What Percentage of Income Should Go to Rent and Utilities?

What Percentage of Income Should Go to Rent and Utilities?

A common rule of thumb for renters states that no more than 30% of your income should go to rent and utility payments each month. This guideline dates back to housing initiatives introduced by the federal government in the 1960s.

Deciding what percentage of income should go to rent and utilities is central to making a realistic budget as a renter. The less you can spend on these items each month, the more money you’ll have to fund your financial goals. Read on for more about calculating a housing budget that’s right for you, as well as creative ways to cut your housing costs.

What Is the 30% Rule?

The 30% rule says that households should spend no more than 30% of their income on housing costs, including rent and utilities. This housing affordability advice dates back to the 1969 Brooke Amendment, which was passed in response to rental price increases and complaints about public housing services.

The Brooke Amendment capped rent for public housing at 25% of residents’ income. This measure was designed to offer financial relief to low-income households participating in public housing programs. In 1981, Congress increased the 25% threshold to 30%, where it has remained to the present day.

Recommended: Should I Sell My House Now or Wait

Check your score with SoFi

Track your credit score for free. Sign up and get $10.*


What Is 30% Based on?

The 30% rule for housing affordability considers two distinct categories of costs: housing and utilities. For renters, this generally means rental payments and basic utilities such as electric, water, and heating. Collectively, these expenses should total no more than 30% of a renter’s gross monthly income.

Gross income is what someone earns before taxes and other deductions are taken out. Net income, on the other hand, is what they actually take home in their paychecks. Basing the 30% rule on someone’s gross income versus their net income will result in a higher dollar amount that should be allocated to rent and utilities.

It’s also important to remember that the 30% rule isn’t set in stone. The average monthly expenses for one person will vary depending on your location’s cost of living, optional costs like renter’s insurance, and whether you have a very low or high income.

If you need help managing your finances, online tools like a money tracker can help you monitor spending, set budgets, and keep tabs on your credit score.

Calculating the Percentage to Go to Rent and Utilities

Figuring out what percentage of income should go to rent and utilities using the 30% rule is a fairly simple calculation. You’d multiply your gross monthly income by 0.30 to figure out the maximum amount you should be budgeting for rent and utility costs. How complicated this calculation is can depend on how often you’re paid and whether your paychecks are always the same amount.

If You Are Paid the Same Amount Every Two Weeks

If you’re paid biweekly and your paychecks are the same, you can calculate your target rent and utilities in one of two ways. First, you take the gross amount reported on one of your paychecks and multiply it by 0.30. You then double that result to find the monthly amount.

So, say your biweekly gross income is $2,500. Thirty percent of that number is $750 ($2,500 x 0.30). If you double it, then your rent and utilities budget should be no more than $1,500 per month.

This strategy doesn’t take into account the two months in a year that there are three biweekly paychecks, however. If you want to find the average amount to spend on rent and utilities each month, you can multiply your biweekly gross paycheck amount by 26 (for 26 paychecks in one year), divide by 12 (for 12 months), then find 30% of that amount.

So using the $2,500 figure once again, if you multiply that by 26, you’d get $65,000. Divide that by 12 to get $5,417 (rounded up), your monthly pay. Thirty percent of that is $1,625, the amount you’d allocate to rent and utilities per month.

If You Are Paid Varying Amounts Every Paycheck

Pinpointing what percentage of income should go to rent and utilities can be a little more challenging if your paychecks aren’t the same from one pay period to the next. That might happen if you’re paid hourly and work different hours each week, receive vacation or sick pay, or part of your income is based on commissions.

In that scenario, you’d want to look at your annual income in its entirety. You can do that by looking at all of your pay stubs for the previous 12 months or checking your most recent W-2 form. Again, you’re looking at gross income, not net pay.

You’d take the gross income for the year, then multiply it by 0.30 to figure out how much of your pay should go to rent and utilities overall. If your gross annual income was $70,000, then your target number would be $21,000 for the year. Divide that by 12 and you’ll find that you should be spending no more than $1,750 per month on rent and utilities using the 30% rule.

How to Reduce Your Rent to 30% or Less of Your Income

If you’ve done the calculations and you’re spending more than 30% of your income on rent and utilities, there are some things you may be able to do to reduce those costs.

Split the Rent With Roommates

Taking on one or more roommates could ease some of the financial load. Remember, it’s important to have a written agreement in place specifying what percentage of rent and utilities each roommate is responsible for.

Also, determine who will pay the rent and utility bills when everyone is chipping in. For example, one person may volunteer to collect payments from everyone else and then cut a check to the landlord or utility company. Consider using a budget planner app to keep track of household bills and payments.

Recommended: 25 Tips for Sharing Expenses With Roommates

Consider a New Location

Moving is another possibility for lowering rent and utility costs if you’re relocating to an area with a lower cost of living. Rent in rural areas may be cheaper than in a trendy urban center, for example. There can even be significant variation in rents in different neighborhoods within the same city.

Keep in mind that relocating can have its trade-offs. For instance, living in a less expensive area may mean giving up certain amenities you enjoyed in your old neighborhood, like walkability or convenient access to stores and restaurants. And of course, you’ll also have to budget for the costs of moving, which can average $1,250 for a local move or $4,890 for a long-distance move.

Work Remotely

Working remotely can have its advantages, including saving money on certain expenses. For example, you may spend less on gas, meals out with coworkers, or office attire.

That said, if you are on a computer all day, you’ll want to take steps to lower your energy bill, such as unplugging at the end of the day and buying energy-efficient lights.

Opting for remote work could also save you money on rent if you’re able to become location-independent. When you’re not tied to a particular city, that frees you up to seek out cheaper areas to live. You could even forgo renting altogether and become a digital nomad. That has its own costs, but you’re not locked in to paying rent to a landlord or utility payments long-term.

Negotiate With Your Landlord

The most effective way to reduce your rent may be to go straight to the landlord and negotiate your rent. Your landlord may be willing to offer a discount or reduced rental rate under certain conditions.

For example, your landlord might agree to reduce your rent by 10% or 15% if you pay six months in advance or agree to a longer lease term. The prospect of guaranteed rental income might be attractive enough for them to offer you a better deal.

You may also be able to get a rate discount by offering to take care of certain maintenance and upkeep tasks yourself. If your landlord normally pays for lawn care, for example, they may be willing to let you pay less in rent if you’re working off the difference by cutting the grass and maintaining the property’s landscaping.

Ask for a Promotion or Find a New Job

Instead of attempting to reduce your costs, you could try a different tactic: Making more money means you can budget more for rent and utility costs.

Asking your boss for a raise or promotion might boost your paycheck. If you hit a dead end, you may consider a more drastic move and look for a higher-paying job. Taking on a part-time job or starting a side hustle can also help you bring in more money to cover rent and utility payments.

What to Consider if 30% Doesn’t Work for You

As noted above, the 30% rule for housing is a somewhat arbitrary number and may not work for everyone. Spending more than 30% of your income on rent and utilities doesn’t automatically mean that you’re living beyond your means, for a variety of reasons.

There are, however, a few actions you can take to streamline your finances and determine what percentage of income should go to rent and utilities.

Try the 50/30/20 Rule

The 50/30/20 budget rule recommends spending 50% of your income on needs, 30% on wants, and the remaining 20% on savings and debt repayment. This budgeting method doesn’t specify an exact percentage or dollar amount to spend on rent and utilities. Instead, those expenses get grouped into the 50% of income allocated to “needs”.

You still need to keep track of your spending to make sure you’re staying within the 50% limit. Using an online budget planner can help you figure out if the 50/30/20 rule is realistic based on your income and expenses.

Pay Down Loans and Debt

Total U.S. household debt reached $17.69 trillion in the first quarter of 2024, according to Federal Reserve data. While a big chunk of that is mortgage debt, Americans also pay a sizable amount of money to credit cards, student loans, personal loans, auto loans, and other debts.

Working to pay off debts can free up more money to allocate to rent and utilities. There are different methods you can use, including the debt snowball method and the debt avalanche.

Look for Cost Savings in Recurring Expenses

One more way to make shouldering higher rent costs easier is to lower your other expenses. Making small changes at home can lead to lower electricity and water bills. Cutting out subscriptions you don’t use, looking for a better deal on car insurance, and eating more meals at home instead of dining out are all simple ways to lower your expenses.

The Takeaway

If you’re spending 30% of your gross (before tax) income or less on rent and utilities, pat yourself on the back. You may spend up to 50% on housing if you have no debt and a healthy savings balance. The important thing is to look at your entire financial picture, including your income, debts, and goals, to decide the figure that’s right for you.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

SoFi helps you stay on top of your finances.

FAQ

What is a good percentage of income to spend on rent?

The 30% rule says that renters should spend no more than a third of their gross income on rent and utility payments. The less you can spend on rent and utilities, the more money you’ll have to fund other financial goals, like saving for emergencies, paying off debt, and planning for retirement.

Is 30% of income on rent too much?

Spending 30% of income on rent may be too much if a significant part of your income is also going toward debt repayment. That may leave you with little money to cover other necessary expenses or discretionary spending.

How much of your monthly income should go to rent?

A common rule of thumb says that roughly one-third of your monthly gross income can go to rent. But if you have substantial savings and no debt, you may be OK with spending a larger percentage of income on rent. On the other hand, if you’re trying to pay off debt or build savings, you may prefer to spend less on rent payments.


About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.



Photo credit: iStock/deliormanli

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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

SORL-Q224-1911201-V1

Read more

Private Credit vs. Private Equity: What’s the Difference?

Private credit and private equity investments offer investors opportunities to build their portfolios in substantially different ways. With private credit, investors make loans to businesses and earn returns through interest. Private equity represents an ownership stake in a private company or a public company that is not traded on a stock exchange.

Each one serves a different purpose, which can be important for investors to understand.

Key Points

•   Private credit and private equity are alternative investments that offer different ways to build portfolios.

•   Private credit involves making loans to businesses and earning returns through interest, while private equity represents ownership stakes in private or delisted public companies.

•   Private credit investors include institutional investors, high-net-worth individuals, and family offices, while private equity investments are often made by private banks or high-net-worth individuals.

•   Private credit generates returns through interest, while private equity aims to generate returns through the sale of a company or going public.

•   Private credit carries liquidity risk, while private equity investments can be affected by the company’s performance and potential bankruptcy.

What Does Private Credit and Private Equity Mean?

Private equity and private credit are two types of alternative investments to the stocks, bonds, and mutual funds that often make up investor portfolios. Alternative investments in general, and private equity or credit in particular, can be attractive to investors because they can offer higher return potential.

However, investors may also face more risk.

💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.

Alternative investments,
now for the rest of us.

Start trading funds that include commodities, private credit, real estate, venture capital, and more.


Private Credit Definition

Private credit is an investment in businesses. Specifically, an investor or group of investors extends loans to private companies and delisted public companies that need capital. Investors collect interest on the loan as it’s repaid. Other terms used to describe private credit include direct lending, alternative lending, private debt, or non-bank lending.

Who invests in private credit? The list can include:

•   Institutional investors

•   High-net-worth individuals

•   Family offices or private banks

Retail investors may pursue private credit opportunities but they tend to represent a fairly small segment of the market overall. Private credit investment is expected to exceed $3.5 trillion globally by 2028.

Private Equity Definition

Private equity is an investment in a private or delisted public company in exchange for an ownership share. This type of investment generates returns when the company is sold, or in the case of a private company, goes public.

Similar to private credit, private equity investments are often the domain of private banks, or high-net-worth individuals. Private equity firms can act as a bridge between investors and companies that are seeking capital. Minimum investments may be much higher than the typical mutual fund buy-in, with investors required to bring $1 million or more to the table.

Private equity is often a long-term investment as you wait for the company to reach a point where it makes sense financially to sell or go public. One difference to note between private equity and venture capital lies in the types of companies investors target. Private equity is usually focused on established businesses while venture capital more often funds startups.

What Are the Differences Between Private Credit and Private Equity?

Private credit and private equity both allow for investment in businesses, but they don’t work the same way. Here’s a closer look at how they compare.

Investment Returns

Private credit generates returns for investors via interest, whereas private equity’s goal is to generate returns for investors after selling a company (or stake in a company) after the company has grown and appreciated, though that’s not always the case.

With private credit, returns may be more predictable as investors may be able to make a rough calculation of their potential returns. Private equity returns are less predictable, as it may be difficult to gauge how much the company will eventually sell for. But there’s always room for private equity returns to outstrip private credit if the company’s performance exceeds expectations. However, it’s important to remember that higher returns are not guaranteed.

Risk

Investing in private credit carries liquidity risk, in that investors may be waiting several years to recover their original principal. That risk can compound for investors who tie up large amounts of capital in one or two sectors of the market. Likewise, changing economic conditions could diminish returns.

If the economy slows and a company isn’t able to maintain the same level of revenue, that could make it difficult for it to meet its financial obligations. In a worst-case scenario, the company could go bankrupt. Private credit investors would then have to wait for the bankruptcy proceedings to be completed to find out how much of their original investment they’ll recover. And of course, any future interest they were expecting would be out the window.

With private equity investments, perhaps the biggest risk to investors is also that the company closes shop or goes bankrupt before it can be sold but for a different reason. In a bankruptcy filing, the company’s creditors (including private credit investors) would have the first claim on assets. If nothing remains after creditors have been repaid, private equity investors may walk away with nothing.

The nature of the company itself can add to your risk if there’s a lack of transparency around operations or financials. Privately-owned companies aren’t subject to the same federal regulation or scrutiny as publicly-traded ones so it’s important to do thorough research on any business you’re thinking of backing.

Ownership

A private credit investment doesn’t offer any kind of ownership to investors. You’re not buying part of the company; you’re simply funding it with your own money.

Private equity, on the other hand, does extend ownership to investors. The size of your ownership stake can depend on the size of your investment.

Investor Considerations When Choosing Between Private Credit and Private Equity

If you’re interested in private equity or private credit, there are some things you may want to weigh before dividing in. Here are some of the most important considerations for adding either of these investments to your portfolio.

•   Can you invest? As mentioned, private credit and equity are often limited to accredited investors. If you don’t meet the accredited investor standard, which is defined by income and net worth, these investments may not be open to you.

•   How much can you invest? If you are an accredited investor, the next thing to consider is how much of your portfolio you’re comfortable allocating to private credit or equity.

•   What’s your preferred holding period? When evaluating private credit and private equity, think about how long it will take you to realize returns and recover your initial investment.

•   Is predictability or the potential for higher returns more important? As mentioned, private credit returns are typically easy to estimate if you know the interest rate you’re earning. However, returns may be lower than what you could get with private equity, assuming the company performs well.

Here’s one more question to ask: how can I invest in private equity?

These investments may not be available in a standard brokerage account. If you’re looking for private credit opportunities you may need to go to a private bank that offers them. When private equity is the preferred option, a private equity firm is usually the connecting piece for those investments.

When comparing either one, remember to consider the minimum initial investment required as well as any fees you might pay.

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

The Takeaway

Private credit and private equity can diversify a portfolio and help you build wealth, though not in the same way. Comparing the pros and cons, assessing your personal tolerance for risk and ability to invest in either can help you decide if alternative investments might be right for you.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

Why do investors like private credit?

Private credit can offer some unique advantages to investors, starting with predictable returns and steady income. The market for private credit continues to grow, meaning there are more opportunities for investors to add these types of investments to their portfolios. Compared to private equity, private credit carries a lower degree of risk.

How much money do you need for private equity?

The minimum investment required for private equity can vary, but it’s not uncommon for investors to need $100,000 or more to get started. In some instances, private equity investment minimums may surpass $1 million, $5 million, or even $10 million.

Can anyone invest in private credit or private equity?

Typically, no. Private credit and private equity investments most often involve accredited investors or legal entities, such as a family office. It’s possible to find private credit and private equity investments for retail investors, however, you may need to meet the SEC’s definition of accredited to be eligible.


About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.



Photo credit: iStock/shapecharge

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.


An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

SOIN0124120

Read more
What Are Over-the-Counter (OTC) Stocks?

What Are Over-the-Counter (OTC) Stocks?

Over-the-counter (OTC) stocks are not traded on a public exchange like the New York Stock Exchange (NYSE) or Nasdaq. Instead, these stocks are traded through a broker-dealer network. Additionally, the over-the-counter market can also include other types of securities. The Financial Industry Regulatory Authority regulates broker-dealers that engage in OTC trading.

For investors, it can be important to understand the meaning of OTC stocks, and where these securities might fit into your portfolio before trading them.

What Are OTC Stocks?

As mentioned, an OTC stock is one that trades outside of a traditional public stock exchange. As such, in order to grasp OTC stock trading and how it works, it helps to have a clear understanding of public stock exchanges.

A stock exchange — like NYSE or Nasdaq — is a regulated environment in which buyers and sellers can trade shares of publicly listed companies. Before a stock can be listed on an exchange for public trading, it first has to meet the guidelines established by that exchange (for example, a company that wants to be listed on the Nasdaq must meet the Nasdaq listing requirements).

Companies may opt to trade shares in the over-the-counter market (meaning, they trade through a broker-dealer) if they’re unable to meet the listing requirements of a public exchange. OTC trading may also appeal to companies that were previously traded on an exchange but have since been delisted.

Also, stocks that are traded on an exchange are called “listed stocks,” while those that trade OTC are often called “unlisted stocks.”

💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

How to Buy OTC Stocks

Investors interested in purchasing OTC stocks may not need to change their investing strategy much, because depending on the exchange or platform they use to buy listed investments, they may be able to buy OTC stocks in much the same way.

Again, this will largely depend on the platform being used, but many — but not all — exchanges or platforms allow investors to trade OTC stocks. This can be done by searching for the OTC stock on the platform and placing an order. Investors may need to know the specific stock ticker they’re looking for, however, so there may be a bit of initial homework involved.

Types of OTC Securities

OTC trading tends to focus on equities, i.e. stocks. In fact, it’s even common to see penny stocks being traded over the counter, or used as a common example of an OTC security. But stocks don’t make up the entirety of OTC trading activity. Other types of investments that can be traded OTC include:

•   Derivatives

•   Corporate bonds

•   Government securities

•   Foreign currency (forex)

•   Commodities

Altogether, there are thousands of securities that trade over the market. These can include small and micro-cap companies, large-cap American Depositary Receipts (ADRs), and foreign ordinaries (international stocks that are not available on U.S. exchanges). Companies that trade over the counter may report to the SEC, though not all of them do.

Types of OTC Markets

In the U.S., the majority of over-the-counter trading takes place on networks operated by OTC Markets Group. This company runs the largest OTC trading marketplace and quote system in the country (the other main one is the OTC Bulletin Board, or OTCBB). While companies that trade their stocks on major exchanges must formally apply and meet listing standards, companies quoted on the OTCBB or OTC Markets do not have to apply for listing or meet any minimum financial standards.

OTC Markets Group organizes OTC stocks and securities into three distinct markets:

•   OTCQX

•   OTCQB

•   Pink Sheets

OTCQX

OTCQX is the first and highest tier, and is reserved for companies that provide the most detail to OTC Markets Group for listing. Companies listed here must be up-to-date with regard to regulatory disclosure requirements and maintain accurate financial records.

Penny stocks, shell corporations, and companies that are engaged in a bankruptcy filing are excluded from this grouping. It’s common to find stocks from foreign companies (e.g. foreign ordinaries) listed here.

OTCQB

The middle tier is designed for companies that are still in the early to middle stages of growth and development. These companies must have audited financials and meet a minimum bid price of $0.01. They must also be up-to-date on current regulatory reporting requirements, and not be in bankruptcy.

Pink Sheets

The Pink Sheets or Pink Open Market has no minimum financial standard that companies are required to meet, nor do they have reporting or SEC registration requirements. These are only required if the company is listed on a Qualified Foreign Exchange.

Be forewarned: OTC Markets Group specifies that the Pink Market is designed for professional and sophisticated investors who have a high risk tolerance for trading companies about which little information is available.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

Pros and Cons of OTC Trading

Investing can be risky in general, but the risks may be heightened with trading OTC stocks. But trading higher risk stocks could result in bigger rewards if they’re able to produce above-average returns.

When considering OTC stocks, it’s important to understand how the positives and potential negatives may balance out — if at all. It’s also helpful to consider your personal risk tolerance and investment goals to determine whether it makes sense to join the over-the-counter market.

Trading OTC Stocks: Pros and Cons

OTC Stock Trading Pros OTC Stock Trading Cons
Over-the-counter trading may be suitable for investors who are interested in early stage companies that have yet to go public via an IPO. Micro-cap stocks and nano-cap stocks that trade over the counter may lack a demonstrated track record of positive performance.
Investing in penny stocks can allow you to take larger positions in companies. Taking a larger position in a penny stock could amplify losses if its price declines.
May appeal to active traders who are more interested in current pricing trends than fundamentals. Limited information can make it difficult to assess a company’s financials and accurately estimate its value.
Trading cryptocurrency on an OTC exchange could help minimize hacking or security risks. OTC securities are subject to less regulation than stocks listed on a public exchange, which may increase the possibility of fraudulent activity.
OTC trading makes it possible to invest in foreign companies or companies that may be excluded from being listed on a public exchange. OTC stocks may be more illiquid than stocks traded on a public exchange, making it more difficult to change your position.

The Takeaway

OTC stocks are those that trade outside of traditional exchanges. Since OTC stocks trade outside of traditional exchanges like the NYSE or Nasdaq, the OTC market gives you access to different types of securities, including penny stocks, international stocks, derivatives, corporate bonds, and even cryptocurrency.

If you’re interested in OTC trading, the first step is to consider how much risk you’re willing to take on and how much money you’re willing to invest. Having a baseline for both can help you to manage risk and minimize your potential for losses.

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

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

FAQ

How do OTC stocks differ from stocks listed on major exchanges?

The primary difference between OTC stocks and stocks listed on major exchanges is exactly that: OTC stocks aren’t not listed on major U.S. stock exchanges. They can still be traded, however, but how they’re listed (or not listed) is the primary differentiator.

How can I buy or sell OTC stocks?

Many investors can use their preferred brokerage or platform to buy and sell OTC stocks. Not all brokerages or investment platforms allow investors to do so, but many do, and trading them often involves searching for the appropriate ticker and executing a trade.

Are there any specific regulations or reporting requirements for OTC stocks?

There are reporting standards for OTC stocks, but those standards are not as stringent as listed stocks. Depending on the OTC market on which an OTC stock trades, more or less reporting may be required.

What are the main factors to consider when researching OTC stocks?

Investors should consider many factors in the OTC market, but among them are volatility, liquidity and trading volume, and applicable regulations. These three factors may have the biggest impact on how an OTC stock performs going forward, though that’s not guaranteed.

Are there any restrictions or limitations on trading OTC stocks?

Not really, other than an exchange, brokerage, or platform perhaps not allowing users or investors to trade OTC stocks or securities. In that case, investors can look for another platform on which to execute trades that does allow OTC trading.


About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.



Photo credit: iStock/JohnnyGreig

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0723106

Read more
NPV Formula: How to Calculate Net Present Value

Net Present Value: How to Calculate NPV

Net present value or NPV represents the difference between the present value of cash inflows and outflows over a set period of time. Knowing how to calculate NPV can be useful when trying to determine whether an investment — either business or personal — will eventually pay off.

In capital budgeting, calculating the net present value can help with estimating the profitability of an investment or expansion project. Meanwhile, investors use the net present value calculation to gauge an investment’s potential rate of return based on the present value of its future cash flows and a discount rate, based on the cost of borrowing or financing.

Key Points

•   Net Present Value (NPV) measures the difference between the present value of cash inflows and outflows over time.

•   Calculating NPV helps determine the profitability of investments or projects by considering future cash flows and a discount rate.

•   The NPV formula incorporates the time value of money, emphasizing that money now is worth more than the same amount in the future.

•   A positive NPV indicates that the earnings from an investment are expected to exceed the cost.

•   NPV is used in capital budgeting to assess the return on project investments before committing funds.

What Is Net Present Value (NPV)?

Net present value is a measure of the value of all future cash flows over the life of an investment, discounted to the present after factoring in inflows, outflows, and inflation, which can erode the value of money over time.

When applying the net present value formula, you’re looking at whether revenues are greater than costs or vice versa to determine whether an investment or project is likely to yield a gain or a loss.

As mentioned, net present value is often used in capital budgeting. Businesses and governments can use capital budgeting methods to determine how much of a return they’re likely to see on a project before funding it. The NPV formula takes into account the time value of money, a concept which suggests that a sum of money received now is worth more than that same sum received at a future date.

How to Calculate NPV

Calculating net present value is a fairly simple operation.

If you want to calculate net present value using the NPV formula, you’d first need to know the expected positive and negative cash flows for an investment or project. You’d also need to know the discount rate. From there, you could complete your calculations in this order:

•   List future cash flows for each year you expect to receive them.

•   Calculate the present value for each cash flow.

•   Add all present values for future cash flows together.

•   Subtract cash outflows from the present value sum of future cash flows.

You’ll need to know the present value calculation to complete the second step.

NPV Formula

Here’s what the NPV formula looks like:

PV = FV/(1 + k)N

In this formula, k is the discount rate and n is the number of time periods.

Again, net present value calculations follow a distinct formula. A positive NPV means earnings from the investment should outpace the cost. Negative NPV, on the other hand, means you’re more likely to lose money on the investment.

The application of the formula depends on the number of expected cash flows for an investment or project.

Example of NPV with a Single Cash Flow Investment

If you’re evaluating potential investments with a single cash flow, then you could use this formula to calculate NPV:

NPV = Cash flow / (1 + i)t – initial investment

In this formula, i represents the required return or discount rate for the investment while t equals the number of time periods involved. The discount rate is an interest rate used to discount future cash flows for a financial instrument.

Weighted average cost of capital (WACC) usually serves as the discount rate for calculating NPV. The WACC measures a company’s cost of borrowing or financing.

Example of NPV with Multiple Cash Flows

If you’re evaluating projects or potential investments with multiple cash flows, you’ll use a different net present value formula. Here’s what the NPV formula looks like in that scenario:

NPV = Today’s value of expected cash flows – Today’s value of invested cash

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

Tools to Help Calculate NPV

If you want to simplify your calculations you could look for an online net present value calculator. Or you could use the NPV function in spreadsheet software, such as Microsoft Excel or something similar. The NPV function helps calculate net present value for an investment based on the discount rate and a series of future cash flows, both positive and negative.

To use this function, you’d simply create a new Excel spreadsheet, then navigate to the “Formulas” tab. Here, you’d choose “Financial”, then from the dropdown menu select “NPV”. This will bring up the function where you can enter the rate and each value you want to calculate.

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.


*Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

What Does NPV Show You?

The NPV formula should tell you at a glance whether you’re likely to make money from an investment, lose money or break-even. This can help when comparing multiple investments to decide where to put your money when you have a limited amount of capital to work with.

It works the same way in capital budgeting. Say a fast-food chain is trying to decide whether to expand into a new market which entails opening up 10 more locations. They could calculate the net present value for each location, based on expected cash flows, to determine whether moving ahead with the project is a financially sound business decision.

What Is a Good NPV?

Generally speaking, a net present value greater than zero is good. This means that the investment or expansion project is likely to yield a gain. When the net present value is below zero, you have negative NPV which means the project or investment is likely to result in a loss.

The higher the number produced by a net present value calculation, the better. But it’s important to remember that the results produced by applying the NPV formula are only as reliable as the data points used in the calculation.

Inaccurate cash flow projections could result in skewed numbers which may produce a net present value estimate that’s above or below the actual returns you’re likely to realize.

Comparing NPV

Here are some ways that NPV stacks up to other types of calculations.

NPV vs Present Value

NPV and present value may sound similar but they measure different things. Present value or PV is the present value of all future cash inflows over a set period of time. Companies use this calculation to estimate values for future revenues or liabilities. When you calculate present value, you’re trying to measure the value of future cash flows today.

Net present value, on the other hand, is the sum of the present values for both cash inflows and cash outflows. With the NPV formula, you’re trying to determine how profitable an investment might be, based on the initial investment required and expected rate of return.

NPV vs IRR

Analysts use IRR or internal rate of return to evaluate proposed capital expenditures. The IRR calculation determines the percentage rate of return at which a project’s cash flows result in a net present value of zero. Like NPV, internal rate of return is also a part of capital budgeting.

Both NPV and IRR measure potential profitability but in different ways. When calculating the net present value of an investment, you’re estimating returns in dollars. With an internal rate of return, you’re estimating the percentage return an investment or project should generate.

Depending on whether you’re trying to target a specific dollar amount or percentage amount for returns, you may apply one or both formulas when evaluating an investment.

NPV vs ROI

Net present value measures expected cash flows for potential investments. You’re looking at future discounted cash flows to determine whether an investment makes sense financially.

Return on investment, or ROI, measures the efficiency of an investment, in terms of the rate of return that the investment is likely to produce. With ROI, you’re looking at the cash flows you’re likely to gain from an investment. To find ROI, you’d add up the total revenues less the total costs involved, then divide that figure by the total costs.

NPV vs Payback Period

The payback period is the period of time required for a return on investment to equal the initial investment. Payback period calculations don’t account for the time value of money. Instead, they look at how long it will take for you to realize a return from an investment that’s equal to the dollar amount that you invested.

Calculating the payback period helps determine how long to hold onto an investment. You might use this method if you’re trying to compare multiple investments to see which one is a better fit for your personal investing timeline. But if you want to get a sense of the total return you’re likely to realize, then you’d still want to apply the net present value formula.

Benefits and Drawbacks of NPV

Net present value can help analyze and evaluate business projects or personal investments. You can easily see at a glance what you could stand to gain — or lose — from making a particular investment. But the NPV formula does have some limitations that are important to be aware of.

Benefits of NPV

Net present value’s main advantage is that it takes the time value of money into consideration. By looking at discounted cash flows you can get a better understanding of the viability of an investment, based on what you’ll get out of it versus what you’ll put in.

This can help with decision-making when choosing investments for your portfolio or making strategic capital investments in a business. Net present value calculations can also help companies with projecting future value based on the investments they make today.

Drawbacks of NPV

The biggest disadvantage or flow associated with net present value is that results depend on the quality of the information that’s being used. If your projections for future cash flows are off, that can produce inaccurate results when using the net present value formula.

NPV can also overlook some hidden costs involved in an investment or project which may detract from total returns. It also doesn’t take into account the margin of safety, or the difference between an investment’s price and its value.

Finally, it’s difficult to use net present value to evaluate projects or investments that are different in size or nature, as the input values are likely to be very different.

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

How Investors Can Use NPV

You can use NPV to evaluate stocks and other securities, including alternative investments, based on your time frame and projected profits. With stocks, for example, net present value can give you an idea of whether a company is a good buy or not by calculating NPV per share.

To do that, you’d divide the company’s net present value by the number of outstanding shares in the company to get this number. If the net value per share is higher than the stock’s current market price, then the stock could be considered a good buy. On the other hand, if the net value per share is below the stock’s current market price that suggests you might lose money if you decide to buy in.

The Takeaway

As discussed, Net present value, or NPV, represents the difference between the present value of cash inflows and outflows over a set period of time. Understanding the net present value formula can help with making smarter investment decisions.

As with any tool, most investors use NPV along with other financial ratios and forms of analysis before deciding whether to purchase any asset. If you have questions about how NPV can be used as a part of an investment strategy, it may be worthwhile to consult with a financial professional.

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

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

FAQ

Is a higher NPV better?

A higher NPV isn’t necessarily a good thing or means that an investment is better than another investment. But in general, a good NPV is a number that’s higher than zero.

What is the basic NPV investment rule?

The basic NPV investment rule is that projects or investments should only be pursued if they’ll lead to gains or productive gains.

Is NPV the same as profit?

NPV is not the same thing as profit, although a positive NPV is indicative of profit, while negative NPV is related to a loss.

Is a NPV of 0 acceptable?

An NPV of zero means that a project or investment isn’t expected to produce significant gains or losses. Whether that’s acceptable or not is up to the individual making the investment decision.

When should NPV not be used?

NPV might not be helpful or useful for comparing investments of drastically different sizes, or projects of different sizes.

Is Excel NPV accurate?

Excel’s NPV calculations should be accurate, but they’re only as accurate as the data that’s entered to make the calculation. So, it could be inaccurate, and it’s a good idea to double-check the calculation.


About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.



Photo credit: iStock/Sanja Radin

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.
Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0124031

Read more
woman on laptop

Guide to Morningstar Ratings

Morningstar is a highly regarded financial services firm whose mission revolves around providing investors with the research and tools, including Morningstar ratings, they need to make informed decisions in their portfolios.

Those tools, used by individual investors as well as institutional investors and financial advisors, include Morningstar fund ratings, which can help investors gauge how well various mutual funds and exchange-traded funds (ETFs) have performed over time.

What are Morningstar Ratings?

In simple terms, the Morningstar ratings system is a tool investors can use to compare financial securities such as mutual funds and ETFs. And if you’re wondering whether Morningstar ratings are legitimate, the answer is yes. Even FINRA, the Financial Industry Regulatory Authority, uses Morningstar ratings.

Morningstar reviews of mutual funds and ETFs reflect different metrics, depending on which ratings system is being applied. The main Morningstar ratings investors may turn to learn more about a particular investment are the Star Ratings and Analyst Ratings. (Morningstar also has a separate ratings system for individual stocks.)

These ratings can be helpful to investors for a variety of reasons — whether they’re trying to diversify their portfolio, or some research into socially responsible investing, and trying to find securities that fit their strategy.

Recommended: ETFs vs Mutual Funds: Learning the Difference

How Morningstar Ratings Work

As Morningstar itself describes, the ratings system uses a methodology based on specific categories and risk-adjusted return measures. The company will only rate a fund that’s been around for more than three years. Morningstar also updates its ratings on a monthly basis.

You can use these ratings to select from the funds available in your 401(k), or to decide which funds to add to an IRA or a taxable brokerage account.

Recommended: Investing in Growth Funds

The “Star Rating” Explained

The Morningstar Star Rating system, more simply referred to as star rating, is a quantitative ranking of mutual funds and ETFs. Introduced in 1985, the star rating looks backward at a fund’s past performance, then assigns a rating from one to five stars based on that performance.

As mentioned, Morningstar reviews ETFs and mutual funds with a record of more than three years, so newer funds do not receive a star rating until they’re reached this milestone. The rating methodology utilizes an enhanced Morningstar risk-adjusted return measure. Specifically, the star ratings system looks at each fund’s three-, five-, and 10-year risk-adjusted returns.

Star ratings can serve as a report card of sorts for comparing different funds, based on how they’ve performed historically. The Morningstar ratings are not forward-looking, as past performance is not a foolproof indicator of future behavior. But investors can use the ratings system as a starting off point for conducting fund research when deciding where to invest.

If you’re looking for a tool to help you compare mutual funds or exchange-traded funds at a glance based on past performance, the star rating system can help.

The “Analyst Rating” Explained

The Morningstar Analyst Rating takes a different approach to ranking funds and ETFs. Instead of looking backward, the qualitative analyst rating looks forward to assess a fund’s ability to outperform similar funds or a market benchmark. Rather than using stars, funds receive a rating of Gold, Silver, Bronze, Neutral or Negative, based on the analyst’s outlook for performance.

The firm does not update analyst ratings as frequently as star ratings. Morningstar reviews for analyst ratings are reevaluated at least every 14 months. The firm typically assigns analyst ratings to funds with the most interest from investors or the most assets.

When ranking funds, analysts look at three specific metrics:

•   People

•   Process

•   Parent

Performance is also taken into account within the People and Process pillars. In order to earn a Gold, Silver or Bronze rating, an analyst must determine that an active fund can beat its underlying benchmark when adjusted for risk.

Generally speaking, these Morningstar reviews go into more detail, in terms of the analysis, ranking, and comparison of funds. If you’re an active trader or a buy-and-hold investor you might use the Morningstar analyst ratings to get a feel for what a particular mutual fund might do next, which can be helpful when an investor is, for example, trying to pick an ETF.

How Morningstar Measures Volatility

Morningstar uses a few key volatility measurements as it aims to minimize risk and maximize returns through strategic diversification. Chief among those measurements are standard deviation, mean, and the Sharpe ratio.
It’s a somewhat complicated process, but using these three measurements in tandem helps Morningstar get a handle on volatility and make appropriate ratings decisions.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

Example of a Morningstar Rating

Morningstar star ratings are free to access for investors on the company’s website, and it’s relatively easy to find plenty of examples of Morningstar ratings on the platform. For instance, to find a star rating for a particular fund or ETF you’d simply search for it using its name or ticker symbol. You can also view Morningstar ratings and picks for funds by category, such as small-cap funds or U.S. index funds.

Here’s an example of a Morningstar rating for the Calvert International Responsible Idx I fund (CDHIX). This fund, which is in the foreign large-blend category and is an index fund, has a four-star rating from Morningstar. You can see at a glance that the fund has an expense ratio of 0.29%, a minimum investment of $100,000 and just over $867 million in assets, as of August 2023.

Are Morningstar Ratings Accurate?

Morningstar fund ratings are designed to be a guide to use as you invest, rather than the absolute word on how well a fund is likely to perform. That’s to say that there’s always going to be risk involved when investing, so don’t expect any rating to be a sure-thing.

So, how well do Morningstar ratings perform over time and are they an accurate guide for investing?

According to Morningstar’s own analysis of its ratings system, the star ratings can be a useful jumping-off point for investors. That analysis resulted in three key findings:

•   Funds with higher star ratings tend to have lower expense ratios and be cheaper for investors to own

•   Higher rated funds tend to be less volatile and experience less dramatic downward swings when the market is in flux

•   Funds that received higher star ratings tended to produce higher returns for investors compared to funds with lower ratings

The analysis didn’t look specifically at how star ratings and fund performance aligned through different bull and bear markets. But the ultimate conclusion Morningstar drew is that the Star Ratings tend to steer investors toward cheaper funds that are easier to own and stand a better chance of outperforming the market.

Use Expense Ratios

According to Morningstar, fees are one of the best predictors of future performance, at least for Star Ratings. For funds and ETFs, that means it’s important to consider the expense ratio, which represents the cost of owning a fund annually, calculated as a percentage of fund assets.

Actively managed funds typically carry higher expense ratios, as they require a fund manager to play an important role in selecting fund assets. Passively managed funds and ETFs, on the other hand, often have lower expense ratios.

So which one is better? The answer is that it all comes down to performance and returns over time. A fund with a higher expense ratio is not guaranteed to produce a level of returns that justify higher fees. Likewise, a fund that has a lower expense ratio doesn’t necessarily mean that it’s a poor investment just because it’s cheaper to own. Morningstar’s research found that the average one-star fund cost significantly more than the average five-star fund.

As you do your own research in comparing funds and ETFs, consider both performance and cost. This can help you find the right balance when weighing returns against fees.

How Should Investors Use Morningstar Ratings?

How much do Morningstar ratings matter in the grand scheme of things? The answer is, it depends on what you need from investment research tools.

Morningstar reviews of mutual funds and ETFs can be helpful for comparing investments, especially if you’re just getting started with the markets. Morningstar is a respected and trusted institution and both the Star and Analyst Ratings are calculated using a systematic approach. The reviews aren’t just thrown together or based on a best guess.

They’re designed to be a guide and not a substitute for professional financial advice. So, for instance, you may use them to compare two index funds that track the same or a similar benchmark. Or you may use them to compare two ETFs that are representative of the same market sector.

Risks of Morningstar Ratings

Morningstar Ratings are not an absolute predictor of how a mutual fund or ETF will perform in the next five minutes, five days, or five years. After all, there’s no way to perfectly predict how any investment will perform as the market changes day to day or even minute-to-minute.

One risk to avoid with Morningstar ratings is relying on them solely as your only research tool and not doing your own independent research. Again, that means checking expense ratios as well as looking at the underlying assets of a particular fund and its investment strategy (i.e. active vs. passive) to determine how well it aligns with your goals and risk tolerance.

Looking only at Morningstar reviews without doing your own due diligence could cause you to invest in funds that aren’t the best fit for your portfolio. Or you may overestimate how well a fund will perform, only to be disappointed later. For those reasons, it’s important to look under the hood, so to speak, to ensure that you fully understand what you’re investing in before buying in.

Morningstar Ratings for Funds

As discussed, Morningstar’s rating system mostly focuses on funds, including index funds, mutual funds, and ETFs. The company also has a ratings system for individual stocks, but its bread and butter is its focus on funds. And, as a quick refresher, it uses a data-driven, quantitative methodology for determining those rankings.

Also, as it bears repeating, a good Morningstar rating does not mean that an investment is risk-free.

Other Investment Risk Rating Providers

Morningstar is just one of many companies that offers investment ratings. An internet search will likely yield many results. But it’s a list that includes many familiar names, such as Bloomberg, Nasdaq Market Data Feeds, S&P Global Market Intelligence, MarketWatch, Thomson Reuters, and others.

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Trading Stocks With SoFi

Having research tools can help you make educated decisions about where and how to invest. Morningstar Ratings are one tool you can use. When you’re ready to invest and apply the knowledge you’ve acquired, the next step is opening an online brokerage account. But keep in mind that there are many ratings services on the market, and that Morningstar’s ratings are far from the only research tool out there.

It’s also important for investors to keep in mind that all investments involve risk, whether they’re highly-rated or not. Be sure to do your due diligence before investing, but know there’s always a chance that things could turn sour on you.

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

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

FAQ

How reliable are Morningstar ratings?

Morningstar ratings are generally considered to be high-quality in the financial industry, but that doesn’t mean that its ratings are always spot-on. All investing involves risk, and even a high rating doesn’t guarantee that an investment will pan out.

Is a Morningstar rating of “5” good?

Morningstar uses a scale of one to five “stars” to rate investments, with five stars being the highest, or best-quality investment. So, yes, a five-star rating is generally considered good, although not risk-free.


About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.



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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0723095

Read more
TLS 1.2 Encrypted
Equal Housing Lender