurance?
Federal flood insurance isn’t sold directly by the federal government. Instead, you can buy NFIP policies through private insurance companies, under what’s known as a Write Your Own (WYO) program.
The NFIP partners with more than 50 insurance companies, so you may be able to work with the same insurance agent or broker who helped you purchase your home and auto policies to get flood coverage.
You can get help finding an NFIP provider online at floodsmart.gov/flood-insurance-provider or by calling the NFIP at 877-336-2627. You also can also check into any private, non-government-backed flood insurance policies that are offered in your area.
You may want to look at including flood insurance as part of your overall personal insurance planning. Don’t wait until you hear predictions of a storm heading your way to start inquiring about a policy, though. There is typically a 30-day waiting period for a flood insurance policy to go into effect.
How Much Does Flood Insurance Cost?
Like most insurance, the cost of a flood policy can depend on the coverage type (building and/or personal contents), the size and age of the building covered, the risk level in your location (based on your flood zone), and other factors, including whether you’re buying a private or NFIP policy.
According to the Federal Emergency Management Agency (FEMA), the average cost of one year of coverage with an NFIP policy is $786. And though that’s not nearly as much as the average cost of a homeowners policy, it can still be a hit to many household budgets.
You may be able to lower the cost of a flood policy by choosing a higher deductible. You can also elevate your home’s electrical panels, heating and cooling systems, and other utilities so they’re less vulnerable to water damage.
For renters, the NFIP offers contents-only policies for as low as $99 annually.
You can also look for a competitive quote on a private flood policy that isn’t backed by FEMA and the NFIP. Just make sure you’re getting a fair price from a stable company that is capable of paying out claims in the event of a major flood.
When Is Flood Insurance Required?
If you have a government-backed mortgage and your home or business is in a high-risk flood area, you are required to have flood insurance. If you don’t have a government-backed loan, your lender may still require that you purchase a flood policy. Even lenders in moderate- to low-risk locations may make it a loan requirement.
Recommended: Is Homeowners Insurance Required to Buy a Home?
Who Should Buy Flood Insurance?
Knowing your designated flood zone can help you decide whether you want to prioritize purchasing flood insurance. You can find your zone by entering your address at the FEMA Flood Map Service Center at MSC.FEMA.gov.
Structures in zones A and V are at the highest risk, while those in zones B, C, and X are considered at moderate to minimal risk. Keep in mind, though, that you can still experience flood damage even if you don’t live in a high-risk zone. According to NFIP data, more than 20% of all insurance claims come from moderate- to low-risk zones.
If you’re moving to a new area where flood insurance isn’t required, you may want to speak with your real estate agent or neighbors about the area’s history and potential for flooding.
How Much Flood Insurance Do You Need?
In many ways, shopping for flood insurance is similar to how you buy homeowners insurance: Calculating how much you’ll need will depend on what you plan to protect and what it might cost to replace if it’s destroyed.
In fact, whether you go with an online insurance company or a traditional insurer, your homeowners insurance company may give you an idea of what it might cost to rebuild or repair your home if it’s damaged. Then you can add on the value of your furnishings and other personal possessions to decide how much flood insurance you need. (If you’re a renter, you can purchase a policy that covers only your belongings.)
Remember, there are limits to how much coverage you can get through an NFIP policy ($250,000 for a building and $100,000 for the contents). If your needs go beyond those limits, you may want to consider buying excess flood insurance through a private flood policy.
The Takeaway
An average flood insurance policy for homeowners costs $786 a year. But most homeowners insurance policies don’t cover flood damage, which can leave a big gap when it comes to protecting your home and belongings. Purchasing a separate flood insurance policy can help fill that gap, and it can be an important part of your overall insurance planning.
Flood policies can cover the building itself, its contents, or both. Make sure you understand what isn’t covered by your policy, such as personal belongings stored in the basement or outside.
If you’re a new homebuyer, SoFi Protect can help you look into your insurance options. SoFi and Lemonade offer homeowners insurance that requires no brokers and no paperwork. Secure the coverage that works best for you and your home.
FAQ
What losses are covered by flood insurance?
A flood insurance policy covers direct physical losses caused by a flood. That could mean repairing or replacing your home, or the furnishings and other belongings in your home, or both.
How do I know if I’m in a flood zone?
Everyone is in a flood zone, but some areas are at a higher risk than others. You can find your zone by entering your address at the FEMA Flood Map Service Center at MSC.FEMA.gov.
Is flooding covered by homeowners insurance?
Some types of water damage are covered by a standard homeowners policy, but flooding usually is not.
Photo credit: iStock/onurdongel
Auto Insurance: Must have a valid driver’s license. Not available in all states.
Home and Renters Insurance: Insurance not available in all states.
Experian is a registered trademark of Experian.
SoFi Insurance Agency, LLC. (“”SoFi””) is compensated by Experian for each customer who purchases a policy through the SoFi-Experian partnership.
Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.
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.
SOPRO-Q424-007
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