May
25
2023

How Do Employee Stock Options Work?

By | Building Your Career, Growing Wealth, invest, Investing, Life & Career | Comments Off on How Do Employee Stock Options Work?

Employee stock options (ESOs) are often included in an employee’s compensation package, and give those employees the opportunity to buy stock in their company at a certain price. Employee stock options have the potential to earn an employee some extra money, depending on the market.

Stock options can also give employees a sense of ownership (and, to a degree, actual ownership) in the company they work for. That can have benefits and drawbacks. But if you’re working in an industry in which employee stock options are common, it’s important to know how they work, the different types, and more.

What Are Employee Stock Options?

As mentioned, employee stock options give an employee the chance to purchase a set number of shares in the company at a set price — often called the exercise price — over a set amount of time. Typically, the exercise price is a way to lock in a lower price for the shares.

This gives an employee the chance to exercise their ESOs at a point when the exercise price is lower than the market price — with the potential to make a profit on the shares.

Sometimes, an employer may offer both ESOs and restricted stock units (RSUs). RSUs are different from ESOs in that they are basically a promise of stock at a later date.

Employee Stock Option Basics

When discussing stock options, there are some essential terms to know in order to understand how options — general options — work. (For investors who may dabble in options trading, some of these terms may be familiar but options trading doesn’t have any bearing on employee stock options.)

•   Exercise price/grant price/strike price: This is the given set price at which employees can purchase the stock options.

•   Market price: This is the current price of the stock on the market (which may be lower or higher than the exercise price). Typically an employee would only choose to exercise and purchase the options if the market price is higher than the grant price.

•   Issue date: This is the date on which you’re given the options.

•   Vesting date: This is the date after which you can exercise your options per the original terms or vesting schedule.

•   Exercise date: This is the date you actually choose to exercise your options.

•   Expiration date: This is the date on which your ability to exercise your options expires.

How Do Employee Stock Option Plans Work?

Again, when you’re given employee stock options, that means you have the option, or right, to buy stock in the company at the established grant price. You don’t have the obligation to exercise your options, but you have the ability to do so if it makes sense to you.

Exercising your stock options means choosing to actually purchase the stock at the given grant price, after a predetermined waiting period. If you don’t purchase the stock, then the option will eventually expire.

ESO Vesting Periods

Typically, employee stock options come with a vesting period, which is basically a waiting period after which you can exercise them. This means you must stay at the company a certain amount of time before you can cash out.

The stock options you’re offered may be fully vested on a certain date or just partially vested over multiple years, meaning some of the options can be exercised at one date and some more at a later date.

ESO Example

For example, imagine you were issued employee stock options on Jan. 1 of this year with the option of buying 100 shares of the company at $10/share. You can exercise this option starting on Jan. 1, 2023 (the vesting date) for 10 years, until Jan. 1, 2033 (the expiration date).

If you choose not to exercise these options by Jan. 1, 2033, they would expire and you would no longer have the option to buy stock at $10/share.

Now, let’s say the market price of shares in the company goes up to $20 at some point after they’ve vested on Jan. 1, 2023, and you decide to exercise your options.

This means you decide to buy 100 shares at $10/share for $1,000 total — while the market value of those shares is actually $2,000.

Exercising Employee Stock Options

It bears repeating: You don’t need to exercise your options unless it makes sense for you. You’re under no obligation to do so. Whether you choose to do so or not will likely depend on your financial situation and financial goals, the forecasted value of the company, and what you expect to do with the shares after you purchase them.

If you plan to exercise your ESOs, there are a few different ways to do so. It’s worth noting that some companies have specifications about when the shares can be sold, because they don’t want you to just exercise your options and then sell off all your stock in the company immediately.

Buy and Hold

Once you own shares in the company, you can choose to hold onto them — effectively, a buy-and-hold strategy. To continue the example above, you could just buy the 100 shares with $1,000 cash and you would then own that amount of stock in the company — until you decide to sell your shares (if you do).

Cashless Exercise

Another way to exercise your ESOs is with a cashless exercise, which means you sell off enough of the shares at the market price to pay for the total purchase.

For example, you would sell off 50 of your purchased shares at $20/share to cover the $1,000 that exercising the options cost you. You would be left with 50 shares.) Most companies offering brokerage accounts will likely do this buying and selling simultaneously.

Stock Swap

A third way to exercise options works if you already own shares. A stock swap allows you to swap in existing shares of the company at the market price of those shares and trade for shares at the exercise price.

For example, you might trade in 50 shares that you already own, worth $1,000 at the market price, and then purchase 100 shares at $10/share.

When the market price is higher than the exercise price — often referred to as options being “in the money” — you may be able to gain value for those shares because they’re worth more than you pay for them.

Why Do Companies Offer Stock Options?

The idea is simple: If employees are financially invested in the success of the company, then they’re more likely to be emotionally invested in its success as well, and it can increase employee productivity.

From an employee’s point of view, stock options offer a way to share in the financial benefit of their own hard work. In theory, if the company is successful, then the market stock price will rise and your stock options will be worth more.

A stock is simply a fractional share of ownership in a company, which can be bought or sold or traded on a market.

The financial prospects of the company influence whether people want to buy or sell shares in that company, but there are a number of factors that can determine stock price, including investor behavior, company news, world events, and primary and secondary markets.

Tax Implications of Employee Stock Options

There are two main kinds of employee stock options: qualified and non-qualified, each of which has different tax implications. These are also known as incentive stock options (ISOs) and non-qualified stock options (NSOs or NQSOs).

Incentive Stock Options (ISO)

When you buy shares in a company below the market price, you could be taxed on the difference between what you pay and what the market price is. ISOs are “qualified” for preferential tax treatment, meaning no taxes are due at the time you exercise your options — unless you’re subject to an alternative minimum tax.

Instead, taxes are due at the time you sell the stock and make a profit. If you sell the stock more than one year after you exercise the option and two years after they were granted, then you will likely only be subject to capital gains tax.

If you sell the shares prior to meeting that holding period, you will likely pay additional taxes on the difference between the price you paid and the market price as if your company had just given you that amount outright. For this reason, it is often financially beneficial to hold onto ESO shares for at least one year after exercising, and two years after your exercise date.

Non-qualified Stock Options (NSOs or NQSOs)

NSOs do not qualify for preferential tax treatment. That means that exercising stock options subjects them to ordinary income tax on the difference between the exercise price and the market price at the time you purchase the stock. Unlike ISOs, NSOs will always be taxed as ordinary income.

Taxes may be specific to your individual circumstances and vary based on how the company has set up its employee stock option program, so it’s always a good idea to consult a financial advisor or tax professional for specifics.

Should You Exercise Employee Stock Options?

While it’s impossible to know if the market price of the shares will go up or down in the future, there are a number of things to consider when deciding if you should exercise options:

•   the type of option — ISO or NSO — and related tax implications

•   the financial prospects of the company

•   your own investment portfolio, and how these company shares would fit into your overall investment strategy

You also might want to consider how many shares are being made available, to whom, and on what timeline — especially when weighing what stock options are worth to you as part of a job offer. For example, if you’re offered shares worth 1% of the company, but then the next year more shares are made available, you could find your ownership diluted and the stock would then be worth less.

The Takeaway

Employee stock options may be an enticing incentive that companies can offer their employees: they present the opportunity to invest in the company directly, and possibly profit from doing so. There are certain rules around ESOs, including timing of exercising the options, as well as different tax implications depending on the type of ESO a company offers its employees.

There can be a lot of things to consider, but it’s yet another opportunity to get your money in the market, where it’ll have the chance to grow.

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

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

SoFi Invest®

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

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

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

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Probability of Member receiving $1,000 is a probability of 0.028%.

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May
25
2023
Performance Charts

Opportunity Cost and Investments

By | Growing Wealth, invest, Investing | Comments Off on Opportunity Cost and Investments

The opportunity cost of an investment refers to the potential gain or loss incurred by not choosing to go with a different investment. Opportunity cost is a term or concept that doesn’t just apply to investing, and can be applied to other economic areas as well.

Investors at all income levels have a limited amount of funds to work with. And while some people are more risk-tolerant than others, considering the opportunity cost of choosing one investment over another will always be necessary. Otherwise, an investor will be more likely to either take excessive risks or miss out on good returns.

Opportunity Cost vs Risk

As noted, the concept of opportunity cost can be applied to almost any situation — not just financial matters. As it relates to investing, it’s especially important to consider applicable risks. But opportunity costs and risk are two different, albeit related, things.

Failing to consider the potential risks of an investment when trying to calculate opportunity cost could lead to an “apples-and-oranges” type of comparison.

Consider this: Someone wants to figure out the opportunity cost of investing in a penny stock rather than buying a U.S. Treasury bond. The latter are relatively safe investments, being 100% backed by the US government.

Penny stocks, on the other hand, carry a high amount of risk, being volatile and having a real possibility of going to zero if the underlying company goes bankrupt.

If an investor thinks about opportunity cost in this example, without factoring in risk, they will choose the penny stock every single time – and without considering the risks involved, doing so would make sense.

Safer investments, like Treasuries, tend to come with low returns. But, again, they’re low-risk assets, so investors should likely expect their expected returns to be low. While a risky investment like a penny stock might yield big gains, it comes with significant risk, and could also yield large losses.

In effect, there’s a tradeoff and inverse relationship between risk and potential reward or returns. Investing in the penny stock risks losing capital, while investing in Treasuries risks losing the larger gains.

What Is Opportunity Cost When Evaluating Investments?

There are two main types of opportunity cost as it relates to financial decisions: Explicit opportunity cost, and implicit opportunity cost.

The first type, explicit opportunity cost, is easy to calculate because it involves the objective value that an investor sacrifices when making one investment decision instead of another. The second type, implicit opportunity cost, can be harder to calculate because it’s more subjective.

Implicit opportunity costs tend to involve resources and a lost opportunity to generate additional income rather than a direct cost.

For example, say someone owns a second home in the Hamptons. This person loves vacationing in the Hamptons so much that they choose not to rent out the home, foregoing the significant revenue that doing so might bring in. That lost revenue represents the implicit opportunity cost of using the home as a luxurious vacation destination rather than a rental property.

How to Calculate Opportunity Cost

It’s important to remember that any attempt at this kind of calculation will be somewhat of an estimation because it’s impossible to predict with 100% certainty. But, for the purposes of trying to calculate opportunity cost, it becomes necessary to make some related assumptions as to risk and reward.

When a skilled financial professional wants to determine how to calculate opportunity cost, they might use a complex mathematical formula called the Net Present Value (NPV) formula. This formula can be calculated in a spreadsheet and includes specific business factors like free cash flow, interest rates, and the number of periods in the future in which free cash flow will happen.

For most individual investors, an all-out calculation using the NPV formula might be going a little overboard. The effort required could be unnecessary, and investors may not always have access to the required information.

However, some simple arithmetic can often work, too. The only required knowledge for such a calculation will be what an investor sacrifices by making one decision rather than another.

A Simple Opportunity Cost Formula

An opportunity cost example equation would look like this:

Opportunity Cost = FO – CO

Where FO is equivalent to the return on the best foregone option, and CO is equivalent to the return on the chosen option. In other words, subtracting the amount of money made on a chosen investment from the amount of money that would have been made on the other, not chosen, investment.

Beyond that, it can also be worthwhile to take into consideration the variables of time and sweat equity. Sweat equity refers to the work that might be required to maintain something. Likewise, time refers to the time a particular economic decision will require.

For example, investors who tend to be more self-directed and choose to do their own research will likely want to pick each specific security in their portfolios and how much capital they want to allocate to each position. That research requires sweat equity, but could lead to higher returns if done well.

Other investors may choose a more passive investment style and either put all of their available capital in a single ETF or use a robo-advisor that chooses security allocations for them. This method minimizes sweat equity but could potentially see lower returns.

When it comes to the simple math, let’s say an investor really likes Restaurant X. She typically eats three Restaurant X meals each week, costing about $10 each, for a total of about $120 per month.

Our Restaurant X fan could decide to cook her own meals three nights a week, with an approximate cost of $60 per month. She then invests the extra $60 she has now saved.

The opportunity cost in this random example is missing out on the Restaurant X experience. The gain would be having a little extra cash to invest each month.

The Takeaway

Opportunity costs in investing refer to the potential gains given up in exchange for choosing one thing over another. It’s theoretical and hypothetical, and can be tricky to grasp, but is an important concept in investing. In the long run, the opportunity cost of choosing to stay out of the market tends to be high. Would-be investors might miss out on potential gains.

Without having money work for itself and earn interest, dividends, or capital gains, it’s very difficult to build long-term wealth. That said, there are many factors to take into consideration when investing, and for some, it may be best to seek the advice of a financial professional for some guidance.

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

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

SoFi Invest®

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

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

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Probability of Member receiving $1,000 is a probability of 0.028%.

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May
25
2023
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Understanding Inverse ETFs

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Understanding Inverse ETFs

An inverse ETF — or short ETF — is a portfolio of securities that allows investors to make a bet that either the broader markets or a particular asset class or market sector will go down in the short term.

There are a wide range of inverse ETFs to choose from — there are currently 89 traded in U.S. markets. They allow investors to make short-term investments in the likelihood that the price of a given asset will go down. Investors can use inverse ETFs to find returns when there are price dips in equities, fixed-income securities, and certain commodities.

How Does an Inverse ETF Work?

To understand inverse ETFs, an investor first needs to know about Exchange Traded Funds (ETFs). An ETF is a portfolio of stocks, or bonds or other securities that trades on an exchange, like a stock. Its share price fluctuates throughout the day, as investors buy and sell shares of the fund.

As with regular ETFs, investors can buy and sell inverse ETFs throughout the day. Unlike the way ETFs work, however, inverse ETFs are designed not to invest in a given index, but to deliver the opposite result. If the index goes down, the ETF is meant to go up, and vice versa.

What Do Inverse ETFs Invest In?

Inverse ETFs — or short ETFs — use complex trading strategies, involving a heavy use of futures contracts, to deliver the opposite result of the markets. Futures contracts are essentially agreements to buy or sell a given asset at a given date and price, regardless of the market price at the time. Using futures contracts, an investor can bet that a given asset, like a stock, will go up or down, without actually owning that asset.

Put simply, investors who think the price of a given stock will go down may buy a futures contract that allows them to sell a stock at a higher price than they think it will trade at by the expiration of the contract. If the price of that stock does go down, they can buy it on the open market cheaply and sell it to the other person or institution at the agreed-upon higher price, and pocket the difference.

An inverse ETF does that with a group of stocks, every trading day. The largest inverse ETFs aim to deliver the opposite returns of major stock indexes, like the Nasdaq or the S&P 500. For example, if the S&P 500 goes down 1% on a given day, then a corresponding inverse ETF could be designed to go up 1% that day.

Leveraged Inverse ETFs

There are other inverse ETFs that take the formula one step further, using leverage. That means they buy the futures contracts in their portfolios partially with borrowed money. That gives them the ability to offer outsized returns — two and three times the opposite of the day’s return — but it also exposes them to sizable single-day losses, and larger losses over time.

For example, on that same hypothetical day when the S&P 500 goes down 1%, the corresponding inverse ETF could be designed to go up by 2%.

Who Invests in Inverse ETFs?

An inverse ETF might seem like a good choice for an investor who is generally pessimistic about the prospects for the broader markets over the next few months or years. But that’s not necessarily the case.

Inverse ETFs only invest in one-day futures contracts. The futures contracts they invest in expire at the end of the trading day, locking in the ETFs’ gains and losses.

With an inverse ETF, it’s not enough to be right about the general direction of a given market, asset class or sector. The performance of inverse ETFs isn’t the exact opposite of the index it tracks over longer periods of time. So, the investor has to be correct on the right days, as well.

Inverse ETFs get a lot of attention in the media during market swoons, when they post eye-popping returns. But most financial professionals probably don’t recommend them as long-term investments. They’re generally best for sophisticated investors with a high tolerance for risk.

What Are the Risks of Inverse ETFs?

Investors who purchase inverse ETFs take on risks that are common to all investors, and also some that are unique to this specific investment vehicle.

•   Loss: If an investor buys an inverse ETF and the index that it shadows goes up, then the investor will lose money. If the given index goes up by 1% that day, then the fund offering the inverse of that index will go down by 1%; with a leveraged ETF, it could even go down by 2% or 3%.

•   Fees: While most ETFs have very low management fees, inverse ETFs may have higher fees, which may take a bite out of returns over time. (It’s worth noting that the management fee can be typically lower than the time and expense of shorting the stocks directly.)

The risks are significant enough that in 2019, the Securities and Exchange Commission proposed new regulations about inverse ETFs, requiring companies that manage leveraged and inverse ETFs to specifically make sure customers understood those risks. The regulation was not approved, which means the onus is still very much on investors to understand the risk.

The Takeaway

Inverse ETFs are designed as tools to allow investors to bet against the market, or specific asset classes. While they come with unique risks, inverse ETFs can help investors find returns during market dips — giving them the chance to short the market with one trade. These ETFs go up as the index goes down, offering opportunity when it might otherwise seem there is none.

The trick: choosing the right inverse ETF on the right day, in order to gain rather than lose. The funds are risky, but can be popular among investors who want to hedge their exposure to a given asset class or market sector, and investors who believe that a given market is due for a big drop.

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

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

SoFi Invest®

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

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

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

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Probability of Member receiving $1,000 is a probability of 0.028%.

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May
25
2023
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Coattail Investing Basics

By | Growing Wealth, invest, Investing | Comments Off on Coattail Investing Basics

Coattail investing, also known as copycat investing, is one of many popular investment strategies and one that involves investors trying to replicate the results of investors that already have a proven track record of success. In effect, investors look at what other successful investors are doing, and replicate it.

For newer investors, this method has some obvious advantages, and can help ease the learning curve a bit. But, of course, there are both benefits and drawbacks, and it’s helpful to know who you can or perhaps should try to replicate before choosing some coattails to ride at random.

How To Be a Coattail Investor

For the most part, coattail investing incorporates a buy and hold strategy, where an investor buys stocks and holds them for the long term — a period of several years or several decades. Publicly available information from the financial press and the Securities Exchange Commission (SEC) website can give copycat investors information on how investors (those managing more than $100 million) have invested their money.

Coattail investing begins with choosing what person or group to watch. Then, based on their investment choices, a copycat investor can choose to replicate those investing strategies either in whole or in part.

In most cases, the average investor probably doesn’t have enough capital to keep up with big money managers and institutions in an exact 1:1 ratio. But watching what they buy and sell (and when), and acting accordingly to some degree, is the heart of coattail investing.

While investors used to have to manually follow their favorite investors by searching the SEC website or elsewhere, today, certain online services exist that help to automate the process.

Some brokerages may even offer “mirror investing” services that allow investors to set their own portfolios to make the same exact trades that their favorite investors make, with customized asset allocations.

Who Do Coattail Investors Follow?

When attempting coattail investing, following those who adopt a “buy and hold” strategy could prove beneficial. Because markets move fast, by the time a trade is executed, the most profitable opportunity may have already passed. Buying and holding takes a long-term time horizon or perspective, meaning it could take some of the timing and guesswork out of the equation, making it easier to realize profits.

A copycat investor could choose to copy just about anyone. That said, there are a few choices most commonly used by those who are successful at copycat investing. These include financial professionals and other investors who can influence markets simply by announcing their positions.

Activist Investors

Activist investors are known for causing stocks to rise when they reveal their own investments. These influencers may be ahead of the curve on investment trends, and financial news media reports on the actions of these investors regularly. Activist investors also often publicize their own moves through blog posts or press releases as well. This tends to make it easy for coattail investors to keep up and act accordingly.

Money Managers

People and institutions that manage over $100 million are required to report their holdings to the SEC. The SEC then publishes this information, making it public. Rather than hire a money manager, some copycat investors simply search for investments that large money managers have made and then choose those they think would be best for their own portfolios.

Large Corporations and CEOs

Successful companies that have accumulated cash reserves are challenged with figuring out where to put that money — and coattail investors sometimes follow suit.

For many years, holding cash and bonds was probably the safest option for investors. But bonds and cash have their risks, too, such as interest rate fluctuations and inflation. This has led some companies to look elsewhere for returns, often in the form of alternative investments.

Unlikely Visionaries

Following more nontraditional investors — people outside the financial world who have made successful investments — might not be as profitable as activist investors or proven money managers, but there can still be insight to be gained.

That may include professional athletes or social media influencers. There are numerous examples of both who have made what turned out to be successful investments of various types. Of course, even if you start to mirror an athlete’s or influencer’s portfolio activity, there’s no guarantee that they’ll continue to make wise choices.

While watching athletes or celebrities for investment advice might not be something anyone would recommend, it can bring a unique perspective from outside the echo chamber and herd mentality of those within the financial world. People who come from outside that world tend to have a different outlook and could see something that others miss.

That said, an investor who looks to popular culture icons for investment advice does run the risk of racking up significant losses. It might not be realistic to establish an entire portfolio around this idea. It’s widely believed that in coattail investing, investors should follow only the most esteemed professional money managers.

What Are the Risks of Coattail Investing?

The main risk of copycat investing is that one might end up following an investor who loses, rather than gains. There could also be psychological risks, such as thinking that because one is copying a successful investor’s moves, all personal responsibility has been taken out of the equation.

In reality, investing always comes with risk, and always requires investors to conduct their own due diligence. Unless a copycat investor is using an automated program that buys and sells as soon as a big investor announces their trade, like a robo advisor of one type or another, they will still have to stay on top of their own investments, even if the decisions of what/when to buy/sell are all recommended by someone else.

The Takeaway

Coattail or copycat investing is a strategy that involves mirroring another investor’s market moves. Copycat investing could be pursued in almost any fashion imaginable. It’s possible to follow anyone for investment advice, using their trades as a game plan.

Investors with an interest in pursuing coattail investing would do well to consider sticking to tracking these types of people and their portfolios. But watching others with more experience and preferring to match their actions more often than not can bring a sense of security to some investors. It can also reduce some of the personal responsibility involved in researching investments and trying to decide when to buy or sell.

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

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

SoFi Invest®

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May
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2023
Auto Insurance Terms, Explained

Auto Insurance Terms, Explained

By | Budgeting & Goals, Financial Independence | Comments Off on Auto Insurance Terms, Explained

Shopping for auto insurance or dealing with an insurance claim? It’s common to hit a few potholes on the way to understanding car insurance.

Auto insurance terminology can be difficult to navigate, so this glossary may help you find your way.

Car Insurance Terminology

Here are basic auto insurance terms explained:

Accident Forgiveness

Accident forgiveness is a benefit that can be added to a car insurance policy to prevent a driver’s premium from increasing after their first at-fault accident.

Each insurer’s definition of accident forgiveness may vary, and it isn’t available in every state. Some insurers include it at no charge, or it may be an add-on, which means it could be earned or purchased.

Actual Cash Value

Actual cash value is the term used to describe what a vehicle was worth before it was damaged or stolen, taking depreciation into consideration. The amount is calculated by the insurer.

Adjuster

An adjuster is an employee who evaluates claims for an insurance company. The adjuster investigates the claim and is expected to make a fair and informed decision regarding how much the insurance company should pay.

Agent or Broker

Both agents and brokers help consumers obtain auto insurance, but there are differences in their roles. An agent represents an insurance company (or companies) and sells insurance to and performs services for policyholders.

A broker represents the consumer and may evaluate several companies to find a policy that best suits that individual, family, or organization’s needs.

Both agents and brokers are licensed and regulated by state laws, and both may be paid commissions from insurance companies.

At Fault

Drivers are considered “at fault” in an accident when it’s determined something they did or didn’t do caused the collision to occur. A driver may still be considered at fault even if no ticket was issued or if the insurance company divides the blame between the parties involved in the accident.

In some states, drivers can’t receive an insurance payout if they are found to be more than 50% at fault.

Casualty Insurance

Casualty insurance protects a driver who is legally responsible for another person’s injuries or property damage in a car accident.

Claim

When an insured person asks their insurance company to cover a loss, it’s called a claim.

Claimant

A person who submits an insurance claim.

Collision Coverage

Collision coverage helps pay for damage to an insured driver’s car if the driver causes a crash with another car, hits an object (a mailbox or fence, for example), or causes a rollover.

It also may help if another driver is responsible for the accident but doesn’t have any insurance or enough insurance to cover the costs.

Collision coverage is usually required with an auto loan. Learn more about smarter ways to get a car loan.

Comprehensive Coverage

Comprehensive coverage pays for damage that’s caused by hitting an animal on the road, as well as specified noncollision events, such as car theft, a fire, or a falling object. It is usually required with an auto loan.

Recommended: How Much Auto Insurance Do I Really Need?

Damage Appraisal

When a car is in an accident, an insurance company’s claims adjuster may appraise the damage, and/or the car owner may get repair estimates from one or two body shops that can do the repairs.

Policyholders can appeal an appraisal if it seems low and they have some backup to prove it.

Declarations Page

This page in an insurance policy includes its most significant details, including who is insured, information about the vehicle that’s covered, types of coverage, and coverage limits.

Deductible

This is the predetermined amount the policyholder will pay for repairs before insurance coverage kicks in. Generally, the higher the deductible, the lower the monthly premium.

Depreciation

Depreciation is the value lost from a vehicle’s original price due to age, mileage, overall condition, and other factors. Depreciation is used to determine the actual cash value of a car when the insurer decides it’s a total loss.

Effective Date

This is the exact date that an auto insurance policy starts to cover a vehicle.

Endorsement

An endorsement, or rider, is a written agreement that adds or modifies the coverage provided by an insurance policy.

Exclusion

Exclusions are things that aren’t covered by an auto insurance policy. (Some common exclusions are wear and tear, mechanical breakdowns, and having an accident while racing.)

Full Coverage

Full coverage usually refers to a car insurance policy that includes liability, collision, and comprehensive coverage.

GAP Coverage

Guaranteed asset protection insurance is optional coverage that helps pay off an auto loan if a car is destroyed or stolen and the insured person owes more than the car’s depreciated value. It covers the difference, or gap, between what is owed and what the insurance company would pay on the claim.

Indemnity

Indemnity is the insurance company’s promise to help return policyholders to the position they were in before a covered incident caused a loss. The insurer “indemnifies” the policyholder from losses by taking on some of the financial responsibility.

Liability Insurance

If you’re at fault in an accident, your liability coverage pays for the other driver’s (or drivers’) car repairs and medical bills.

Coverage limits are often expressed in three numbers. For example, if a policy is written as 25/50/15, it means coverage of up to $25,000 for each person injured in an accident and $50,000 for the entire accident and $15,000 worth of property damage.

The cost of liability-only car insurance varies by state, as does the required minimum level of liability insurance.

Recommended: What Does Liability Auto Insurance Typically Cover?

Limit

This is the maximum amount a car insurance policy will pay for a particular incident. Coverage limits can vary greatly from one policy to the next.

Medical Payments Coverage

Medical payments coverage (or medical expense coverage, or MedPay) is optional coverage that can help pay medical expenses related to a vehicle accident.

It covers the insured driver, their passengers, and any pedestrians who are injured when there’s an accident, regardless of who caused it.

It also may cover the policyholder when that person is a passenger in another vehicle or is injured by a vehicle when walking, riding a bike, or riding public transportation. This coverage is not available in all states.

No-Fault Insurance

Several states have no-fault laws, which generally means that when there’s a car accident, everyone involved files a claim with their own insurance company, regardless of fault.

Also known as personal injury protection, no-fault insurance covers medical expenses regardless of who’s at fault. It doesn’t mean, however, that fault won’t be determined. No-fault insurance refers to injuries and medical bills. If a person’s car is damaged in an accident and they were not at fault, the at-fault driver’s insurance company will be responsible for the repairs.

Optional Coverage

Optional coverage refers to any car insurance coverage that is not required by law.

Personal Injury Protection

Several states require personal injury protection (PIP) coverage to help pay for medical expenses that an insured driver and any passengers suffer in an accident, regardless of who’s at fault.

PIP also may cover loss of income, funeral expenses, and other costs. PIP is the basic coverage required by no-fault insurance states.

Primary (and Secondary) Driver

The person who drives an insured car the most often is considered its primary driver. Typically, the primary driver is the person who owns or leases the vehicle. If spouses share an insurance policy, they may both be listed as primary drivers on a car or cars.

A car may have multiple secondary, or occasional, drivers. These are generally licensed drivers who live in the same household (children, grandparents, roommates, nannies, etc.) and may use the insured car occasionally but are not the car’s primary driver.

Recommended: Cost of Car Insurance for Young Drivers

Primary Use

This term refers to how a vehicle will most often be used — for commuting to work, for business, for farming, or for pleasure.

Premium

A premium is the amount a person pays for auto insurance. Premiums may be paid monthly, quarterly, twice a year, or annually, depending on personal choice and what the provider allows.

Replacement Cost

Some insurance companies offer replacement cost coverage for newer vehicles. This means that if a car is damaged or stolen, the insurer will pay to replace it with the same vehicle.

Coverage varies by company, and not every insurance company offers replacement coverage.

State-Required Minimum

Every state has different legal minimum requirements for the types and amounts of insurance coverage drivers must have. The limits are usually low. Lenders may require more coverage for those who are buying or leasing a car.

Total Loss or ‘Totaled’

If a car is severely damaged, the insurer may determine that it is a total loss. That usually means the car is so badly damaged that it either can’t be safely repaired or its market value is less than the price of putting it back together.

If a state has a total-loss threshold, an insurer considers the car a total loss when the cost of the damage exceeds the limit set by the state.

Underwriting

The underwriting process involves evaluating the risks (and determining appropriate rates) in insuring a particular driver.

Insurance underwriting these days is often done with a computer program. But if a case is unusual, a professional may step in to further assess the situation.

Uninsured and Underinsured Motorist Coverage

Uninsured motorist and underinsured motorist coverage protects drivers and their passengers who are involved in an accident with a motorist who has little or no insurance. Some states require this coverage, but the limits vary.

Some states require this coverage, but the limits vary.

Uninsured/underinsured motorist bodily injury insurance covers medical costs. Uninsured/underinsured motorist property damage pays to repair a vehicle.

The Takeaway

Understanding car insurance basics is important for drivers. Knowing auto insurance terms, coverage your state or lender may require, and what other types of coverage could further safeguard your finances can make you a more informed consumer.

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.

Compare quotes from top car insurance carriers.

Insurance not available in all states.
Gabi is a registered service mark of Gabi Personal Insurance Agency, Inc.
SoFi is compensated by Gabi for each customer who completes an application through the SoFi-Gabi partnership.

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

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