Hypothecation may not be a word you’ve heard before, but it describes a transaction you may have participated in. Hypothecation is what happens when a piece of collateral, like a house, is offered in order to secure a loan.
Auto loans and mortgages frequently involve hypothecation, since it allows the lender to repossess the car or house if the borrower is later unable to pay.
There are, though, some more subtle details to understand about hypothecation, particularly if you’re in the market for a home loan. Read on to learn about hypothecation loans.
Note: SoFi does not offer hypothecation. However, SoFi does offer home equity loan options.
What Is Hypothecation?
Hypothecation is essentially the fancy word for pledging collateral. If you’re taking out a secured loan — one in which a physical asset can be taken by the lender if you, as the borrower, default — you’re participating in hypothecation. (Hypothecation is also possible in certain investing scenarios. We’ll briefly talk about that later.)
As mentioned above, some of the most common hypothecation loans are auto loans and mortgages. If you’ve ever purchased a car, it’s likely you have (or had) a hypothecation loan, unless you paid the full purchase price in cash.
It’s important to understand that, just because the asset is offered as collateral, it doesn’t mean the owner loses legal possession or ownership rights of it. For instance, with an auto loan, the car is yours even though the lender might hold the title until the loan is paid off.
You also maintain your rights to the positive parts of ownership, such as income generation and appreciation. This is perhaps most obvious in the case of homeownership. Even if you’re paying a mortgage on your property, you still have the right to lease the place out and collect the rental income.
However, the lender has the right to seize the property if you fail to make your mortgage payments. (Which would be a bad day for both you and your renters.)
Why Is Hypothecation Important?
Hypothecation makes it easier to qualify for a loan — particularly a loan for a lot of money — because the collateral makes the transaction less risky for the lender.
For instance, hypothecation is the only way that most people are able to qualify for a mortgage. If those loans weren’t secured with collateral, lenders might have very steep eligibility requirements before they would pay out hundreds of thousands of dollars for a home on a piece of land!
Unsecured loans, however, are possible. A personal loan is a good example.
With an unsecured loan, you’re not at risk of having anything repossessed from you, and you can use the money for just about anything you want.
It’s a trade-off: Unsecured loans are riskier for the lender, so they tend to be harder to qualify for and to carry higher interest rates than secured loans.
On the other hand, if you compare a car loan and personal loan of equal length, you’ll likely be subject to a stricter eligibility screening to get the unsecured loan and pay more interest on it in the end.
Along with hypothecation in the context of a secured loan for a physical asset, like a house or a car, hypothecation also occurs in investing — though usually only if you take on advanced investment techniques.
Hypothecation occurs when investors participate in margin lending: borrowing money from a broker in order to purchase a stock market security (like a share of a company).
This technique can help active, short-term investors buy into securities they might not otherwise be able to afford, which can lead to gains if they hedge their bets right.
But here’s the catch: The other securities in the investor’s portfolio are used as collateral, and can be sold by the broker if the margin purchase ends up being a loss.
TL;DR: Unless you’re a well-studied day trader, buying on margin probably isn’t for you and you should not worry about hypothecation in your investment portfolio. But you’ll want to know it can happen in investing, too.
A mortgage is a classic example of a hypothecation loan: The lending institution foots the six-digit (or seven-digit) cost of the home upfront, but retains the right to seize the property if you’re unable to make your mortgage payments.
Hypothecation also occurs with investment property loans. A lender might require additional collateral to lessen the risk of providing a commercial property loan. A borrower might hypothecate their primary home, another piece of property, a boat, a car, or even stocks to secure the loan.
Given the size of most home loans and the risk of losing the home, you may wonder if taking out a mortgage is worth it at all.
Even though any kind of loan involves going into debt and taking on some level of risk, homeownership is still usually seen as a positive financial move. That’s because much of the money you pay into your mortgage each month ends up back in your own pocket in some capacity…as opposed to your landlord’s bank account.
As you pay off a mortgage, you’re slowly building equity in your home. Homes have historically tended to increase in value.
There is such a thing as rehypothecation, which is what happens when the collateral you offer is in turn offered by the lender in its own negotiations.
But this, as anyone who lived through the 2008 housing crisis knows, can have dire consequences. Remember The Big Short? Rehypothecation was part of the reason the housing market became so fragile and eventually fell apart. It is practiced much less frequently these days.
The Takeaway
Hypothecation simply means that collateral, like a house or a car, is pledged to secure a loan. Mortgages are a classic example of hypothecation, and hypothecation is the reason most of us are able to qualify for such a large loan.
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Student loan interest rates are rising. In July 2024, interest rates rose to their highest level in 16 years. Rates for undergraduate loans have increased almost 19% over last year and 44% over the past five years. Some loan rates for graduate students have never been as high as they are now.
Why are student loan interest rates so high? Some of it comes down to perception: Interest rates are up after a decade of historical lows. But other factors also come into play.
Read on to learn how student loan interest rates are set, why interest rates are going up, and the different options available for managing high-interest student loans.
Key Points
• Federal student loan interest rates have risen to their highest levels in years, and rates for some loans for graduate students are at record highs.
• Interest rates on federal student loans are set annually by Congress, influenced by the 10-year Treasury note rate plus a fixed increase. Rates are capped at specific limits.
• Private lenders determine interest rates on private student loans, using benchmarks such as the prime rate. Borrowers’ credit scores and credit history also impact private loan rates.
• Students who don’t have a strong credit history may need a cosigner on a private student loan to qualify for more favorable rates.
• Methods to help pay off student loans include paying any accruing interest while in school, using an income-driven repayment plan after graduation, and refinancing student loans.
Understanding Student Loans
There are two main types of student loans — federal and private student loans. Federal loans are offered by the Department of Education (DOE) and they include Direct Subsized and Unsubsidized student loans for undergraduate students, and Direct Unsubsidized loans and Direct PLUS loans for graduate or professional students.
• Direct Subsidized loans are for undergraduates who have financial need. You fill out the Free Application for Student Aid (FAFSA), and your school determines how much you can borrow. The interest on the loan is paid by the DOE while you’re in school and for a six-month grace period after graduation.
• Direct Unsubsidized loans are available for undergrads and graduate students. A borrower does not have to prove financial need for these loans. Again, your school determines the amount you can borrow. However, unlike Direct Subsidized loans, the interest on Direct Unsubsidized loans begins to accrue as soon as the loan is disbursed.
• Direct PLUS loans are for eligible parents (typically called a parent PLUS loan) and grad students. To be approved for one of these loans, a borrower must undergo a credit check and cannot have an adverse credit history. Interest accrues on Direct PLUS loans while the student is in school.
Here’s a look at how the interest rates on these federal loans have increased over the last four years:
School Year 2021 – 2022
School Year 2022 – 2023
School Year 2023 – 2024
School Year 2024 – 2025
Direct Subsidized and Unsubsidized Loans for Undergrads
3.73%
4.99%
5.50%
6.53%
Direct Unsubsidized Loans for Graduate or Professional Students
5.28%
6.54%
7.05%
8.08%
Direct PLUS Loans for Graduate or Professional Students or Parents of Undergrads
6.28%
7.54%
8.05%
9.08%
There are several different repayment plans for federal student loans, including the standard 10-year plan; graduated repayment in which your monthly payments gradually increase over 10 years; extended payment, which gives you up to 25 years to repay your loans; and income-driven repayment plans that base your monthly payments on your income and family size. Federal loans come with benefits such as federal loan forgiveness.
Private student loans are issued by private lenders, such as banks, credit unions, and online lenders. Their interest rates and loan terms differ from lender to lender. The interest rates on private student loans may be fixed or variable, and the rate you get depends on your credit history. You can use student loan refinancing later on for potentially better interest rates and terms on your private loans, if you’re eligible. (Federal loans can be refinanced as well, but they then become private loans and lose the federal benefits mentioned above.)
By using our student loan refinance calculator, you can check the interest rate and repayment terms you could qualify for — and find out if refinancing makes sense for your situation.
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Factors Contributing to High Interest Rates
Congress sets federal student loan interest rates, while private loan rates depend on the credit rating of the borrower (or their student loan cosigner, if they have one). But that’s not the whole story.
The federal government adjusts federal student loan rates every year based on 10-year Treasury notes, plus a fixed increase. Rates are also capped, so they can’t rise above a certain limit. Here are the formulas:
• Direct Unsubsidized Loans for Undergraduates: 10-year Treasury + 2.05%, capped at 8.25%
• Direct Unsubsidized Loans for Graduates: 10-year Treasury + 3.60%, capped at 9.50%
• PLUS Loans to Graduate Students and Parents: 10-year Treasury + 4.60% Capped 10.50%
The rates for Treasury notes are set based partly on global market conditions and the state of the economy. When market conditions are in flux, the rates for Treasury notes tend to rise.
Federal student loan interest rates are fixed over the life of the loan. That means, if you get a federal student loan for your freshman year, the rate it was issued with won’t change despite Congress setting a new rate every year. If you need to take out another federal student loan for your sophomore year, however, you’ll then get the new rate, not the previous one.
Private student loan rates vary by lender and fluctuate with market trends. A borrower’s credit history also determines the rate they get for a private student loan.
Another factor is that student loans are unsecured. Unsecured loans are not tied to an asset that can serve as collateral. Secured loans, by comparison, are backed by something of value, such as a car or house, which can be seized if you default. But lenders can’t seize a degree. So student loan interest rates may be higher than secured loan rates because the lender’s risk is higher.
Comparison of Federal and Private Student Loan Interest Rates
Why are student loan interest rates so high? As noted above, private student loan rates will fluctuate with market trends and from lender to lender. They also depend on a borrower’s credit score. As of November 2024, some private student loan rates start at about 4% and go up to around 17%.
Private student loan rates for 10-year loans may be higher than the federal interest rate when you are comparing rates concurrently on offer. The rates may be lower for a loan that has a shorter term length than the standard 10 years of federal loans.
What’s more, private student loan rates and student loan refinance rates that are currently on offer can very well be lower than the federal interest rate you received at the time of getting your loan. And you can shop around with private lenders for the best interest rates.
Pros and Cons of Federal and Private Student Loans
Both federal and private student loans have advantages and drawbacks.
Pros of federal student loans include:
• Interest rates for federal loans are fixed over the life of the loan
• The rates for federal loans may be lower than the rates you might get for private student loans
• Depending on the type of federal loan you have, the government may pay your interest while you are in school and during the six-month grace period after graduation
• Federal loans have federal programs and protections such as income-driven repayment plans and federal deferment options
Cons of federal student loans include:
• You can’t shop around for interest rates
• If you take out a new loan in subsequent years, you may get a higher rate than you got with your initial loans
• Borrowing limits may be lower compared to private student loans
Pros of private student loans include:
• You can shop around with different private lenders for lower rates
• Borrowers (or cosigners) with very good or excellent credit can get lower interest rates
• May offer higher borrowing limits than federal loans, spending on what a borrower is eligible for
Cons of private student loans include:
• Borrowers with poor credit will get higher interest rates or may not be able to qualify for a loan
• If the loan has a variable interest rate, it may rise over time
• Private loan student holders don’t have access to the same programs and protections that federal student loan borrowers do
• Deferment and forbearance options (if any) depend on the lender
Interest Rates for Graduate and Professional Degrees
For graduate students and those pursuing advanced professional degrees, interest rates on federal Direct PLUS loans and Direct Unsubsidized Loans for graduate and professional students are substantially higher than the interest rate for Direct Subsidized and Unsubsidized loans for undergrads.
For the 2024-2025 school year, the interest rates are:
Direct PLUS loan: 9.08% Direct Unsubsidized loans for graduate and professional students: 8.08% Direct Subsidized and Unsubsidized loans for undergraduate students: 6.53%
The higher rates on loans for graduate and professional students add significantly to the cost of borrowing. Not only that, the interest on these loans begins accruing immediately and while the borrower is in school, which also adds to the overall amount they’ll need to repay.
It’s worth noting that loans for graduate students have much higher borrowing limits than federal loans for undergrads. Graduate students can usually borrow up to $20,500 each year, with a lifetime cap of $138,500. Undergrad borrowers can typically borrow $5,500 for the first year, $6,500 for the second year, and $7,500 for the next two years, up to a total of $31,000.
Credit Score Impact on Private Student Loan Interest Rates
Private lenders will look at your creditworthiness when determining your interest rate. This involves considering such factors as:
• Credit score: Lenders have different requirements when it comes to credit scores for private student loans, but many look for a score of at least 650. As a student, you may not have that high a score, and in that case, you may need a cosigner on the loan in order to be approved.
• Credit history: When entering college, most students have little to no credit history. That means the lender could be unsure of their ability to repay the loan since students don’t typically have a history of paying any loans. This can lead to a higher interest rate.
• Your cosigner’s finances: Since many private student loan applicants are relatively new to debt and have no credit history, they might be required to provide a cosigner, as previously mentioned. A cosigner shares the burden of debt with you, meaning they’re also on the hook to pay it back if you can’t. A cosigner with a strong credit history can potentially help secure a lower interest rate on private student loans.
To help build your credit as a student, having student loans can help. Managing your student loans responsibly is a good way to help establish credit.
In addition, you might consider getting a credit card with a lower line of credit and use it to cover a few small expenses such as groceries and transportation. Be sure to pay your bill on time each month and in full if you can. Strategies like these can help you build credit over time.
Whether you’re still in school or you’ve just graduated, you have options that may save you money. But it’s important to be proactive. Here are some potential actions you could take:
If You’re Still in College or Grad School
Borrowers with Direct Unsubsidized loans are responsible for the interest that accrues while they’re in school and immediately after. They don’t have to make payments while enrolled, but not making payments means that, in certain situations, interest may “capitalize” — that is, it will be added to the principal. In other words, a borrower would be paying interest on the interest.
To save yourself money on interest, consider making interest-only payments during school until your full repayment period begins after graduation. It will take a small bite out of your budget now, but it can save you money in the long run.
If you have Direct Subsidized loans, no interest will accrue until your grace period ends.
If You Graduated
Borrowers are automatically placed on the standard repayment plan, unless they select another option. The standard repayment plan spreads repayment over 10 years. Other options, such as the extended plan, extend the repayment term, which can make payments more manageable in the present, but that means you may pay more in interest over the life of the loan.
With an income-driven repayment (IDR) plan, your monthly student loan payments are based on your income and family size. Your monthly payments are typically a percentage of your discretionary income, which usually means you’ll have lower payments. At the end of the repayment period, which is 20 or 25 years, depending on the IDR plan, your remaining loan balance is forgiven.
You could also explore student loan forgiveness through a state or federal program. Borrowers with federal student loans who work in public service may be eligible for the Public Service Loan Forgiveness (PSLF) program. If you work for a qualifying employer such as a not-for-profit organization or the government, PSLF may forgive the remaining balance on your eligible Direct loans after 120 qualifying payments are made under an IDR plan or the standard 10 year repayment plan.
In addition, check with your state to find out what loan forgiveness programs they may offer.
Refinancing Student Loans
Refinancing is one way to deal with high-interest student loan debt if you don’t qualify for federal protections. You can potentially lower your interest rate or your monthly payments.
If you’re considering refinancing to save money, you could be a strong candidate if you’ve strengthened your credit since you first took out your loans. Unlike when you were first headed to college, you may now have a credit history for lenders to take into account. If you’ve never missed a payment and have continually built your credit, you might qualify for a lower interest rate.
Having a stable income can also help. Being able to show a consistent salary to a private lender may help make you a less risky investment, which in turn could also help you secure a more competitive interest rate.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.
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A shareholder activist may be a hedge fund, institutional investor, or wealthy individual who uses an ownership stake in a company to influence corporate decision-making. Shareholder activists, sometimes called activist investors, typically seek to change how a company is run to improve its financial performance. However, they may also have other objectives, such as increasing transparency or promoting social responsibility.
Activist shareholders can impact the way a company is managed, thus affecting its stock price. As such, you may benefit from understanding shareholder activism and how these investors may impact the stocks in your portfolio.
Key Points
• Shareholder activists use ownership stakes to influence corporate decisions, aiming to improve financial performance or promote transparency and social responsibility.
• Activists can be hedge funds, institutional investors, or wealthy individuals seeking changes in company management.
• Activist investors may use media and shareholder voting to gain support for their proposals and influence company strategies.
• Goals of activism vary, from improving environmental impact to unlocking shareholder value through strategic changes.
• Activism can lead to stock volatility, but targeted stocks may still be valuable for diversified portfolios if proposed changes are supported.
How Shareholder Activism Works
Shareholder activism is a process in which investors purchase a significant stake in a company to influence the management of the company. When an investor builds up a large enough stake in a company, this usually opens up channels where they may discuss business proposals directly with management.
Activist investors may also use the shareholder voting process to wield influence over a company if they believe it is mismanaged. This more aggressive tactic may allow activist shareholders to nominate their preferred candidates for the board of directors or have a say on a company’s management decisions.
Activist investors typically own a relatively small percentage of shares in a company, perhaps less than 10% of a firm’s outstanding stock, so they may need to convince other shareholders to support their proposals. They often use the media to generate support for their campaigns.
Shareholder activists may also threaten lawsuits if they do not get their way, claiming that the company and its board of directors are not fulfilling their fiduciary duties to shareholders.
Activist investors’ goals can vary. Some investors may want to see companies improve their environmental and social impact, so they will suggest that the company adopt a Corporate Social Responsibility framework. Other investors try to get the company to adopt changes to unlock shareholder value, like selling a part of the company or increasing dividend payouts.
However, shareholder activism can also be a source of conflict between shareholders and management. Some activist investors may prefer the company unlock short-term gains that benefit shareholders, perhaps at the expense of long-term business operations. These investors may exit a position in a company once they unlock the short-term gains with little concern for the company’s future prospects.
There are three primary types of shareholder activists: hedge funds, institutional investors, and individual investors. So, your average investor who may be doing a bit of online investing or building a retirement portfolio likely wouldn’t qualify as a shareholder activist. Each type of shareholder activist has its distinct objectives and strategies.
Hedge Funds
Hedge funds are private investment vehicles usually only available to wealthy individuals who make more than $200,000 annually or have a net worth over $1 million. These funds often take a more aggressive approach to shareholder activism, like public campaigns and proxy battles, to force a company to take specific actions to generate a short-term return on its investment.
Institutional Investors
Institutional investors are typically large pension funds, endowments, and mutual funds that invest in publicly-traded companies for the long term. These investors often use their voting power to influence a company’s strategy or management to improve their investment’s financial performance.
Individual Investors
Though less common than hedge funds and institutional investors, very wealthy individual investors sometimes use their own money to buy shares in a company and then push for change.
Examples of Shareholder Activists
Shareholder activism became a popular strategy in the 1970s and 1980s, when many investors – called “corporate raiders” – used their power to push for changes in a company’s management. Shareholder activism has evolved since this period, but there are still several examples of activist investors
For example, Carl Icahn is one of the most well-known shareholder activists who made a name for himself as a corporate raider in the 1980s. He was involved in hostile takeover bids for companies such as TWA and Texaco during the decade.
Since then, Icahn has been known for taking large stakes in companies and pushing for changes, such as spin-offs, stock buybacks, and management changes. More recently, Icahn spearheaded a push in early 2022 to nominate two new directors to the board of McDonald’s. His goal was to get McDonald’s to change its treatment of pigs. However, his preferred nominees failed to get elected to the board.
Another well known activist investor is Bill Ackman, the founder and CEO of Pershing Square Capital Management, a hedge fund specializing in activist investing. Ackman is known for his high-profile campaigns, including his battle with Herbalife.
In 2012, Ackman shorted the stock of Herbalife, betting the company would collapse. He accused Herbalife of being a pyramid scheme and called for a government investigation. Herbalife denied the allegations, and the stock continued to rise. Ackman eventually closed out his position at a loss.
Other examples of shareholder activists include Greenlight Capital, led by David Einhorn, and Third Point, a hedge fund founded by Dan Loeb.
In 2013, Einhorn took a stake in Apple and pushed for the company to return more cash to shareholders through share repurchases and dividends. Apple eventually heeded his advice and initiated a plan to return $100 billion to shareholders through dividends and buybacks.
In 2011, Loeb’s hedge fund took a stake in Yahoo and pushed for the company to fire its CEO, Scott Thompson. Thompson eventually resigned, and Yahoo appointed Loeb to its board of directors. More recently, in 2022, Loeb took a significant stake in Disney and started a pressure campaign calling on the company to spin-off or sell ESPN. However, he eventually backed off that suggestion.
Is Shareholder Activism Good for Individual Investors?
Depending on the circumstances, a shareholder activist campaign may be good for investors. Some proponents argue that shareholder activism can improve corporate governance, promote ESG investing, and lead to better long-term returns for investors.
Others contend that activist investors are primarily interested in short-term gains and may not always have the best interests of all shareholders in mind. While individual investors may benefit from a stock’s short-term spike after an activist shareholder’s campaign, this rally may not last for investors interested in long-term gains.
The Takeaway
Shareholder activists use their financial power to try to influence the management of publicly traded companies. Because activist investors often leverage the media to promote their goals, individual investors may read about these campaigns and worry about how they could affect their holdings.
Generally, the impact of shareholder activism on investors depends on the specific goals of the activist and the response of the company’s management. If an activist successfully pressures management to make changes that improve the company’s performance, this can increase shareholder value. However, if an activist’s campaign is unsuccessful or the company’s management resists the activist’s demands, this can lead to a decline in the stock price.
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In countries where there is a carbon tax, businesses must pay a levy based on the amount of carbon emissions produced by their business operations. A carbon tax is designed to reduce the amount of carbon in the atmosphere — also known as CO2 emissions.
There are generally two types of carbon taxes: a tax on quantities of greenhouse gases emitted, and a tax on carbon-intensive goods and services such as gasoline production. In the United States, several carbon tax proposals have been introduced in Congress, but none have yet been implemented.
Key Points
• A carbon tax is a levy on businesses for their carbon emissions, aimed at reducing CO2 emissions and promoting low-emission energy sources.
• Two main types of carbon taxes exist: one on greenhouse gas emissions and another on carbon-intensive goods and services.
• The U.S. does not have a federal carbon tax, but several states and localities have implemented regional versions, with ongoing discussions about a national approach.
• Revenue from carbon taxes can fund environmental restoration and decarbonization, though deciding the best use of these funds is challenging.
• Countries like Finland, Norway, and Sweden have high carbon tax rates, and the concept is becoming increasingly popular as a climate change tool globally.
How Does a Carbon Tax Work?
When a government implements a carbon tax, a price per ton of greenhouse gas emissions is chosen, and a company is taxed the applicable amount for every ton of carbon it emits or is responsible for. In some cases, the price per ton increases the more an entity emits, thereby incentivizing companies to reduce and prevent emissions.
What Type of Carbon Is Taxed?
Although it is called a carbon tax, usually the price is actually per ton of CO2 gas emitted. That’s because every fossil fuel has a particular amount of carbon content in it, and when burned each carbon molecule combines with two oxygen molecules and becomes CO2 gas which goes into the atmosphere.
So the amount of emissions associated with the fuel can be taxed at the point of extraction, refinement, import, or use.
As many ESG investors likely know, burning coal emits the highest amount of CO2, followed by diesel, gasoline, propane, and natural gas. Therefore, coal gets taxed higher than other fossil fuels. Once CO2 is emitted into the atmosphere, it remains there for a hundred years or more, creating a greenhouse effect which heats up the planet and leads to climate change (hence the name “greenhouse gases”).
Only products associated with the burning of fossil fuels get taxed. So products such as plastic that contain petroleum but don’t directly result in CO2 emissions don’t get taxed.
What Is the Economic Impact of Carbon Taxation?
Since a carbon tax increases costs across the entire supply chain, everyone from extractors to consumers are theoretically incentivized to reduce fossil fuel consumption. Those being taxed can raise the prices of their goods and services, but only as much as the market is willing to pay while allowing them to remain competitive.
What Is the Social Impact of Carbon Emissions?
The theory around carbon pricing is that each ton of CO2 should have a price equal to the social cost of carbon. The social cost of carbon is the current amount of estimated damages over time that each ton of CO2 emitted causes today.
In addition to causing climate change, emissions and pollution typically lead to negative effects on human health and natural ecosystems. Thus investing in companies with lower carbon emissions can be considered a type of socially responsible investing.
Over time, the social cost of carbon increases, because each ton of emissions is more damaging as climate change worsens. Therefore, the price of carbon and the tax would increase over time.
Those producing emissions know that the tax will increase over time, and so investments into decarbonization are worth it to them today. For instance, a company can invest in solar energy and wind power, and while that might have a high upfront cost for them, over time it could be worth it could help them avoid a rising carbon tax.
Examples of Carbon Taxes
Understanding carbon taxes is an important facet of sustainable investing. Carbon taxes have been put into place in many countries around the world so far, and their popularity is rising. As of 2024, 75 countries had a form of carbon tax or energy tax.
• Finland was the first country to implement a carbon tax in 1990, soon followed by Norway and Sweden in 1991. In 2024, Finland’s price per ton was more than $100. Norway is known to have one of the strictest carbon taxes.
• The Canadian province of British Columbia implemented a carbon tax in 2008. In 2019, South Africa became the first African country to install a carbon tax.
• Although there is not yet a federal carbon tax in the U.S., there are more than 50 regional ones. For instance, the city of Boulder, CO, implemented a carbon tax in 2006 after it passed a local vote.
Support for a U.S. federal carbon tax has generally increased over time, but one of the things holding it back is debate about how the revenue from the tax would be used. A few ideas include: paying back consumers through a carbon dividend; using the money to fund infrastructure upgrades or low-emissions technologies, or reducing other taxes.
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The Importance of Carbon Tax
Scientists believe that reducing global emissions is essential to stop the buildup of CO2 in the Earth’s atmosphere. The more CO2 gets emitted, the more the planet warms and the worse climate change becomes — including the frequency of climate-related disasters.
Global temperatures have already increased 1°C over pre-industrial levels, and if emissions are not reduced temperatures are projected to rise 4°C by the end of this century.
A carbon tax is a powerful tool to discourage the use of fossil fuels and incentivize a shift to low- and zero-emission energy sources. This is why many people invest in green stocks.
Pros and Cons of Carbon Tax
There are several pros and cons to a carbon tax.
Some of the pros of a carbon tax include:
• The carbon tax is a way to regulate emissions without having to actually mandate production and consumption limits directly.
• Carbon taxes incentivize companies and individuals to reduce and avoid emissions.
• Carbon taxes are easy to administer.
• A carbon tax may help reduce the buildup of greenhouse gasses, which in turn may help reduce pollution, improve air and water quality, and more.
• The revenue raised through a tax can be used to fund decarbonization efforts, environmental restoration, and other projects.
• Other programs, such as an incentive using renewable energy, haven’t been as successful in reducing fossil-fuel use.
A few cons of a carbon tax include:
• It can be challenging to figure out how the revenues should be spent.
• A carbon tax can be put on any point of a supply chain and it’s hard to decide which is best.
• It’s hard to predict how much emissions will be reduced as a result of the carbon tax.
• If a carbon tax increases energy costs, this can have a big impact on lower-income households which tend to spend a higher percentage of their income on energy than higher-income households.
• If one country implements a carbon tax and others don’t, then that puts local industries at a competitive disadvantage. If they have to raise prices, customers may start buying from the countries that don’t have the tax, resulting in the same or more emissions. For this reason carbon tax plans build in ways to prevent emissions leakage and issues with competition. Some of these include rebates, exemptions for particular industries, and taxation based on past emissions.
• Companies can purchase carbon offsets or carbon credits to lower the amount they pay in taxes. They can also use those offsets to claim that they are carbon neutral or carbon negative. This isn’t exactly true, since they are still emitting carbon. The ability to purchase offsets reduces their incentive to decarbonize.
Who Regulates Carbon Taxes?
Carbon tax programs are regulated by federal, state, or local governments. Regulation involves setting the price per ton of carbon, deciding which entities get taxed, collecting the tax, and deciding how the revenues are spent.
There is an ongoing discussion about the international coordination of carbon pricing. If a minimum price per ton is set, this would eliminate issues around competition and guarantee a certain amount of effort towards emission reduction. Canada has already implemented national price coordination. The minimum price per ton in Canadian provinces and territories is CAD $50.
Which Countries Have the Highest Carbon Tax?
Below are a few of the countries that have the highest carbon tax rates. The rates are in USD price per ton:
• Uruguay: $155.87
• Switzerland: $130.81
• Sweden: $125.56
• Liechtenstein: $96.30
• Norway: $90.86
The Takeaway
A carbon tax can be a powerful tool for reining in carbon emissions, and potentially helping reduce the amount of greenhouse gasses in the atmosphere. Essentially, these taxes penalize companies by making them pay a fee for CO2 emissions relating to their products or operations.
While the U.S. doesn’t have a federally mandated carbon tax, there are state and local levies. Given concerns about climate change, it’s likely that more countries will continue to adopt and adjust carbon taxes.
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An investment risk pyramid is an illustration used to help investors understand the risk/reward profile of various assets. The investment risk pyramid uses a base, middle, and top to rank investments by the likelihood of losing money or seeing big returns. The tool is useful when getting started with investing.
Building a portfolio is no easy task. It requires due diligence and an assessment of your risk tolerance and return goals. The investment risk pyramid may help you determine what approaches work best for you.
What Are Investment Pyramids?
Investment pyramids are practical tools for gauging how risky certain asset types are. The pyramid model has been used in many areas for a long time, and it’s useful when learning what your risk tolerance is.
An investment risk pyramid has three levels grouped by risk/return profile. The least-risky securities are found in the large base; growth and moderately risky assets are in the middle; then the most speculative strategies are at the top.
Again, this can be helpful to investors who are looking to buy and sell stocks or other securities, and also get a sense of how much associated risk they’re introducing or jettisoning from their portfolio.
How Investing Pyramids Work
There are many investing risk need-to-knows, and the pyramid of investment risk works by helping investors understand the connection between their asset allocation and their risk tolerance.
The visual should ultimately lead individuals to better grasp what percentage of their investable assets should go to which types of investments based on risk level and return potential.
Using a risk pyramid investment strategy provides a basic framework for analyzing portfolio construction. The investment risk pyramid is structured so that it suggests people hold a higher percentage of lower-risk assets, and relatively little in the way of ultra-high-risk, speculative assets.
Base of the Pyramid
Managing investment risk is among the most fundamental aspects of investing, and risk is controlled by ensuring an allocation to some safe securities. The base of the investment risk pyramid, which is the bulk of total assets, contains low-risk assets and accounts. Investments such as government bonds, money markets, savings and checking accounts, certificates of deposit (CDs), and cash are included in the base.
While these securities feature relatively low risk, you might lose out to inflation over time if you hold too much cash, for example.
Middle of the Pyramid
Let’s step up our risk game a bit by venturing into the middle of the investment risk pyramid. Here we will find medium-risk assets. In general, investments with some growth potential and a lower risk profile are in this tier. Growth and income stocks and capital appreciation funds are examples.
Other holdings might include real estate, dividend stock mutual funds, and even some higher-risk bond funds.
Top of the Pyramid
At the top of the investment risk pyramid is where you’ll find the most speculative asset types and even margin investing strategies. Options, futures, and collectibles are examples of high-risk investments.
You will notice that the top of the pyramid of investment risk is the smallest – which suggests only a small portion of your portfolio should go to this high-risk, high-reward niche.
Sample Investment Pyramid
Here’s what a sample investment risk pyramid might contain:
Top of the pyramid, high risk: Speculative growth stocks, put and call options, commodities, collectibles, cryptocurrency, and non-fungible tokens (NFTs). Generally, just a small percentage of an overall portfolio should be allocated to the top of the pyramid.
Middle of the pyramid, moderate risk: Dividend mutual funds, corporate bond funds, blue-chip stocks, and variable annuities. Small-cap stocks and foreign funds can be included, too. A 30-40% allocation could make sense for some investors.
Base of the pyramid, low risk: U.S. government Treasuries, checking and savings accounts, CDs, AAA-rated corporate bonds. This might comprise 40-50% of the portfolio.
Pros and Cons of Investment Pyramids
The investment risk pyramid has advantages and disadvantages. Let’s outline those to help determine the right investing strategy for you.
Pros
The investment risk pyramid is useful as a quick introduction to asset allocation and bucketing. Another upside is that it is a direct way to differentiate asset types by risk.
Cons
While the investment risk pyramid is helpful for beginners, as you build wealth, you might need more elaborate strategies beyond the pyramid’s simplicity. Moreover, in the end, you determine what securities to own – the pyramid is just a suggestion.
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Examples of Low-Risk Investments
Let’s describe some low-risk investments in more detail since these are including the investment risk pyramid’s biggest tier.
Bonds
Bonds are essentially a loan you make to the government or other entity for a set amount of time. In return for lending your money, the debtor promises to pay you back at maturity along with periodic coupon payments, like interest.
Lower-risk bonds include short-term Treasury bills while riskier bonds are issued by speculative companies at a higher yield.
Cash
Cash feels like a low-risk asset, but ideally you would store it in an interest-bearing savings account in order to keep up with inflation.
Also consider that holding too much cash can expose you to inflation risk, which is when cash loses value relative to the cost of living.
Bank Accounts
You can earn a rate of return through a bank account with FDIC insurance. Keeping an emergency fund in a checking account can be a prudent move so you can pay expenses without having to sell assets like stocks and bonds or take on debt.
Examples of High-Risk Investments
At the top of the pyramid, you will find assets and strategies that may generate large returns, but also expose you to serious potential losses. Margin trading is a method often employed by some investors to try and increase their returns.
Margin Trading
Margin trading is using borrowed funds in an attempt to amplify returns. A cash account vs. margin account has key differences to consider before you go about trading. Trading with leverage offers investors the possibility of large short-term gains as well as the potential for outsize losses, so it is perhaps best suited for sophisticated investors.
Options
Options on stocks and exchange-traded funds (ETFs) are popular these days. Options, through calls and puts, are derivative instruments that offer holders the right but not the obligation tobuy shares at a specific price at a predetermined time. These are risky since you can lose your entire premium if the option contract strategy does not work out for the holder.
Collectibles
Collectibles, such as artwork or wine, are alternative investment types that may provide some of the benefits of diversification, but it’s hard to know what various items are worth since they are not valued frequently. Consider that stocks and many bonds are priced at least daily.
Collectibles might also go through fad periods and booms and bust cycles, which can add to the risk factors in this category.
Discovering Your Risk Tolerance
The investment risk pyramid is all about helping you figure out your ability and willingness to accept risk. It is a fundamental piece of being an investor. You should consider doing more research and even speaking with a financial advisor for a more detailed risk assessment along with an analysis of what your long-term financial goals are.
The Takeaway
Using an investment risk pyramid can make sense for many investors. It’s an easy, visual way to decide which asset classes you might want to hold in your portfolio, so that the percentage of each (i.e. your asset allocation) is aligned with your risk tolerance.
The other helpful aspect of the investment risk pyramid is that it presumes a bigger foundation in lower-risk investments (the bottom tier), with gradually smaller allocations to moderate risk and higher-risk assets, as you move up the pyramid. This can be helpful for a long-term strategy. In a nutshell, the investment risk pyramid helps you figure out how to allocate investments based on your risk tolerance and return objectives.
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FAQ
What are the levels of an investment pyramid?
The levels of an investment risk pyramid are low-risk at the base, moderate-risk in the middle, and high-risk at the top. The risk/return investment pyramid helps investors understand how to think about various assets they may want to own.
What does investment risk refer to?
Investment risk can be thought of as the variance in return, or how great the chance is that an investment will experience sharp losses. While the risk investment pyramid helps you build a portfolio, you should also recognize that a diversified stock portfolio performs well over time, while cash generally loses out due to the risk of inflation.
What are some examples of high-risk investments?
High-risk investments include speculative assets like options, trading securities on margin, and even some collectibles that might be hard to accurately value since they are based on what someone might be willing to pay for them. The low-risk to high-risk investments pyramid can include virtually any asset.
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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
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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.
¹Claw Promotion: Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.
