May
18
2024
What Is Market Value? How to Calculate and Use It

Market Value: Definition and Methods to Calculate It

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Market Value: Definition and Methods to Calculate It

Market value is a common term used in value investing to describe how much a company or asset is worth on exchanges and financial markets. Essentially it is the value of a security in the eyes of market investors. Understanding the current standing of a business in its particular industry and the broader market is important when making investing decisions.

Key Points

•   Market value is the price at which an asset would trade in a competitive auction setting.

•   It is determined by multiplying the current share price by the number of outstanding shares.

•   Factors influencing market value include company performance, industry trends, and overall market conditions.

•   Market value can fluctuate greatly over time due to changes in investor sentiment and market dynamics.

•   Various methods to calculate market value include income approaches, asset-based approaches, and market comparison approaches.

What Is Market Value?

Market value, also referred to as OMV, market capitalization, or “open market valuation,” is the price of an asset in an investment marketplace or the value the asset has within a community of investors. It is calculated by multiplying current share price in a marketplace by the number of outstanding shares. Read on to learn what market value is and how to calculate market value.

The market value represents the price that investors will pay for an asset, and therefore changes significantly over time. The more investors will pay for the asset, the higher the market value.

What investors are willing to pay depends on various factors, including the fundamentals of the asset itself, as well as the business cycle and current levels of demand for that asset. Market value could be anything from under $1 million for small businesses to more than $1 trillion for large corporations.

It’s easy to determine the market value of frequently traded assets (by looking at their current prices), but harder to determine the market value of illiquid assets, such as real estate or a company, that don’t trade very often. Market value per share is a company’s market value divided by its number of shares.

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Factors that Impact Market Value

Many factors determine market value, including a company’s profitability and its debt levels. Market value fluctuates significantly over time. Market values often move in tandem with the overall market sentiment.

During bull markets or economic expansions, market values often increase, and during bear markets they go down. Other factors influencing market value include:

•   The company’s performance

•   Long-term growth potential

•   Supply and demand of the asset

•   Company profitability

•   Company debt

•   Overall market trends

•   Industry trends

•   Valuation ratios such as earnings per share, book value per share, and price-to-earnings ratio (P/E ratio)

Earnings per Share

The higher a company’s earnings per share, the more profitable it is. A more profitable business has a higher market value, and vice versa.

Book Value per Share

Investors calculate a company’s book value per share by dividing its equity by its total outstanding shares. A company with a higher book value than market value may have an undervalued stock.

Price-to-Earnings Ratio (P/E Ratio)

Investors calculate P/E ratio by dividing a company’s current stock price by its earnings per share amount. A higher P/E ratio means a stock’s price market value might be high relative to its earnings.

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How Is Market Value Calculated?

There are multiple ways to calculate market value. Here’s a look at a few of them:

Income method

There are two methods of calculating market value using income:

•   Discounted Cash Flow (DCF): To find discounted cash flow, investors project a company’s future cash flow and then discount it to find its present value. The amount it gets discounted reflects current market interest rates along with the amount of risk the business has.

•   Capitalized Earnings Method: With capitalized earnings, investors find the value of a stable, income-producing property by taking its net operating income over time and dividing it by the capitalization rate. The capitalization rate is an estimate of how much potential return on investment the asset has.

Assets Method

Using the assets approach, investors find an asset’s fair market value (FMV) by determining how many liabilities and adjusted assets a company has, including intangible assets, unrecorded liabilities, and off-balance sheet assets.

Market method

Using a market-based approach, there are a few more ways market value can be determined:

•   Public Company Comparable: This company compares similar businesses that are in the same industry or region and about the same size. Ratios like P/E, EV/Revenue, and EV/EBITDA can help compare all the similar companies.

•   Precedent Transactions: Using the precedent transactions method, market value reflects how much investors paid for other similar company’s stock in previous transactions. Investors can get a sense of how much a company’s value is by looking at similar companies.

Example of Market Value

Using the capitalized earnings valuation method, here’s an example of the market value calculation. The formula used when calculating via capitalized earnings is as such:

Market value = Earnings/capitalization rate

Earnings are rather self-explanatory, and the capitalization rate is the required rate of return for investors, a number reached by subtracting a company’s expected growth rate from the investor’s expected rate of return. For this example, we’ll make things simple and say that the capitalization rate is 10%, and the company’s earnings are $1 million

Using the formula: Market value = $1 million/10%

That calculates to $10,000,000.

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Limitations of Market Value

Market value is a very useful tool for understanding how much a company is worth and whether it is a good time to invest or sell its stock. However, it has a few limitations:

•   Fluctuation: Company stocks go up and down every day, and, therefore market value also always changes. Various factors affect market value, and it is very dynamic, which is important for investors to keep in mind when making trading decisions.

•   Precedent data: It’s easier to find market value for established businesses because it requires historical pricing data to find it. New businesses don’t have such data, making it harder for investors to determine their market value.

The Takeaway

Market value is very useful for analyzing a stock. It is easiest to calculate market value of assets such as stocks and futures that are traded on exchanges because it is easy to access their market prices. Market value for less frequently traded assets can be difficult and requires some assumptions and calculations.

Calculating market value can be useful for investors of all stripes, but it can be easy to get lost in the math. Be sure to double-check your math and consider the limitations of market value before making investing decisions.

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FAQ

Is market value the same as market capitalization?

Market value is the price at which a buyer purchases an asset, and can refer to a company or a security such as a stock, future, or asset. Market cap is the value of the total number of outstanding shares of a company, based on their current market value.

Is market value the same as book value?

Market value and book value per share, or explicit value, are different and can be very different amounts, but they are often used in conjunction by investors looking to gain an understanding of an asset’s value. Book value is the net value of a company’s balance sheet assets, while market value is the price at which a buyer purchases an asset.

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SoFi Invest®

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

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

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

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

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May
18
2024

What Is an Interval Fund?

By | invest, Investing, Terminology | Comments Off on What Is an Interval Fund?

Interval funds are closed-end mutual funds that don’t trade publicly on an exchange. These funds are so named because they offer to repurchase a percentage of outstanding shares at periodic intervals.

Investing in interval funds can be attractive since they have the potential to generate higher yields. However, they’re less liquid than other types of funds, owing to the restrictions around when and how you can sell your shares.

Key Points

•   Interval funds are closed-end mutual funds that offer to repurchase a percentage of outstanding shares at periodic intervals.

•   Investing in interval funds can generate higher yields but they are less liquid compared to other funds.

•   Interval funds make periodic repurchase offers to shareholders based on a schedule set in the fund’s prospectus.

•   Interval funds may hold a variety of underlying investments such as private credit, real estate, private equity, venture capital, and infrastructure.

•   Interval funds differ from closed-end funds and mutual funds in terms of trading on an exchange, initial public offering, and liquidity.

How Do Interval Funds Work?

Interval funds are alternative investments that work by making periodic repurchase offers to shareholders according to a schedule set in the fund’s prospectus.

Shareholders are not obligated to accept the offer but if they do, they receive a share price that’s based on net asset value (NAV). Repurchase intervals may occur quarterly, biannually, or annually.

These funds typically rely on an active management strategy, which is designed to produce returns that outpace the market. But because of the types of investments held by interval funds, as well as the fund’s structure, the trade-offs are potentially higher risk and far less liquidity.

💡 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.

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

What Types of Assets Do Interval Funds Hold?

Interval funds may hold a variety of underlying investments that are different from what traditional funds may invest in, which is partly why interval funds are considered a form of alternative investing. An interval fund’s prospectus should include a detailed account of its underlying assets to help investors better understand what they’re investing in.

Recommended: Alternative Investment Guide

Private Credit

Private credit refers to lending that occurs outside the scope of traditional banking. Rather than going through a bank for a loan, businesses gain access to the capital they need through private lending arrangements.

Also referred to as direct lending or private debt, private credit helps to fill a void for businesses that have been unable to secure traditional financing. Private credit can also offer investors an opportunity, as private credit generates returns for investors in the form of interest on the loans.

Real Estate

Real estate can be an attractive investment for investors who are seeking an inflationary hedge with low correlation to the stock market. Interval funds may invest in private real estate investment trusts (REITs), private real estate funds, commercial properties, and land. Some real estate interval funds focus on real estate debt investments.

Private Equity

Private equity refers to investments in companies that are not publicly traded on an exchange. Private equity funds pool capital from multiple investors to purchase companies, overhaul them, and sell them at a profit. This type of investment can prove risky, as there are no guarantees that the company’s value will increase but if it does, the rewards for investors can be great.

Venture Capital

Venture capital is a form of private equity in which investors provide funding to startups and early-stage businesses. In exchange, investors receive an equity stake in the company. Venture capitalists have an opportunity to make their money back once the company goes public by selling their shares.

Infrastructure

Infrastructure interval funds invest in the mechanisms, services, and systems that make everyday life possible. Investments are focused on:

•   Transportation

•   Energy and utilities

•   Housing

•   Healthcare

•   Communications

These types of investments can be attractive as they tend to produce stable cash flow since a significant part of the population relies on them.

How Does the Repurchase Process Work?

An interval fund makes repurchase offers according to the schedule set in the prospectus. Shareholders should be given advance notice of upcoming repurchase offers and the date by which they should accept the offer if they prefer to do so. The fund should also specify the date at which the repurchase will occur.

In terms of the timing, it may look something like this:

•   Once shareholders are notified of an upcoming repurchase offer, they have three to six weeks to respond.

•   After the acceptance deadline passes, there may be a two-week waiting period for the repurchase to occur.

•   Investors who accepted the repurchase offer may have up to a one-week wait to receive proceeds owed to them.

The price shareholders receive is based on the per share NAV at a set date. A typical repurchase offer is 5% to 25% of fund assets. interval funds may collect a redemption fee of up to 2% of repurchase proceedings. This fee is paid to the fund to cover any expenses related to the repurchase.

What’s the Difference Between an Interval Fund and a Closed-End Fund?

Closed-end funds issue a fixed number of shares, with no new shares issued later (even to keep up with demand from investors). An interval fund is categorized as a closed-end fund legally. However, interval funds don’t behave the same way as other closed-end funds. Specifically:

•   There’s typically no initial public offering (IPO)

•   Interval funds do not trade on an exchange

•   Investors can purchase shares at any time

The third point makes interval funds more like open-end funds, but there’s a key difference there as well. Interval funds can hold a much higher percentage of assets in illiquid investments than open-end funds.

What’s the Difference Between an Interval Fund and a Mutual Fund?

Interval funds are different from traditional mutual funds, which are also a type of pooled investment. With a mutual fund, investors can buy shares to gain exposure to a wide variety of underlying assets. The fund may pay out dividends to investors or offer the benefit of long-term capital appreciation.

Investors can buy mutual fund shares at any time, but unlike an interval fund, these shares trade on a stock exchange. The fund’s share price is set at the end of the trading day. Mutual funds can offer greater liquidity to investors since you can buy shares one day and sell them the next day or even the same day.

Interval funds don’t offer that benefit as you must wait until the next repurchase date to sell your shares. An interval fund may also be more expensive to own compared to a mutual fund, as there are often additional costs that apply.

Investor Considerations

If you’re interested in alternative investments and you’re considering interval funds, there are some important things to keep in mind.

•   What is the minimum investment required and can you meet it?

•   How does your risk tolerance align with the risk profile of the fund you’re weighing?

•   What is the schedule for repurchase offers and how does that align with your liquidity needs?

•   How much will you pay to invest in the fund?

•   What is your target range for returns?

Due to their illiquid nature, it may not make sense for the average investor to tie up a large part of their portfolio in interval funds. It’s also important to keep in mind that the minimum investment may be in the five-figure range, which is often well above the minimum needed to trade mutual fund shares.

💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Potential Upside

The potential upside of interval funds is the possibility of earning returns that beat the average return of the stock market. Depending on the fund’s strategy and underlying investments, it’s possible to realize returns that are substantially higher than what you might get with a traditional open-end mutual fund.

Interval funds can add diversification to a portfolio and give you access to illiquid investments that might otherwise be closed off to you. While there are risks involved, interval funds may be less susceptible to market volatility as they have a lower correlation to stocks overall.

Although lack of liquidity may be problematic for some investors, it can benefit others who may be tempted to give in to investing biases. Since you can’t easily sell your shares, interval funds can prevent you from making panic-driven decisions with this segment of your portfolio.

Recommended: Why Portfolio Diversification Matters

Possible Risks

Much of the risk associated with interval funds lies in their underlying investments. If a fund is investing in private credit or venture capital, for example, and the companies the fund backs fail to become profitable, that can directly impact the returns you realize as an investor.

As mentioned, liquidity risk can also be an issue for investors who don’t want to feel locked into their investments. Even if you’re comfortable with only being able to redeem shares at certain times, there’s always market risk which could negatively affect the NAV share price you’re offered.

The Takeaway

Interval funds can be rewarding to investors, but they’re more complex than other types of mutual funds or exchange-traded funds. Weighing the pros and cons is an important step in deciding whether to invest. You may also consider talking it over with a financial advisor before adding interval funds to your portfolio.

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).


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

FAQ

Are interval funds a good investment?

Interval funds may be a good investment for investors who are comfortable with higher risk exposure given the potential to earn higher rewards. The complexity of these alternative investments may make them less suitable for individuals who are just getting started with building a portfolio.

What’s the difference between an interval fund and an ETF?

An exchange-traded fund (ETF) is a type of mutual fund that trades on an exchange like a stock; an interval fund is a closed-end fund that doesn’t trade on an exchange. ETFs can offer exposure to a pool of different investments, including some of the same illiquid investments that an interval fund may hold. But whereas the majority of ETFs are passively managed, most interval funds have an active portfolio manager.

Do interval funds pay dividends?

Interval funds can pay dividends though they’re not required to do so. When collecting dividends from an interval fund or any other type of mutual fund, it’s important to understand how that income will be treated for tax purposes.

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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.


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.
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.

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.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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.


Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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May
18
2024
What Is a Guaranteed Minimum Income Benefit (GMIB)?

What Is a Guaranteed Minimum Income Benefit (GMIB)?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is a Guaranteed Minimum Income Benefit (GMIB)?

A guaranteed minimum income benefit (GMIB) is an optional rider that can be included in an annuity contract to provide a minimum income amount to the annuity holder. An annuity is an insurance product in which you pay a premium to the insurance company, then receive payments back at a later date. There are a number of different types of annuities, with different annuity rates.

A GMIB annuity can ensure that you receive a consistent stream of guaranteed income. If you’re considering buying an annuity for your retirement, it’s helpful to understand what guaranteed minimum income means, and how it works.

Key Points

•   A Guaranteed Minimum Income Benefit (GMIB) is an optional rider in an annuity contract ensuring a minimum income.

•   GMIBs protect annuity payments from market volatility, offering stable income in retirement.

•   These benefits are available in variable or indexed annuities, which tie earnings to market performance.

•   The cost of GMIBs can be high, as adding riders increases the overall expense of the annuity.

•   Evaluating the financial stability of the annuity provider is crucial, as the company’s health impacts the security of the guaranteed income.

GMIBs, Defined

A guaranteed minimum income benefit (GMIB) is a rider that the annuity holder can purchase, at an additional cost, and add it onto their annuity. The goal of a GMIB is to ensure that the annuitant will continue to receive payments from the contract — that’s the “guaranteed minimum income” part — without those payments being affected by market volatility.

Annuities are one option you might consider when starting a retirement fund. But what are annuities and how do they work? It’s important to answer this question first when discussing guaranteed minimum income benefits.

As noted, an annuity is a type of insurance contract. You purchase the contract, typically with a lump sum, on the condition that the annuity company pays money back to you now or starting at a later date, e.g. in retirement.

Depending on how the annuity is structured, your money may be invested in underlying securities or not. Depending on the terms and the annuity rates involved, you may receive a lump sum or regular monthly payments. The amount of the payment is determined by the amount of your initial deposit or premium, and the terms of the annuity contract.

A GMIB annuity is most often a variable annuity or indexed annuity product (though annuities for retirement can come in many different types).

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How GMIBs Work

Let’s look at two different types of annuities for retirement: variable and indexed.

•   Variable annuities can offer a range of investment types, often in the form of mutual funds that hold a combination of stocks, bonds, and money market instruments.

•   Indexed annuities offer returns that are indexed to an underlying benchmark, such as the S&P 500 index, Nasdaq, or Russell 2000. This is similar to other types of indexed investments.

With either one, the value of the annuity contract is determined by the performance of the underlying investments you choose.

When the market is strong, variable annuities or indexed annuities can deliver higher returns. When market volatility increases, however, that can reduce the value of your annuity. A GMIB annuity builds in some protection against market risk by specifying a guaranteed minimum income payment you’ll receive from the annuity, independent of the annuity’s underlying market-based performance.

Of course, what you can draw from an annuity to begin with will depend on how much you invest in the contract, stated annuity rates, and to some degree your investment performance. But having a GMIB rider on this type of retirement plan can help you to lock in a predetermined amount of future income.

Recommended: Types of Retirement Accounts

Pros & Cons of GMIBs

Guaranteed minimum income benefit annuities can be appealing for investors who want to have a guaranteed income stream in retirement. Whether it makes sense to purchase one can depend on how much you have to invest, how much income you’re hoping to generate, your overall goals and risk tolerance.

Weighing the pros and cons can help you to decide if a GMIB annuity is a good fit for your retirement planning strategy.

Pros of GMIBs

The main benefit of a GMIB annuity is the ability to receive a guaranteed amount of income in retirement. This can make planning for retirement easier as you can estimate how much money you’re guaranteed to receive from the annuity, regardless of what happens in the market between now and the time you choose to retire.

If you’re concerned about your spouse or partner being on track for their own retirement, that income can also carry over to your spouse and help fund their retirement needs, if you should pass away first. You can structure the annuity to make payments to you beginning at a certain date, then continue those payments to your spouse for the remainder of their life. This can provide reassurance that your spouse won’t be left struggling financially after you’re gone.

Cons of GMIBs

A main disadvantage of guaranteed minimum income benefit annuities is the cost. The more riders you add on to an annuity contract, the more this can increase the cost. So that’s something to factor in if you have a limited amount of money to invest in a variable or indexed annuity with a GMIB rider. Annuities may also come with other types of investment fees, so you may want to consult with a professional who can help you decipher the fine print.

It’s also important to consider the quality of the annuity company. An annuity is only as good as the company that issues the contract. If the company were to go out of business, your guaranteed income stream could dry up. For that reason, it’s important to review annuity ratings to get a sense of how financially stable a particular company is.

Examples of GMIB Annuities

Variable or indexed annuities that include a guaranteed minimum income benefit can be structured in different ways. For example, you may be offered the opportunity to purchase a variable annuity for $250,000. The annuity contract includes a GMIB order that guarantees you the greater of:

•   The annuity’s actual value

•   6% interest compounded annually

•   The highest value reached in the account historically

The annuity has a 10-year accumulation period in which your investments can earn interest and grow in value. This is followed by the draw period, in which you can begin taking money from the annuity.

Now, assume that at the beginning of the draw period the annuity’s actual value is $300,000. But if you were to calculate the annuitized value based on the 6% interest compounded annually, the annuity would be worth closer to $450,000. Since you have this built into the contract, you can opt to receive the higher amount thanks to the guaranteed minimum income benefit.

This example also illustrates why it’s important to be selective when choosing annuity contracts with a guaranteed minimum income benefit. The higher the guaranteed compounding benefit the better, as this can return more interest to you even if the annuity loses value because of shifting market conditions.

It’s also important to consider how long the interest will compound. Again, the more years interest can compound the better, in terms of how that might translate to the size of your guaranteed income payout later.

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The Takeaway

As discussed, guaranteed minimum income benefits (GMIB) are optional riders that can be included in an annuity contract to provide a minimum income amount to the annuity holder. Annuities can help round out your financial strategy if you’re looking for ways to create guaranteed income in retirement.

Annuities may be a part of a larger investment and retirement planning strategy, along with other types of retirement accounts. To get a better sense of how they may fit in, if at all, it may be a good idea to speak 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

What are guaranteed benefits?

When discussing annuities for retirement, guaranteed benefits are amounts that you are guaranteed to receive. Depending on how the annuity contract is structured, you may receive guaranteed benefits as a lump sum payment or annuitized payments.

What is the guaranteed minimum withdrawal benefit?

The guaranteed minimum withdrawal benefit is the amount you’re guaranteed to be able to withdraw from an annuity once the accumulation period ends. This can be the annuity’s actual value, an amount that reflects interest compounded annually or the annuity contract’s highest historical value.

What are the two types of guaranteed living benefits?

There are actually more than two types of guaranteed living benefits. For example, your annuity contract might include a guaranteed minimum income benefit, guaranteed minimum accumulation benefit or guaranteed lifetime withdrawal benefit.

Photo credit: iStock/Luke Chan

SoFi Invest®

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

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

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

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

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May
18
2024

Mega Backdoor Roths, Explained

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Mega Backdoor Roths, Explained

For those who earn an income that makes them ineligible to contribute to a Roth IRA, a mega backdoor Roth IRA may be an effective tool to help them save for retirement, and also get a potential tax break in their golden years.

Only a certain type of individual will likely choose to employ a mega backdoor Roth IRA as a part of their financial plans. And there are a number of conditions that have to be met for mega backdoor Roth to be possible.

Read on to learn what mega backdoor Roth IRAs are, how they work, and the important details that investors need to know about them.

Key Points

•   A mega backdoor Roth IRA allows high earners to save for retirement with potential tax benefits, despite income limits on traditional Roth IRAs.

•   This strategy involves making after-tax contributions to a 401(k) and then transferring these to a Roth IRA.

•   Eligibility for a mega backdoor Roth depends on specific 401(k) plan features, including the allowance of after-tax contributions and in-service distributions.

•   Contribution limits for 401(k) plans in 2023 allow for significant after-tax contributions, enhancing the potential retirement savings.

•   The process, while beneficial, can be complex and may require consultation with a financial professional to navigate potential hurdles.

What Is a Mega Backdoor Roth IRA?

The mega backdoor Roth IRA is a retirement savings strategy in which people who have 401(k) plans through their employer — along with the ability to make after-tax contributions to that plan — can roll over the after-tax contributions into a Roth IRA.

But first, it’s important to understand the basics of regular Roth IRAs. A Roth IRA is a retirement account for individuals. For tax year 2023, Roth account holders can contribute up to $6,500 per year (or $7,500 for those 50 and older) of their post-tax earnings. That is, income tax is being paid upfront on those earnings — the opposite of a traditional IRA. For 2024, they can contribute up to $7,000 (or $8,000 for those 50 and older).

Individuals can withdraw their contributions at any time, without paying taxes or penalties. For that reason, Roth IRAs are attractive and useful savings vehicles for many people.

But Roth IRAs have their limits — and one of them is that people can only contribute to one if their income is below a certain threshold.

In 2023 the limit is $138,000 for single people (people earning more than $138,000 but less than $153,000 can contribute a reduced amount); for married people who file taxes jointly, the limit is $218,000 (or between $218,000 to $228,000 to contribute a reduced amount).

In 2024 the limit is $146,000 for single people (people earning more than $146,000 but less than $161,000 can contribute a reduced amount); for married people who file taxes jointly, the limit is $230,000 (or between $230,000 to $240,000 to contribute a reduced amount).

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

Get a 1% IRA match on rollovers and contributions.

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1Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

How Does a Mega Backdoor Roth Work?

When discussing a mega backdoor Roth, it’s helpful to understand how a regular backdoor Roth IRA works. Generally, individuals with income levels above the thresholds mentioned who wish to contribute to a Roth IRA are out of luck. However, there is a workaround: the backdoor Roth IRA, a strategy that allows high-earners to fund a Roth IRA account by converting funds in a traditional IRA (which has no limits on a contributors’ earnings) into a Roth IRA. This could be useful if an individual expects to be in a higher income bracket at retirement than they are currently.

Mega backdoor Roth IRAs involve 401(k) plans. People who have 401(k) plans through their employer — along with the ability to make after-tax contributions to that plan — can potentially roll over up to $46,000 in 2024, and $43,500 in 2023, in after-tax contributions into a Roth IRA. That mega Roth transfer limit has the potential to boost an individual’s retirement savings.

Example Scenario: How to Pull Off a Mega Backdoor Roth IRA

The mega backdoor Roth IRA process is pretty much the same as that of a backdoor Roth IRA. The key difference is that while the regular backdoor involves converting funds from a traditional IRA into a Roth IRA, the mega backdoor involves converting after-tax funds from a 401(k) into a Roth IRA.

Whether a mega backdoor Roth IRA is even an option will depend on an individual’s specific circumstances. These are the necessary conditions that need to be in place for someone to try a mega backdoor strategy:

•   You have a 401(k) plan. People hoping to enact the mega backdoor strategy will need to be enrolled in their employer-sponsored 401(k) plan.

•   You can make after-tax contributions to your 401(k). Determine whether an employer will allow for additional, after-tax contributions.

•   The 401(k) plan allows for in-service distributions. A final piece of the puzzle is to determine whether a 401(k) plan allows non-hardship distributions to either a Roth IRA or Roth 401(k). If not, that money will remain in the 401(k) account until the owner leaves the company, with no chance of a mega backdoor Roth IRA move.

If these conditions exist, a mega backdoor strategy should be possible. Here’s how the process would work:

Open a Roth IRA — so there’s an account to transfer those additional funds to.

From there, pulling off the mega backdoor Roth IRA strategy may sound deceptively straightforward — max out 401(k) contributions and after-tax 401(k) contributions, and then transfer those after-tax contributions to the Roth IRA.

But be warned: There may be many unforeseen hurdles or expenses that arise during the process, and for that reason, consulting with a financial professional to help navigate may be advisable.

Who Is Eligible for a Mega Backdoor Roth

Whether you might be eligible for a mega backdoor Roth depends on your workplace 401(k) retirement plan. First, the plan would need to allow for after-tax contributions. Then the 401(k) plan must also allow for in-service distributions to a Roth IRA or Roth 401(k). If your 401(k) plan meets both these criteria, you should generally be eligible for a mega backdoor Roth IRA.

💡 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.

Contribution Limits

If your employer allows for additional, after-tax contributions to your 401(k), you’ll need to figure out what your maximum after-tax contribution is. The standard 401(k) contribution limit for all types of contributions to a 401(k) (meaning employee, employer, and after-tax contributions) in 2023 is $22,500 (or $30,000 for those 50 and older). For 2024, the limit is $23,000 (or $30,500 for those 50 and older).

The IRS allows up to $66,000, or $73,500 including catch-up contributions for those 50 and up, in total contributions to a 401(k) in 2023. For 2024, the total limits are $69,000, or 76,500 including catch-up contributions for those 50 and up.

So how much can you contribute in after-tax funds? Here’s an example. Say you are under age 50 and you contributed the max of $22,500 to your 401(k) in 2023, and your employer contributed $8,000, for a total of $30,500. That means you can contribute up to $35,500 in after-tax contributions to reach the total contribution level of $66,000.

Is a Mega Backdoor Roth Right For Me?

Given that this Roth IRA workaround has so many moving parts, it’s worth thinking carefully about whether a mega backdoor Roth IRA makes sense for you. These are the advantages and disadvantages.

Benefits

The main upside of a mega backdoor Roth is that it allows those who are earning too much to contribute to a Roth IRA a way to potentially take advantage of tax-free growth.

Plus, with a mega backdoor Roth IRA an individual can effectively supercharge retirement savings because more money can be stashed away. It may also offer a way to further diversify retirement savings.

Downsides

The mega backdoor Roth IRA is a complicated process, and there are a lot of factors at play that an individual needs to understand and stay on top of.

In addition, when executing a mega backdoor Roth IRA and converting a traditional IRA to a Roth IRA, it could result in significant taxes, as the IRS will apply income tax to contributions that were previously deducted.

The Future of Mega Backdoor Roths

Mega backdoor Roths are currently permitted as long as you have a 401(k) plan that meets all the criteria to make you eligible.

However, it’s possible that the mega backdoor Roth IRA could go away at some point. In prior years, there was some legislation introduced that would have eliminated the strategy, but that legislation was not enacted.

The Takeaway

Strategies like the mega backdoor Roth IRA may be used by some investors to help achieve their retirement goals — as long as specific conditions are met, including having a 401(k) plan that accepts after-tax contributions.

While retirement may feel like far off, especially if you’re early in your career or still relatively young, it’s generally wise to start thinking about it sooner rather than later.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

Are mega backdoor Roths still allowed in 2023?

Yes, mega backdoor Roths are still permissible in 2023.

Is a mega backdoor Roth worth it?

Whether a mega backdoor Roth is worth it depends on your specific situation. It may be worth it for you if you earn too much to otherwise be eligible for a Roth IRA and if you have a 401(k) plan that allows you to make after-tax contributions.

Is a mega backdoor Roth legal?

Yes, a mega backdoor Roth IRA is currently legal.

Are mega backdoor Roths popular among Fortune 500 companies?

A number of Fortune 500 companies allow the after-tax contributions to a 401(k) that are necessary for executing a mega backdoor Roth IRA.

What is a super backdoor Roth?

A super backdoor Roth IRA is the same thing as a mega backdoor Roth IRA. It is a strategy in which people who have 401(k) plans through their employer — along with the ability to make after-tax contributions to that plan — can roll over the after-tax contributions into a Roth IRA.

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

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

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.

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.


Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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.
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2024
What Is Theta in Options? All You Need to Know

What Is Theta in Options? All You Need to Know

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is Theta in Options? All You Need to Know

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

Theta, in relation to options, describes the rate in change in an option’s value. Options have two sources of value: intrinsic value and time value. From the moment an options contract is created, the time value component decays. This rate of change in value with respect to time is known as theta.

Understanding theta is crucial if you are going to trade options. Several factors, including an option’s moneyness and the time to expiration, will impact theta. Here are the basic concepts that you should know about.

Key Points

•   Theta measures the rate at which an option’s value decreases over time, specifically due to the passage of time.

•   As options approach their expiration date, their time value decays, which is quantified by theta.

•   Theta is typically represented as a negative dollar amount, indicating the daily loss in value of the option.

•   The impact of theta is more pronounced as the expiration date nears, accelerating the decay of the option’s time value.

•   Understanding theta is essential for options traders, as it helps in timing the market and managing potential risks and returns.

How Does Theta Work?

Holding all other factors equal, options tend to decline in value over time as they approach their expiration date. The intuition behind this relationship is simple: once an option expires, it can no longer be exercised, and thus it no longer has any value.

This rate of change in value of an option is referred to as theta. Usually displayed as a negative dollar amount, an option’s theta value represents how much an option’s price decreases per day as it matures.

💡 Interested in Theta? Check out the other Greeks in options trading.

What Are Examples of Theta?

One way to think of theta in options trading is an analogy of an ice cube sitting on a countertop. As the ice cube sits on the warm countertop, it gradually melts away, and the melting becomes more rapid as time passes. Similarly, an option’s time value always decreases, with the decrease becoming more rapid the closer an option is to expiring.

Let’s say there is a stock ABC with a price of $80. The theta for an options contract expiring in three months with a strike price of $85 might be -$0.05. That means you can expect to lose five cents per day due to time decay, or theta. That doesn’t necessarily mean that the security’s price will go down each day, since it will also be affected by up and down movements of the underlying stock price itself.

In this scenario, not all options of stock ABC will have the same theta value of -$0.05. An option with the same strike price of $85 but a year until expiration will usually have a lower theta than one expiring next month.

💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the
OCC Options Disclosure Document.

What Is a Negative Theta in Options?

Because theta represents the amount of money an option contact loses every day, it is customarily represented as a negative number. A theta value of -$0.15 for a particular option means that particular option will lose 15 cents of time value each day.

But because the time value loss of an option (theta) isn’t linear, you shouldn’t expect it to lose exactly 15 cents of time value every day. Theta will increase as the option expiration date gets closer. This is very important to know if you’re attempting to time the market, since it will help you understand when the best time is to make your move.

Understanding Options Theta Decay

There are many different strategies for trading options, and theta affects them differently. Since theta is a negative number, it works against buyers of options. But if you are selling an option (like in a covered call or other option strategy), theta works in your favor.

When you are selling an option contract, you are hoping that the option will decrease in value or expire worthless. So a high theta value works for an option seller since it represents the amount of money the contract will lose each day.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

Calculating Theta

Calculating theta, or any of the other Greeks, requires using advanced mathematical formulas, and depends on the particular pricing model you choose. Options investors typically calculate theta on a daily or weekly basis.

Generally theta will be smaller for options that are far away from their expiration date and larger as you get closer to expiration. You can use this knowledge to determine your best plan depending on your time horizon for investing.

The Takeaway

Whether you’re trading basic options or more complicated options spreads, it is important to understand theta. It represents how much value your option will lose as time moves closer to its maturity, holding other factors constant. One needs to be especially careful to take note of theta when trading out-of-the-money options.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

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

Photo credit: iStock/fizkes

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.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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