Terminology Archives | Page 66 of 76

Mar

2023

What Is Broker Call, or Call Money Rate?

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

The broker’s call — also called “call money rate” or “call loan rate” — refers to the interest rate that brokerage firms pay to banks when they borrow money.

Brokerage firms borrow money from banks in the form of call loans in order to offer loans to traders and investors with margin accounts. As such, the interest rate that brokerages pay banks is what’s referred to as the broker’s call, or call money rate.

Banks can call those loans back from brokerages at any time (hence the name “call loans”), which may cause brokerages to call the money they lent to traders or investors (in the form of margin). That’s one example of what’s referred to as a “margin call.”

Broker Call Rate Definition

The broker call rate is the interest rate that brokerage firms pay banks for borrowing money that they, in turn, loan to traders and investors to pursue margin trades. Since many brokerage firms allow investors to trade “on margin,” the brokerages need to have access to a pool of money that they can borrow from.

In effect, banks lend money to brokerages, and the brokerages lend money to investors — each loan carries a different rate. The broker call rate, again, is the interest rate that the brokerages pay to the banks.

Investors and traders that are using margin to trade will be on the hook for interest payments to the brokerages, and the applicable interest rate for those traders are called margin rates.

But, in terms of a broker call rate, that is only referring to the interest rates that brokerages pay to banks, not the margin rates traders pay to brokerages for their margin accounts.

In addition, although the broker call rate is quoted as an annual rate, these loans are typically for much shorter periods of time. As such, the fees are assessed daily. If the annual rate is 5%, the overnight rate is 5% divided by 365 days or roughly 0.014% per day.

Margin rates, or the rates charged to traders, would be higher.

Explaining Call Money Rate

Although the terms sound quite different, the broker call rate and the call money rate are essentially the same thing: it’s the interest rate that brokers pay to banks for borrowing money. That typically comprises short-term loans that the brokers then turn around and lend to traders or investors for use in margin accounts.

Brokerages will typically include a service charge, expressed as a percentage, on top of the call money rate to get their margin rates. So, in effect, traders or investors using margin accounts pay a premium, plus interest, to trade with margin loans.

As an investor is deemed capable of borrowing more money, the gap between the broker call rate and the margin rate narrows.

Brokerages drive extra revenue by exploiting the difference in interest rates, just as investors do the same via interest rate options.

The Use of the Term ‘Call’

A quick side note: You may have noticed that the term “call” is a common financial term with various meanings, including:

1. A brokerage issuing a “margin call” requiring a borrower to increase the cash in their account or sell assets to raise cash for their account.

2. A lender “calling a loan” on a borrower, requiring them to repay their debt.

3. Yield to call is another example of the word that in this phrase refers to bonds.

What Is a Call in Options Trading?

A “call” is also a common type of option (the two main types of options are puts and calls), but the sense of the word here is quite different. A call option is a derivative contract that gives investors the right, but not the obligation, to buy a certain number of shares of an underlying asset.

While options trading and margin trading are similar in that they use leverage, margin trading specifically involves borrowed funds. A margin account is not required for options trading.

How Is the Broker Call Rate Calculated?

The broker call rate in the U.S. fluctuates continuously, but generally increases along with interest rates across the board due to the Federal Reserve lifting benchmark rates. Conversely, as the Federal Reserve cuts rates, the broker call rate falls as well.

The broker call rate and the Federal Reserve funds rates are tightly linked, but they are not required to be the same.

It’s also important to know that the broker call rate fluctuates on a daily basis, much like other interest rates. With that in mind, the broker call rate’s calculation is less of a calculation, and more based on a benchmark, such as the London InterBank Offered Rate, or LIBOR rate.

LIBOR serves as a benchmark interest rate that lenders around the world use when they lend to another financial institution on a short-term basis. As such, it makes sense that it would serve as the benchmark for the broker call rate.

But LIBOR is being phased out as of the beginning of 2022, and is being replaced in most instances by the Secured Overnight Financing Rate (SOFR). The transition won’t fully replace LIBOR until 2023, however.

How Does It Affect Margin Traders?

Margin traders utilize leverage to attempt to supercharge their returns. That is, they’re borrowing more money than they actually have in order to make bigger trades. This increases their investing risk, but can also increase their gains.

And, as discussed, it’s pretty obvious how the broker call rate can affect margin traders. Since brokerages need to borrow money from banks, and pay the associated costs for doing so (in the form of interest), they need to turn a profit through their own lending activities. Lending to margin traders, by charging interest plus a service fee or other related cost, helps them cover those costs.

So, the higher the broker call rate, the more interest brokerages need to pay banks in interest charges. That gets passed down to margin traders, who, in turn, end up paying more in interest charges to brokerages when they use margin. This is one of the drawbacks when using a cash account versus a margin account — there are additional costs to consider for using margin, which can eat into returns.

Broker Call Rate Example

Here’s an example of how the broker’s call rate may come into play in the real world:

Brokerage X needs to offer margin funds for its clients with margin accounts, but doesn’t have the money to cover its needs. So, it borrows the money from Bank Y at a predetermined broker call rate. Bank Y decides that the rate will be the current LIBOR rate, plus 0.1%. So, if the LIBOR rate is 3%, for example, the broker call rate is 3.1%.

Brokerage X then uses the borrowed funds to offer margin funds to its clients, for which it charges a margin rate of 4%, plus a $10 service fee. By doing so, Brokerage X drives a little extra revenue through its lending activities, and when the traders pay the margin funds back, it can return them to Bank Y, paying the 3.1% broker call rate for the privilege of borrowing.

Current Call Money Rate

The current call money rate is published daily by the Wall Street Journal, and others. As it fluctuates often, margin traders, or others who may be subject to those fluctuations, can or should make a habit of looking at the current rate in the event that it changes their strategy.

Due to the Federal Reserve raising benchmark rates in an effort to blunt high inflation, the call money rate has seen rapid increases throughout 2022. As recently as June 2021, for instance, the call money rate was only 2%.

Margin Trading With SoFi

The broker call rate is the interest rate that brokerage firms pay banks for borrowing money that they, in turn, loan to traders. Since many brokerage firms allow investors to trade “on margin,” the brokerages need to have access to a pool of money that they can borrow from.

Brokerages typically charge a fee, expressed as a percentage, on top of the call money rate to get their margin rates. So, in effect, investors using margin accounts pay interest to trade stocks with margin loans — plus a little extra.

Leveraged trades are complicated and can be risky. While using borrowed money lets traders place bigger bets, and possibly see bigger gains, they also risk steep losses.

If you’re interested in opening a margin account, you can start by opening a new investing account with SoFi. From there you can apply for a margin loan and start trading. SoFi doesn’t charge commission, and SoFi members have access to complimentary financial advice from professionals.

Get one of the most competitive margin loan rates with SoFi, 11%*

FAQ

Who decides the call rate for margin trading?

A brokerage ultimately decides the costs associated with margin trading for investors. But as far as what determines the broker call rate, it goes back to the rate as determined by the prevailing benchmark interest rate, such as LIBOR, or the Secured Overnight Financing Rate (SOFR), which is taking precedence as LIBOR is phased out.

What is the overnight call rate?

The overnight call rate refers to the interest rate that banks use when lending or borrowing overnight. Again, since the call money rate is constantly fluctuating, the overnight call rate may or may not be different from the call money rate during normal trading hours.

Photo credit: iStock/YakobchukOlena

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*Borrow at 11%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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.
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Mar

2023

FDIC Insurance: What It Is And How It Works

By Kim Franke-Folstad | Budgeting & Goals, money, Terminology | Comments Off

With the Federal Deposit Insurance Corporation (FDIC) recently in the news, many people are wondering what the FDIC is, exactly, and what it does.

The Federal Deposit Insurance Corporation, or FDIC, is an independent agency of the U.S. government. In the unlikely event of a bank failure, it protects you and reimburses your deposits, typically up to $250,000 per depositor, per insured bank, per account ownership category.

People often take the FDIC guarantee for granted now, but it was created from a very real need and has kept many people and their money safe.

Here, you’ll learn more about this important aspect of banking, including:

• What the FDIC is

• What the FDIC does

• How does the FDIC work

• Which accounts are and are not eligible for FDIC protection

What Is the FDIC?

The FDIC is the shorthand way of referring to the Federal Deposit Insurance Corporation. It is an independent agency created by Congress in 1933, after the Great Depression, when thousands of banks failed. The goal was to shore up confidence in the U.S. financial system and protect Americans from losing their cash if their bank failed.

In January 1934, the FDIC began insuring deposits, covering them up to $2,500. That number has increased through the years, of course, most recently with the Emergency Economic Stabilization Act of 2008. President George W. Bush signed the act to temporarily raise FDIC insurance coverage from $100,000 to $250,000 per depositor during the financial crisis. President Barack Obama made the coverage hike permanent in 2010 with the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

It’s important to note how this insurance works: The standard coverage is $250,000 per depositor, per insured bank, for each account ownership category. Joint accounts may be covered up to $500,000.

What Does the FDIC Do?

Since its creation, no depositor has lost any money from an FDIC-insured deposit. This means that, unlike your great-grandparents, you can put your money into an eligible financial institution, whether a savings vs. checking account or other qualifying account, and know it’s more secure than stuffing it under your mattress. (Yes, that used to be a thing for many savers.)

Also of note: Though it’s the customers’ money that’s covered by the FDIC, the agency is funded by premiums paid by the banks and from earnings on investments in U.S. Treasury securities. Customers do not pay for this insurance; they are automatically covered when they open an FDIC-insured account.

There are rules and limits you should know about, however, if you want to make the most of the FDIC’s coverage.

Types of Accounts Insured by the FDIC

The FDIC insures all deposit accounts at insured banks and savings associations up to the FDIC’s limits, including:

• Checking accounts

• Savings accounts

• Money market accounts

• Certificates of deposit (CDs)

• Prepaid cards when the underlying funds are deposited in an insured bank (these funds are only insured in the instance of bank failure, not loss or theft)

• Certain retirement savings accounts, but only when placed in certain types of investments and in accordance with all FDIC requirements.

Deposit accounts, such as checking and savings accounts, money market deposit accounts, and certificates of deposit, can all be held in traditional IRAs and Roth IRAs and are eligible for FDIC insurance.

How to Tell if Your Money Is FDIC-Insured

How can you tell for sure if your account is covered? While the FDIC insures deposits in most banks and savings associations, not all of them are protected. Every FDIC-insured depository institution must display an official sign at each teller window or teller station, so that’s an easy way to check if you bank at a brick-and-mortar location.

If you’re using an online bank or a mobile-first financial product, the company’s website should contain information about its coverage.

Or you can find out if your deposits are insured by using the FDIC BankFind tool .

Types of Accounts Not Insured by the FDIC

Now, here are the kinds of funds not covered by FDIC insurance. Money held in these ways, even if purchased from an insured financial institution, is not protected:

• Stocks

• Bonds

• Annuities

• Mutual funds

• Municipal securities

• Life insurance policies

• The contents of a safety deposit box

This is an important point to note as you think about your financial security.

Also, you may wonder about the FDIC vs. NCUA in terms of protecting your finances. The National Credit Union Administration (NCUA), created by Congress in 1970, covers federally insured credit unions in much the same way as the FDIC covers banks, including deposits up to $250,000. If your funds are held at a credit union, you may want to make sure it has NCUA coverage. The FDIC will not be protecting you, but it’s likely the NCUA is.

How FDIC Insurance Works

Here’s more important intel if you’re wondering, How does the FDIC work?

The FDIC covers your holdings in certain accounts, as listed above. What amount of money is insured in a bank account? Usually, the limit is $250,000. It is calculated to cover both principal and interest earned by the depositor. If you have an account that has $200,000 in it and has accrued $20,000 in interest, you will be covered in the amount of $220,000.

As mentioned above, there is a standard $250,000 cap on FDIC insurance. If you have high net worth, this coverage may not be enough. As a result, you may want to keep in mind that by having money in excess of that amount in one bank or one account, you may be putting yourself at risk.

Because the $250,000 applies to each bank where you have an account, one way you may be able to increase the FDIC insurance coverage available to you is by using multiple banks.

Another option is to structure your accounts properly within a single bank. If you have any concerns about your coverage, it can be a good idea to discuss them with a representative at your bank.

Quick Money Tip: Most savings accounts only earn a fraction of a percentage in interest. Not at SoFi. Our high-yield savings account can help you make meaningful progress towards your financial goals.

What Happens if a Bank Fails?

If a bank were to fail, the FDIC would intervene in two ways:

• The FDIC would pay depositors up to the insurance limit to cover their losses. So, if you had $10,500 in an insured account and the bank failed, you would be reimbursed for that amount. Typically, this happens within a few days after a bank closes.

• The FDIC also takes responsibility for collecting the assets of the failed bank and settling its debts. As assets are sold, depositors who had more than the $250,000 limit in an insured account may receive payments on their claim.

How to Recover Your Money if a Bank Fails

Because of the FDIC safety net, you won’t likely see fearful customers lining up to get their money the way they did before deposit insurance was established.

Still, when a bank closes, it can cause depositors to worry and wonder how to get their money. Typically, there are one of two scenarios when a bank fails:

• Most commonly, you would become a depositor at a healthy, FDIC-insured bank. You would have access to your insured funds at this new bank and could likely choose to keep your accounts there if you like.

• If there is not a healthy, FDIC-insured bank that can step in quickly, the FDIC will likely pay the insured depositor by check within as little as a few days after the bank closes.

As for immediate next steps if you learn your bank is closing, the FDIC aims to post information as promptly as possible, or you can contact the agency at 877-ASK-FDIC or visit the FDIC Support Center website .

The Takeaway

Though it’s quite a rare occurrence, a bank can fail when it takes on too much risk or, as was the case recently, was exposed to interest rate risk. If your bank is covered by FDIC insurance you can receive reimbursement up to $250,000, meaning your funds aren’t lost for good. FDIC insurance covers checking, savings, money market accounts, CDs, and other deposit accounts.

The FDIC does not cover some of the other financial products or services offered by banks, including stocks, bonds, mutual funds, annuities, and securities.

Putting your money in a brick-and-mortar financial institution isn’t the only way to make sure it’s protected. SoFi Checking and Savings is a mobile-first online bank account that keeps your hard-earned dollars safe; all accounts receive FDIC insurance of up to $250,000 per member.

What’s more, we offer an array of great features that can make managing your money easier, such as spending and saving in one convenient place and using savings tools such as Vaults and Roundups. Plus, you’ll earn a competitive annual percentage yield (APY) and pay no account fees, both of which can help your money grow faster.

Want security, convenience, and no account fees? Bank smarter with SoFi.

FAQ

How often does a bank fail?

Currently, banks fail very rarely. In the past two years, no banks failed in the United States. However, the FDIC was created in response to thousands of bank failures around the time of the Great Depression.

How does the FDIC differ from the NCUA?

FDIC insurance applies to qualifying accounts at banks. NCUA insurance covers qualifying accounts at credit unions.

How many banks are FDIC insured?

As of September 2022, the FDIC insured a total of 4,746 institutions. Of these, 4,157 were commercial banks, and 589 were savings institutions.

Are credit unions FDIC-insured?

Credit unions don’t qualify for FDIC insurance. Instead, they may be covered by the National Credit Union Administration, or NCUA, insurance.

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Mar

2023

What Is an ESG Index? 5 ESG Indexes to Know

By Kenny Zhu | Growing Wealth, invest, Investing, Terminology | Comments Off

An index is a group of companies that reflect the performance of a certain sector. Thus an ESG index includes companies that meet certain criteria for environmental, social, and governance standards and reflect that sector.

Just as a large-cap equity index like the S&P 500 can be used as a performance benchmark for the performance of large-cap U.S. stocks, different ESG indexes can be used as benchmarks for sectors focused on sustainable or socially responsible investing (sometimes called SRI) practices.

Some indexes may also include or exclude companies as a form of risk mitigation.

The challenge is that the criteria for what constitutes sustainable investing, in any form, is inconsistent throughout the industry.

Nonetheless, recent industry research suggests that ESG investing strategies perform similarly to, and sometimes better than conventional strategies. By knowing some of the top ESG indexes, then, it’s possible to invest in funds that capture the performance of that index, and put your money toward companies whose aim is to focus on positive environmental, social, and corporate governance outcomes.

What Are ESG Indexes?

There are a number of ESG indexes maintained by major data providers which track the performance of firms that embrace ESG or SRI criteria. Why are environmental, social, and governance factors considered important enough to be the foundation of dozens of industry indexes?

Some investors believe in investing their money in the stocks of companies (or other securities) that reflect certain proactive values regarding the planet, society, and fair and ethical corporate structures. At the same time, adherence to ESG factors is increasingly considered by many stakeholders as a form of risk management. For example, investors might choose to assess a company’s ESG scores or ratings to gauge its risk exposure (as well as possible future financial performance). Consumers might want to know about a company’s environmental and social practices to inform their purchasing decisions.

While you cannot invest in an index, investors can gain exposure to ESG companies in an index by purchasing an index mutual fund or exchange-traded fund (ETF) that seeks to replicate the performance of that index (aka passive investing).

Just as there are many different flavors of equity indexes — from large cap to small cap, domestic to international, and so on — there are numerous ESG indexes. These exist in many forms, depending on the underlying metrics used to construct them, and there are hundreds of ESG index funds and ETFs that investors can access.

Recommended: How to Invest in ESG Stocks

New Growth in the ESG Sector

According to Deloitte, some 149 ESG-related funds were launched in 2021 alone, making up 22% of all funds launched by managers in that year.

The number of ESG-related funds on the market continues to grow, roughly a third of them passively managed index funds or ETFs. In 2021, socially responsible U.S. mutual funds saw record inflows of some $70 billion — a 36% increase over 2020. However, ESG funds saw substantial outflows through 2021 and most of 2022. But sustainable funds still managed to outperform non-sustainable funds through Q3 of 2022, despite challenging market conditions, according to Morningstar research as of September 30, 2022.

ESG vs Socially Responsible Investing: What’s the Difference?

There are various terms for investing according to a certain set of values — including impact investing and socially responsible investing (SRI) — and not all of them refer to green investing strategies. Some terms may be used interchangeably, but there are some key differences to understand.

• Impact investing is a broad term that encompasses investors who seek measurable outcomes. Impact investing may or may not have anything to do with environmental or social factors.

• Socially responsible investing is also a broader label, typically used to reflect progressive values of protecting the planet and natural resources, treating people equitably, and emphasizing corporate responsibility.

• Securities that embrace ESG principles, though, may be required to adhere to specific standards for protecting aspects of the environment (e.g. clean energy, water, and air); supporting social good (e.g. human rights, safe working conditions, equal opportunities); and corporate accountability (e.g. fighting corruption, balancing executive pay, and so on).

ESG Investing Standards

That said, there isn’t one universally observed set of criteria that define an ESG investment or an ESG index. Rather, each ESG index and corresponding index fund is typically based on proprietary metrics of qualitative and quantitative factors relating to environmental, social, and governance factors.

These metrics may be formulated internally by investment managers/research teams, based on metrics established by popularly accepted ESG frameworks, or a combination of both.

While it’s clear where the money’s been trending with regards to ESG investments, prudent investors should still remain selective when it comes to picking an ESG fund, as how these indexes are constructed can sometimes be based on opaque methodologies.

5 Commonly Used ESG Indexes

Following is an overview of five ESG indexes commonly used as benchmarks for some of the largest ESG funds, and the manner in which they’re constructed.

1. S&P 500 ESG Index

The S&P 500 ESG Index consists of 307 domestic investments across the broader market. All firms included in the index must meet specified ESG criteria established by S&P Dow Jones Indices.

ESG Criteria: According to S&P, the index uses an exclusionary methodology to filter out firms within the S&P 500 that partake in undesirable business activities, defined as follows:

• Firms operating within the thermo coal, tobacco, and controversial weapons industries.

• Companies that score within the bottom 5% of the United Nations Global Compact (UNGC).

• Companies that score within the bottom 25% of ESG scores within each global GICs industry group.

2. Nasdaq-100 ESG Index

The Nasdaq-100 ESG Index consists of 96 separate securities that meet ESG criteria established by Nasdaq. The parent index includes 100 of the largest domestic and international non-financial firms that trade on the Nasdaq exchange.

ESG Criteria: Firms must meet the following requirements, at a minimum, to qualify under the index:

• “An issuer must not be involved in certain specific business activities, such as alcohol, cannabis, controversial weapons, gambling, military weapons, nuclear power, oil & gas, and tobacco.”

• “…an issuer must be deemed compliant with the United Nations Global Compact principles, meet business controversy level requirements.”

• “…have an ESG Risk Rating Score that meets the requirements for inclusion in the Index.”

3. MSCI KLD 400 Social Index

Established in 1990, the MSCI KLD 400 Social Index is one of the first and oldest socially responsible investing (SRI) indexes, making it a popular standard for evaluating long-term ESG performance.

The KLD 400 Social index comprises 402 U.S. securities that meet the ESG standards set by the MSCI ESG Research team.

ESG Criteria: MSCI uses the following methodology to determine eligibility and inclusion within the index.

• Companies involved in nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms, GMOs, and adult entertainment are excluded.

• Must have an MSCI ESG rating above “BB.”

• Must have an MSCI Controversies score above “2.”

4. MSCI USA Extended ESG Focus Index

The MSCI USA Extended ESG Focus Index includes securities across the U.S. equity markets, but selects constituents from the MSCI USA parent index using an optimization process that targets companies with high ESG ratings in each sector. Companies related to segments such as tobacco, controversial weapons, producers of or ties with civilian firearms, thermal coal and oil sands are excluded.

The MSCI USA Index has 628 constituents while the MSCI USA Extended ESG Focus Index has around 321, which means an exclusion close to 49%.

5. FTSE US All Cap Choice Index

The FTSE U.S. All Cap Choice Index is part of the FTSE Global Choice Index Series. It’s designed to help investors align their investment choices with their values, by selecting companies based on the impact of their products and conduct on society and the environment., but excludes companies involved in:

• Vice-related industries (e.g. alcohol, tobacco, gambling, adult entertainment)

• Non-renewable energy (e.g. fossil fuels, nuclear power)

• Weapons (conventional military weapons, controversial military weapons, civilian firearms)

• Companies are also excluded based on controversial conduct and diversity practices

Risks and Drawbacks of ESG Indexes

As with all investments, the risks of choosing ESG-linked investments is that they may not necessarily outperform over your target timeframe. There are also unique ESG-linked issues that come with evaluating these indexes.

Diversification Risk

The primary risk of using an ESG-based strategy is the risk of underperformance and the risk of reduced diversification relative to cheaper, broader-market index funds.

This isn’t a surprise, as many of the top ESG indexes are market capitalization (“cap”) weighted, which means that the largest firms in the index bear the greatest responsibility for changes in index values.

Given that some of most popular ESG investments also track the performance of the broader-market indexes, this makes these particular indexes less attractive as part of a diversifying strategy.

Higher Costs

Another issue of concern is that some ESG funds charge higher fees and expense ratios relative to conventional funds.

While these fees aren’t necessarily head and shoulders above broader-market index funds, they can get progressively more expensive depending on how nuanced the fund’s investing strategy is. This is because ESG is a factor-based investment strategy which entails more complexity than traditional broader-market indexing.

Typically, the longer the time frame for comparison, the greater the risk for underperformance becomes, net of fees.

Inconsistency of ESG Standards

Perhaps the biggest drawback of ESG-investing is the inconsistent reporting among industry firms, and the desire for more uniformity among which ESG frameworks are applied.

In other words, the ESG criteria established at one institution for their index or funds has little or no bearing on the ESG criteria employed by another firm.

Because sustainable investing has grown over the past decade, there has been an industry-wide movement towards greater consistency in ESG criteria and reporting. The Securities and Exchange Commission (SEC) has even recently undertaken efforts to codify aspects of financial reporting when it comes to ESG-related investments.

Nevertheless, these efforts remain in their early stages, and investors should continue to be discerning when it comes to picking ESG-linked investments.

Relevance of ESG Criteria

Existing ESG frameworks run the gamut when it comes to which metrics they choose to apply; whether these metrics are actually relevant to the underlying investments can be debated. For example, metrics related to carbon emissions may be relevant to heavy industry, but how relevant would those metrics be to the financial or technology sectors?

To address the issue of relevance, some ESG-linked funds have introduced an additional factor to correctly weight relevance of certain criteria. However, individual investors would do well to identify and assess when these solutions are applied.

Finally, expect to encounter data consistency issues when trying to quantify information that is naturally qualitative, particularly when management at each firm has wide discretion over how they choose to represent those metrics.

The Takeaway

There’s no doubt that enthusiasm for ESG investing has grown over the past decade, and continues to gain traction. Understanding ESG indexes and how they apply sustainability rules and criteria to the companies in the index can help investors understand the corresponding index mutual funds and ETFs they may want to invest in.

Due to the sheer number of ESG-centric investments available to date, it’s a good idea to be selective when reviewing the underlying strategy of each fund, and understanding the underlying methodology of how each index constructs its portfolio.

Exploring and incorporating sustainable strategies in your portfolio can be easy when you open an online brokerage account with SoFi Invest. The app allows you to buy and sell shares of stocks, ETFs, fractional shares, IPO shares, and more. Even better, SoFi members have complimentary access to advice from professionals, who can answer any questions you may have.

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.

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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.

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.

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

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.

SOIN0722051

Mar

2023

Guide to Risk Neutral Probability

By Kenny Zhu | Growing Wealth, invest, Investing, Terminology | Comments Off

“Risk neutral,” in the context of investing, means that an investor focuses on the expected gains of a potential investment rather than its accompanying risks. This concept comes up frequently in options trading, as it’s one of the core tenets in how options are valued.

Risk neutrality is more of a conceptual focus for valuation than a strategy that’s applied on a daily basis. It’s often used as a conceptual framework for the valuation of options and other complex derivatives by sophisticated investment firms.

What Is Risk Neutral?

Risk-neutral investors are solely concerned with the expected returns of an investment, regardless of its underlying risks. When confronted with a gamble versus a sure thing, risk neutral investors are indifferent as long as the expected value of both options balance out.

Risk Neutral vs Risk Averse

Contrast risk neutrality with “risk aversion,” which does consider risk and strongly prefers certainty when comparing investment alternatives. While risk averse investors consider expected value, they will also demand a “risk premium,” or additional benefit, for taking on any additional risk in a transaction. This is what leads to their preference for the more “certain” option, even when the mathematical expected value of two alternative investments is the same.

Risk neutral investors are indifferent between investment options with the same expected values, regardless of the accompanying risk factors. The concept of risk does not play into a risk-neutral investor’s decision-making process, and no risk premium is demanded for uncertain outcomes with equal expected values.

In reality, most retail investors are risk averse, e.g. they have a low risk tolerance, rather than risk neutral. It’s easy to spot this investor preference, given the incessant focus of financial firms on mitigating risk. Terms like “risk-adjusted returns” are frequently used, and entire doctrines in behavioral economics and game theory are built around the cornerstones of loss or risk-aversion.

The difference between risk-neutral vs. risk-averse investors can be illustrated using an example comparing separate sets of probabilities.

Example of Risk Neutrality

To illustrate risk neutrality, consider a hypothetical situation with two investment options: one which involves a guaranteed payoff of $100, while the other involves a gamble, with a 50% chance of a $200 payoff and a 50% chance you receive nothing.

In our hypothetical scenario, the risk neutral investor would be indifferent between the two options, as the expected value (EV) in both cases equals $100.

1. EV = 100% probability X $100 = $100

2. EV = (50% probability X $200) + (50% probability X $0) = $100 + 0 = $100

However, a risk averse investor would introduce the added variable of risk into their decision, thereby unbalancing the alternatives above. Given that the 2nd option involves uncertainty, and therefore risk, the risk averse investor would demand an added payoff to justify taking on any added risk.

Reframing the problem above, the risk averse investor would choose option 1, given a) both options return the same expected value, and b) option 1 involves the greatest certainty.

On the other hand, the risk neutral investor would remain indifferent, as risk does not factor into their decision-making process.

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Risk Neutral Pricing and Valuation

Conceptually, risk neutrality is used extensively in valuing derivative securities because it establishes a theoretical basis for finding the equilibrium price between buyers and sellers in any transaction. It’s therefore an important aspect of options trading strategies.

Given that risk-averse investors demand a premium for taking on additional risk, while each individual investor’s risk tolerance can differ. This risk premium can present a problem from an analytical perspective; it introduces “noise” and analytical complexity which can complicate the pricing of derivatives and other investments.

Conceptually, the value of an investment is calculated as the present value of all its current and future cash flows. Future cash flows are discounted using its expected rate of return, which factors in the risk-neutral rate of return along with any added risk premia.

While the risk-neutral rate of return can be assumed to be the same for a given set of investments, the risk premium can vary according to the risk tolerance of individual investors, which complicates the present value calculation, additionally it often skews the calculated value of a security below what the expected future benefit might imply.

To adjust for this complexity in derivatives trading, mathematicians and financial professionals often find it useful to apply risk-neutral measures when pricing derivatives.

Understanding Risk Neutral Probability

The concept of risk neutrality is used to find objective pricing for derivatives; risk neutral probability therefore removes the noisy risk factor from calculations when finding fair value.

This differs from real-world risk-based pricing, which introduces any number of security-specific or market-based factors back into the calculation. The downside of this “real-world probability” is that it makes calculating value an exceedingly complex exercise, as you would need to make fine-tuning adjustments for almost every unique factor that might affect your investment.

Ultimately, risk-neutral probabilities allow you to apply a consistent single rate towards the valuation of all assets for which the expected payoff is known. This allows for ease and simplicity when approaching the valuation process.

However, that’s not to say that risk-aversion and other costs are not factored into calculations, as risk-averse investors would never choose to accept trades that don’t offer risk premiums over the long run.

Instead, risk-neutral probabilities represent the basis on which to build your investment valuation thesis, allowing you to selectively layer on any number of other risk factors later in the process.

Investing Today

Identifying what type of investor you are is important before diving in. If you’re a risk-neutral investor, choosing between risky and non-risky investments will be based on expected values.

If you are risk averse, your investment opportunities will need to be assessed based on whether you are receiving a risk premium commensurate with the risk you perceive.

If you want to learn more about risk and investing, SoFi Invest is a great place to get started. When you set up an online stock trading account, you have access to a range of self-directed options for both brokerage and retirement investing.

Remember that options trading is complex and can entail significant risk for new investors. It’s important to establish a solid investing foundation before moving onto more advanced trading strategies like options trading.

With SoFi, user-friendly options trading is finally here.

FAQ

Is risk neutral the same as risk free?

Risk neutral does not imply risk free. Risk neutral is simply a conceptual approach for evaluating trade offs without the impact of risk-factors.

Risk continues to exist in the context of each investment when evaluating tradeoffs; risk neutral simply suspends risk as a factor in the evaluation process.

What makes some companies risk neutral?

From a theoretical perspective, companies behave in a risk-neutral manner because firms have the means to hedge their risks away. They can do this by purchasing insurance, buying financial derivatives, or transferring their risk to other parties. This allows them to focus on expected outcomes rather than the risk-related costs of those decisions.

Conceptually, shareholders also want firms to make decisions in a risk-neutral manner, as individual investors can hedge risk exposure themselves by buying the shares of any number of other firms to diversify and offset these risk factors.

What is an example of risk neutral?

An example of risk neutral would be an individual who’s indifferent between 1) a 100% chance of receiving $1,000, versus 2) a 50% chance of receiving $2,000, and a 50% chance of receiving nothing.

In both cases, the expected value would be $1,000, after calculating for both probability and return. This expected value would be what risk-neutral investors would focus on. By contrast, a risk-averse individual would choose option 1, as the outcome has more certainty (and less risk).

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

Mar

2023

401(k) Blackout Periods: All You Need to Know

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

A 401(k) blackout period is a hiatus during which plan participants may not make certain changes to their 401(k) accounts. Employers who offer 401(k) plans typically impose blackouts when they need to update or alter aspects of their plans. A blackout period may last anywhere from a few days to several weeks.

A blackout period doesn’t mean that the account is frozen. Employees in a payroll deduction plan can often continue making scheduled contributions to their 401(k) accounts during a blackout period, and assets held in 401(k) accounts remain invested in the market.

What Is a 401(k) Blackout Period?

As noted above, a 401(k) blackout period is a temporary suspension of employees’ ability to access their 401(k) accounts for actions such as withdrawals or portfolio adjustments. Companies use blackout periods to update or change their 401(k) retirement savings plans. Unfortunately, these blackout periods may sometimes be inconvenient for employees.

When Is a 401(k) Blackout Period Necessary?

There are several situations that might call for an employer to implement a 401(k) blackout period. Some common reasons include:

• Changes to the plan. Employers may need to implement a blackout period to allow for changes to their 401(k) plans, such as adding or eliminating investment alternatives or modifying the terms of the plan.

• New management. If an employer’s 401(k) plan is managed by a third party, the employer might decide to change sponsors or financial managers. A blackout period would give the employer time to transfer the assets and records.

• Mergers and acquisitions. Acquisition of a new firm or a merger with another company could require a blackout period while the two companies integrate their 401(k) plans.

• Issues with compliance. If an employer finds that the terms of their 401(k) plan violate federal laws, they may need to impose a blackout period while they conduct audits and bring the plan into compliance.

How Long Can a 401(k) Blackout Period Last?

A 401(k) blackout period can last for a few days or for a few weeks, but the typical duration is 10 days. The length often depends on the reason for the blackout and how much time it will take to implement the scheduled fixes. There is no legal maximum blackout period for 401(k) plans.

Will I Be Given a 401(k) Blackout Notice?

Employers are required to notify employees in advance of a blackout period. For blackout periods expected to last more than three days, employers must give at least 30 days’ (and not more than 60 days’) notice, according to the federal Employee Benefits Security Administration (EBSA). If the period’s beginning or ending date changes, employers are expected to provide an updated blackout notice as soon as reasonably possible.

Employers must provide this notice in writing, either by mail or email. The notice should include the reason for the blackout.

What Should I Do Before the Blackout Starts?

If a 401(k) blackout period is approaching, there are some steps you can take to prepare. Here are a few things to consider doing before the blackout starts:

• Review the account. Once you get your blackout notice, take some time to review your 401(k) plan, including your current contributions, investment options, and overall balance. This overview can help you zero in on anything that may need correction before the blackout begins.

• Make any appropriate changes. If you need to fine-tune how you’re investing in your 401(k), such as by adjusting contribution amounts or reallocating investments, try to do so before the blackout period. This will help ensure that your changes take effect as soon as possible.

• Communicate with your employer. For questions about the blackout period or requests for additional information, your employer is likely to be the best resource. They should be able to provide more details and address account-related concerns.

Starting Out With a New 401(k)

People starting a new job that offers a 401(k) plan have some decisions to make. Plan details to consider before committing to a new 401(k) account may include:

• Contribution limits. The Internal Revenue Service (IRS) sets limits on annual 401(k) contributions. In 2023, the contribution limit is $22,500 for those under age 50 and $30,000 for those 50 and older. If you want to max out your 401(k), knowing these limits can help you schedule your contributions appropriately.

• Investment options. Most 401(k) plans offer a range of investment vehicles, including mutual funds, exchange-traded funds (ETFs), and individual stocks. As you’re preparing for retirement, researching various asset types will help you see which ones align with your investment goals and risk tolerance.

• Fees. Some 401(k) plans charge fees for services such as plan administration or investment management. Understanding how the plan’s fees may impact your overall returns is crucial.

• Employer match. Many employers offer a matching contribution to employee 401(k) accounts. This means that the employer will kick in an additional percentage to augment an employee’s contributions. An employer match is a way of boosting your retirement savings, which may lead to bigger investment gains over time.

The Takeaway

Employees with 401(k) retirement accounts occasionally experience blackout periods. People may not access or alter their accounts during these breaks, which occur when employers and 401(k) plan sponsors need time to update or retool their retirement benefit plan. Blackout periods typically last for a few days or weeks. By law, participants must be notified at least 30 days ahead of a scheduled blackout period. This enables them to make any desired investment changes beforehand.

One convenient way of investing for retirement is through SoFi individual retirement accounts. You can open an online IRA account from your phone and start saving right away. If you have questions, SoFi has a team of professional advisors available to help.

Help grow your nest egg with a SoFi IRA.

FAQ

What is a retirement-fund blackout period?

A 401(k) blackout period is a multi-day pause during which the employer or the plan administrator typically update or maintain the plan. During this time, employees can’t alter their 401(k) retirement accounts. Making withdrawals or changing asset allocations may be prohibited. Though a blackout period is temporary, it can last several weeks or more.

Can you contribute to your 401(k) during the blackout period?

This depends on the specific terms of the employer’s 401(k) plan and the blackout period. Some plans may allow employees to keep setting aside money in their 401(k) accounts during a blackout; others may not. Your employer or plan administrator will have information on your plan’s rules for contributions.

How do I get my 401(k) out of the blackout period?

In most cases, there is nothing you can do to avoid or shorten your 401(k) blackout period. A blackout period generally comes to an end once the employer or plan administrator has completed the necessary plan updates. If you have additional questions about the duration of the blackout period or how to access your account again, your employer should be able to answer them.

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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.

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.
SOIN0422057

What Is Broker Call, or Call Money Rate?

Broker Call Rate Definition

Explaining Call Money Rate

The Use of the Term ‘Call’

What Is a Call in Options Trading?

How Is the Broker Call Rate Calculated?

How Does It Affect Margin Traders?

Broker Call Rate Example

Current Call Money Rate

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FAQ

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What is the overnight call rate?

FDIC Insurance: What It Is And How It Works

What Is the FDIC?

What Does the FDIC Do?

Types of Accounts Insured by the FDIC

How to Tell if Your Money Is FDIC-Insured

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Types of Accounts Not Insured by the FDIC

How FDIC Insurance Works

What Happens if a Bank Fails?

How to Recover Your Money if a Bank Fails

The Takeaway

FAQ

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How does the FDIC differ from the NCUA?

How many banks are FDIC insured?

Are credit unions FDIC-insured?

What Is an ESG Index? 5 ESG Indexes to Know

What Are ESG Indexes?

New Growth in the ESG Sector

ESG vs Socially Responsible Investing: What’s the Difference?

ESG Investing Standards

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5 Commonly Used ESG Indexes

1. S&P 500 ESG Index

2. Nasdaq-100 ESG Index

3. MSCI KLD 400 Social Index

4. MSCI USA Extended ESG Focus Index

5. FTSE US All Cap Choice Index

Risks and Drawbacks of ESG Indexes

Diversification Risk

Higher Costs

Inconsistency of ESG Standards

Relevance of ESG Criteria

The Takeaway

Guide to Risk Neutral Probability

What Is Risk Neutral?

Risk Neutral vs Risk Averse

Example of Risk Neutrality

Finally, user-friendly options trading is here.*

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

Risk Neutral Pricing and Valuation

Understanding Risk Neutral Probability

Investing Today

FAQ

Is risk neutral the same as risk free?

What makes some companies risk neutral?

What is an example of risk neutral?

401(k) Blackout Periods: All You Need to Know

What Is a 401(k) Blackout Period?

When Is a 401(k) Blackout Period Necessary?

How Long Can a 401(k) Blackout Period Last?

Will I Be Given a 401(k) Blackout Notice?

What Should I Do Before the Blackout Starts?

Starting Out With a New 401(k)

The Takeaway

FAQ

What is a retirement-fund blackout period?

Can you contribute to your 401(k) during the blackout period?

How do I get my 401(k) out of the blackout period?

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