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Sep

2023

What Is Scalp Trading?

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

Scalp trading, or scalping, is a style of short-term trading used with stocks, cryptocurrencies, and other assets. The goal of this trading style is to make profits off of small changes in asset prices. Generally this means buying a stock, waiting for it to increase in value by a small amount, then selling it.

The theory behind it is that many small gains can add up to a significant profit over time. Scalp trading is one of the most popular day trading strategies. Scalping requires a lot of focus, quick decision-making, the right trading tools, and a strategy — and even then, it’s no sure thing. Since traders make many small gains, one big loss could wipe out all their profits.

How Scalping Works in Trading

The goal of scalping is to make many small profits during a trading session. This is the opposite of a buy-and-hold or long term trading strategy, where one hopes to see their portfolio grow over time. Scalpers might make anywhere from 10 to more than 100 trades in a single day, taking a small profit on as many of them as possible. And they might only stay in each position for a few minutes.

With each trade they assess the risk-to-reward ratio with a goal of profiting on more than 50% of their trades. Each win may be small, but the profits can add up over time if they outnumber the losses. Often, scalpers make use of stop losses and leverage when making trades.

Scalp trading reduces risk exposure, since traders only have their money in the market for a short amount of time. It can also be an easier day trading strategy than some others because the goal is to capitalize on small price movements. Small moves happen constantly in the market, and it’s easier to make a profit of a few cents or dollars than a larger amount.

However, any type of day trading involves a significant amount of risk. Scalping is challenging and can result in large losses. This is just one reason why some traders use scalping along with other trading methods.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

Scalp Trading Strategies

There are many different scalp trading strategies, some of which can be used together.

Systematic Planning

Technical analysis helps scalp traders spot trading opportunities and plan exits ahead of time. Traders use one-minute charts, Level II quotes, moving averages, exchange order books, and other tools while scalping. Since positions may be entered and exited within seconds or minutes, five- or 10-minute charts aren’t very useful.

On the Fly

Although fundamental analysis doesn’t play a large role in scalping, it can help to identify stocks that are currently in the news or of interest based on a current event, which may lead to more price movement and trading opportunities. Higher volatility is generally a good sign for scalpers.

Shorting Stocks

Some scalpers also short stocks and sell when they decrease in value. This can be done with the same asset repeatedly, or with different assets throughout a trading session.

Bid/Ask Profiting

Some scalpers prefer to earn profits off of the bid/ask spread rather than actual stock price movements. This takes a significant amount of experience and is a particular trading skill that takes time to learn. It entails looking for trades with a wide spread, meaning a large difference between the broker’s ask price and the price at which a trader buys the asset.

Range Trading

With this strategy, the trader waits for an asset to enter a specific price range before they start trading. Generally, the range is between a support and a resistance level.

Market Making

Market making is when traders post a bid and an offer on a stock at the same time. This only works with stocks that trade a large volume but have low volatility, and the profits are small.

How to Scalp Trade

While there is no one way to engage in scalp trading, these are the general guidelines that scalpers follow to make decisions:

• Create a watchlist each day based on fundamental analysis and news

• Trade stocks with enough liquidity that there will be price movement and more options for exit points

• Quickly sell a stock isn’t increasing in value

• Make a daily profit goal

• Set goals for each stock trade and stick to them

• Buy stocks at breakouts

• Keep trades short for more chance at a profitable exit

• Adjust exit points as stocks move.

Pros and Cons of Scalp Trading

Scalp trading is a particular day trading strategy which works well for some people, there are many risks associated with day trading.

Pros of Scalp Trading

• Small gains can add up to significant returns

• It reduces risk exposure to market due to short trade times

• It may be easier than some other day-trading strategies

• It can be easier to make profitable trades when the goal is to profit off of small movements rather than large price movements

• There are many trading opportunities, no matter what the market conditions are.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Cons of Scalping

• Even one large loss can cancel out any gains made during a trading session

• It requires a lot of focus to watch the charts for several hours and execute trades, and can be tedious

• It requires knowledge and experience with technical analysis

• Transaction and commission fees can add up quickly if making multiple trades per day—and potentially cancel out profits. It’s key to use a broker that doesn’t charge commissions or one that offers discounts to high volume traders.

• If traders experience a few losses it can be distressing, and it’s easy to let emotions get in the way of good trading habits. Scalping may be one of the most stressful trading strategies.

• Scalpers often use margin trading and leverage to increase their positions, which can be very risky.

The Takeaway

Scalp trading, or scalping, is a style of short-term trading used with stocks or other securities. Scalping is best suited for more experienced traders, since it requires an understanding of technical analysis, fast trades, and an understanding of how to set up and execute trades in specific ways.

But scalp trading is just one of many different strategies when it comes to trading stocks and other assets. While trading can seem complex, there are simple ways to get started building a portfolio.

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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.

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

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Sep

2023

Inherited 401(k): Rules and Tax Information

By Ashley Kilroy | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

When you inherit a 401(k) retirement account, there are tax rules and other guidelines that beneficiaries must follow in order to make the most of their inheritance.

Inheriting a 401(k) isn’t like getting a simple inheritance, e.g. cash, property, or jewelry. How you as the beneficiary must handle the account is determined by your relationship to the deceased, your age, and other factors.

Understanding the tax treatment of an inherited 401(k) is especially important, as 401(k) accounts are tax-deferred vehicles, so regardless of your status as a beneficiary you will owe taxes on the withdrawals from the account, now or later.

What Is an Inherited 401(k)?

As the name suggests, an inherited 401(k) is an employer-sponsored retirement plan that is bequeathed to an individual, either a spouse or a non-spouse.

When an individual sets up their 401(k) to begin with, they generally fill out a beneficiary form. This form may include their spouse (if the account holder was married), children, siblings, or others.

In most cases, when the account holder of a 401(k) dies, the account is automatically bequeathed to the surviving spouse, unless the will specifies otherwise. This is not the case if your partner dies and you weren’t married. In that case, the 401(k) does not pass to the surviving partner, unless they are officially designated as an account beneficiary.

What to Do If You’re Inheriting a 401(k)

The rules for inheriting a 401(k) are different when you inherit the account from a spouse versus someone who wasn’t your spouse. Depending on your relationship, you’ll have different options for what you can do with the money and how those options affect your tax situation.

Remember, a 401(k) is a tax-deferred retirement account, and the beneficiary will owe taxes on any withdrawals from that account, based on their marginal tax rate.

Inheriting a 401(k) From a Spouse

A spouse has a number of options when inheriting an IRA. But be careful; there are a number of wrinkles given that the rules have changed in the last few years.

• You could rollover the inherited 401(k) into your own 401(k) or into an inherited IRA: For most spouses, taking control of an inherited 401(k) by rolling over the funds is often the smartest choice. A rollover gives the money more time to grow, which could be useful as part of your own retirement strategy. Also, rollovers do not incur penalties or taxes. (But if you convert funds from a traditional 401(k) to a Roth 401(k) or a Roth IRA, you will likely owe taxes on the conversion to a Roth account.)

Also remember that once the rollover is complete, traditional 401(k) or IRA rules apply, meaning you’ll face a 10% penalty for early withdrawals before age 59 ½.

And when you reach age 73, you must start taking required minimum distributions (RMDs). Because RMD rules have recently changed, owing to the SECURE Act 2.0, it may be wise to consult a financial professional to determine the strategy that’s best for you.

• Take a lump sum distribution: Withdrawing all the money at once will not incur a 10% early withdrawal penalty as long as you’re over 59 ½, but you’ll owe income tax on the money in the year you withdraw it — and the amount you withdraw could put you into a higher tax bracket.

• You can reject or disclaim the inherited account, passing it to the next beneficiary.

• Last, you could leave the inherited 401(k) where it is: If you don’t touch or transfer the inherited 401(k), you are required to take RMDs if you’re at least 73. If you’re not yet 73, other rules apply and you may want to consult a professional.

Inheriting a 401(k) from a Non-Spouse

The options for a non-spouse beneficiary (e.g. a child, sibling, etc.) are far more limited. For example, as a non-spouse beneficiary you cannot rollover an inherited 401(k) into your own retirement account.

• You can “disclaim” or basically reject the inherited account.

• If the account holder died in 2019 or earlier, you can take withdrawals for up to 5 years — as long as the account is empty after the 5-year period. If the account holder died in 2020 or after, you have 10 years to withdraw all the funds. You must start taking withdrawals starting no later than Dec. 31 of the year after the death of the account holder. These rules are known as the 5-year and 10-year rules.

• A positive point to remember: If you are a non-spouse beneficiary and younger than 59 ½ at the time the withdrawals begin, you won’t face a 10% penalty for early withdrawals.

The exception to this rule is if you’re a minor child, chronically ill or disabled, or not more than 10 years younger than the deceased, you can take distributions throughout your life.

💡 Quick Tip: Before opening a brokerage account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

How RMDs Impact Inherited 401(k)s

If the account holder died prior to Jan. 1, 2020, anyone can use the so-called “life expectancy method” to withdraw funds from an inherited IRA. That means taking required minimum distributions, or RMDs, based on your own life expectancy per the IRS Single Life Table (Publication 590-B).

But if the account holder died after Dec. 31, 2019, the SECURE Act (also known as the “Setting Every Community Up for Retirement Enhancement Act of 2019”) outlines different withdrawal rules for those who are defined as eligible designated beneficiaries.

What Is an Eligible Designated Beneficiary?

To be an eligible-designated beneficiary, and be allowed to take RMDs based on your own life expectancy, an individual must be one of the following:

• A surviving spouse

• No more than 10 years younger than the original account holder at the time of their death

• Chronically ill

• Disabled

• A minor child

Individuals who are not eligible-designated beneficiaries must distribute (i.e. withdraw) all the funds in the account by December 31st of the 10th year of the account owner’s death.

Eligible-designated beneficiaries are exempt from the 10-year rule: With the exception of minor children, they can take distributions over their life expectancy.

Minor children must take any remaining distributions within 10 years after their 18th birthday.

How to Handle Unclaimed Financial Assets

What if someone dies, leaving a 401(k) or other assets, but without a will or other legally binding document outlining the distribution of those assets?

That money, or the assets in question, may become “unclaimed” after a designated period of time. Unclaimed assets may include money, but can also refer to bank or retirement accounts, property (e.g. real estate or vehicles), physical assets such as jewelry.

Unclaimed assets are often turned over to the state where that person lived. However, it is possible for relatives to claim the assets through the appropriate channels. In most cases, it’s incumbent on the claimant to provide supporting evidence for their claim, since the deceased did not leave a will or other documentation officially bequeathing the money to that person.

The Takeaway

Inheriting a 401(k) can be a wonderful and sometimes unexpected financial gift. It’s also a complicated one. For anyone who inherits a 401(k) — spouse or otherwise — it can be helpful to review the options for what to do with the account, in addition to the rules that come with each choice.

In some cases, the beneficiary may have to take required distributions (withdrawals) based on their age. In some cases, those required withdrawals may be waived. In almost all cases, withdrawals from the inherited 401(k) will be taxed at the heir’s marginal tax rate.

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).

Easily manage your retirement savings with SoFi.

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.

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.

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

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Sep

2023

Guide to Morningstar Ratings

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

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

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

What are Morningstar Ratings?

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

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

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

How Morningstar Ratings Work

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

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

Recommended: Investing in Growth Funds

The “Star Rating” Explained

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

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

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

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

The “Analyst Rating” Explained

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

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

When ranking funds, analysts look at three specific metrics:

• People

• Process

• Parent

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

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

How Morningstar Measures Volatility

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

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

Example of a Morningstar Rating

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

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

Are Morningstar Ratings Accurate?

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

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

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

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

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

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

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

Use Expense Ratios

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

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

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

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

How Should Investors Use Morningstar Ratings?

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

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

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

Risks of Morningstar Ratings

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

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

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

Morningstar Ratings for Funds

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

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

Other Investment Risk Rating Providers

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

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

Trading Stocks With SoFi

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

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

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

FAQ

How reliable are Morningstar ratings?

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

Is a Morningstar rating of “5” good?

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

SoFi Invest®

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

Sep

2023

Guide to Investing in a Bear Market: 8 Investing Strategies

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

While it may seem counterintuitive to invest during a bear market — a prolonged market decline typically of 20% or more — in fact there are opportunities during downturns, if you know where to look and what strategies to use.

Market conditions during a bear market are unusual, and securities may behave in different ways. By knowing which bear market investing strategies might make sense, it’s possible to mitigate losses and possibly realize some gains.

Also, for investors with a long-term wealth-building goal, it’s important to remember that bear markets are often relatively short. So rather than panic, it can help to look for potential investment opportunities that may be beneficial.

How to Invest in a Bear Market: 8 Options

Some investors may be tempted to sell assets during a bear market, content to keep their money in cash while the markets seem to slide. However, there are some bear market investing strategies investors may want to consider.

1. Invest Defensively

The first of these bear market strategies involves buying assets that may increase in price when the overall financial markets decline. Many factors influence which investments perform well during a bear stock market.

Investors may shift their portfolios to defensive stocks, to bigger and more mature companies, and companies in sectors with constant demand such as utilities and food. These may be good assets to hold during bear markets because these stocks tend to hold steady, even in a downturn.

Defensive investments may provide consistent income through dividend payouts (more on that below) while experiencing less volatile share price action during market downturns. Buying assets like these at the beginning of a downturn can be beneficial.

2. Consider Dollar-Cost Averaging

Using a dollar-cost averaging strategy isn’t limited to bear markets; it’s a time-honored practice among many buy-and-hold investors.

Dollar-cost averaging is when you buy a set dollar amount of an investment at regular intervals (e.g. weekly, monthly, quarterly), regardless of whether the markets are up or down. That way, when prices are lower you buy more; when prices are higher you buy less. Otherwise, you might be tempted to buy less when prices drop, and buy more when prices are increasing, based on your emotions.

For example, if you invest $100 in Stock A at $20 per share, you get 5 shares. The following month, say, the price has dropped to $10 per share, but you stay the course and invest $100 in Stock A — and you get 10 shares. Now you own 15 shares of stock A at an average price of $13.33.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

3. Use Short Strategies

One of the more sophisticated bear market trading strategies is placing bets that will rise in value when other investments lose value. This might involve, for example, purchasing put options contracts on stocks that may decline in value. A put option allows investors to benefit from falling share prices.

Shorting stocks to speculate on falling stock prices is another strategy investors can employ. When investors short a stock, they sell borrowed shares and hopefully repurchase them at a lower price. The investor profits when the price they pay to buy back the shares is lower than the price at which they sold the borrowed shares.

Alternatively, investors might consider inverse exchange-traded funds (ETF) as the overall market declines. An inverse ETF tracks a market index and, through complex trading strategies, looks to produce the opposite result of the index. For example, if the S&P 500 index declines, an inverse ETF that tracks the index will hopefully increase in value.

However, using put options, inverse ETFs, and other short strategies involves many nuances that may be complicated for some investors. They are very risky trading strategies that could compound losses if the bets do not work out. Interested investors ought to conduct additional research before considering this strategy.

4. Hold for the Long Haul

During a bear market, it’s not always necessary to do anything special. Investors with a long time horizon sometimes choose to hold on and stay the course, even when a portfolio declines in value. Taking a long-term perspective may pay off well over many years, as the market as a whole tends to trend upward over time.

For example, the bear market that began in December 2007 was over by March 2009, lasting about a year and a half. But the bull market that followed lasted almost eleven years; the S&P 500 index recouped its losses from the bear market by March 2013, and from March 2009 through February 2020, the S&P 500 increased just over 400%

💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.

5. Diversify Your Holdings

It also helps if investors have a well-diversified portfolio during any market. Diversifying typically ensures that all of an investor’s eggs are not in one basket, which can help mitigate the risk of loss, since you’re not overexposed in one sector or asset class.

One easy way to accomplish portfolio diversification might be to buy structured securities like ETFs or index funds.

6. Focus on Dividend Stocks

One way to invest during a bear market is to focus on stocks that provide income, i.e. dividend-paying stocks. Typically, these companies are bigger, more established, and growth oriented. And, clearly, they have the ability to give investors a regular payout.

A dividend is a portion of a company’s earnings that is paid to its shareholders, as approved by the board of directors. Companies usually pay dividends quarterly, but they may also be distributed annually or monthly.

Most dividends are paid in cash, on a per-share basis. For example, if the company pays a dividend of 50 cents per share, an investor with 100 shares of stock would receive $50.

Many investors who rely on dividend-paying stocks do so as part of an income investing strategy — which also serves investors during a downturn.

7. Look Toward Growth

While value stocks are generally considered undervalued relative to their actual worth, growth stocks are shares of companies that have the potential for higher earnings, often rising faster than the rest of the market. In addition, growth stocks have shown historic resilience in market downturns.

These companies tend to reinvest their earnings back into their business to continue their company’s growth spurt. Growth investors are betting that a company that’s growing fast now, will continue to grow quickly in the future.

To spot growth stocks, investors look for companies that are not only expanding rapidly but may be leaders in their industry. For example, a company may have developed a new technology that gives it a competitive edge over similar companies.

Recommended: Value vs. Growth Stocks

8. Consider Laying Low

If none of the above bear market strategies appeals to you, there is always the option of “playing dead,” as the saying goes. This derives from the advice given to those in the wilderness who might face a live bear: to not panic or do anything rash or risky.

In the same way, some investors believe the best way to handle a bear market is to stay calm, moving a portion of your portfolio into more secure and stable investments like Treasury bills, bonds, and money market funds.

What Causes a Bear Market and How Long Do They Last?

The causes of bear markets can vary. Sometimes a weak economy is the main cause — e.g. low employment, low productivity, disappointing corporate earnings. But a bear market might also be the result of a sudden shock, like the brief bear market that hit during the early days of the pandemic.

Other events that can spark a bear market might include geopolitical crises, a paradigm shift (e.g. the growth of the digital workforce), or government actions that impact taxes, interest rates, and so forth.

Bear Markets Run Short

As noted above, bull markets generally last far longer on average than bear markets — about 1,752 days for the average bull market versus 363 days for the average bear.

This is another factor to bear in mind if you’re thinking about investing in a bear market. Developing smart bear market investing strategies has to take into account the shorter time frames as well as the unusual market conditions.

Bear Market Investing vs Bull Market Investing

For those investing for the long term, the only real difference between a bear market and a bull market will be a temporary dip in the value of their portfolio. The main goal will be to stay the course. As mentioned, long-term investors often make regular, recurring purchases of financial assets.

During bull markets, a common investment strategy is to buy and hold. This tends to work because bull markets are characterized by most asset classes rising in unison.

However, investors may have to be a little more active with their portfolios during bear markets. Some investors choose to increase the amount of money they put into their investments during market downturns. Their overall strategy remains the same, but buying more assets at lower prices lets them acquire a larger number of assets overall.

For those with a higher risk tolerance looking to make short-term gains (often referred to as speculators), a mix of strategies might be employed. Speculators may look to short the market using puts or inverse ETFs, or research assets likely to increase in value due to current bear market trends.

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When the financial markets are in turmoil and your portfolio seems to be in the red, you may be tempted to panic. You may want to sell off your assets to mitigate further losses, content to pocket the cash. However, this sort of strategy may be short-sighted for most investors as it locks in your losses.

Also, you may be setting yourself up to miss a potential rally by getting out of the markets. After all, bear markets are often relatively short-lived and are followed by bull markets.

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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.
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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.

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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.
SOIN1022018

Sep

2023

Averaging Down Stocks: Meaning, Example, Pros & Cons

By AJ Smith | Growing Wealth, invest, Investing | Comments Off

Averaging down stocks refers to a strategy of buying more shares of a stock you already own after that stock has lost value — effectively buying the same stock, but at a discount. In other words, it’s a way of lowering the average cost of a stock you already own.

It’s similar to dollar-cost averaging, where you invest the same amount of money in the same securities at steady intervals, regardless of whether the prices are rising or falling.

While this strategy has a potential upside — if the stock price then rises again — it does expose investors to greater risk.

Table of Contents

What Is Averaging Down?
Example of Averaging Down
Why Average Down on Stock
Pros and Cons of Averaging Down
Tips for Averaging Down on Stock
The Takeaway

What Is Averaging Down?

By using the strategy of averaging down and purchasing more of the same stock at a lower price, the investor lowers the average price (or cost basis) for all the shares of that stock in their portfolio.

So if you buy 100 shares at one price, and the price drops 10%, for example, and you decide to buy 100 more shares at the lower price, the average cost of all 200 shares is now lower.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Example of Averaging Down

Consider this example: Imagine you’ve purchased 100 shares of stock for $70 per share ($7,000 total). Then, the value of the stock falls to $35 per share, a 50% drop.

To average down, you’d purchase 100 shares of the same stock at $35 per share ($3,500). Now, you’d own 200 shares for a total investment of $10,500. This creates an average purchase price of $52.50 per share.

Potential of Gain Averaging Down

If the stock price jumps to $80 per share, your position would be worth $16,000, a $5,500 gain on your initial investment of $10,500. In this case, averaging down helped boost your average return. If you’d simply bought 200 shares at the initial price of $70 ($14,000), you’d only see a gain of $2,000.

Potential Risk of Averaging Down

As with any strategy, there’s risk in averaging down. If, after averaging down, the price of the stock goes up, then your decision to buy more of that stock at a lower price would have been a good one. But the stock continues its downward price trajectory, it would mean you just doubled down on a losing investment.

While averaging down can be successful for long-term investors as part of a buy-and-hold strategy, it can be hard for inexperienced investors to discern the difference between a dip and a warning sign.

Why Average Down on Stock

Some investors may use averaging down stocks as part of other strategies.

1. Value Investing

Value investing is a style of investing that focuses on finding stocks that are trading at a “good value” — in other words, value stocks are typically underpriced. By averaging down, an investor buys more of a stock that they like, at a discount.

But in some cases, a stock may appear undervalued when it’s not. This can lead investors who may not understand how to value stocks into something called a value trap. A value trap is when a company has been trading at low valuation metrics (e.g. the P/E ratio or price-to-book value) for some time.

While it may seem like a bargain, if it’s not a true value proposition the price is likely to decline further.

2. Dollar-Cost Averaging

For some investors, averaging down can be a way to get more money into the market. This is a similar philosophy to the strategy known as dollar-cost averaging, as noted above, where the idea is to invest steadily regardless of whether the market is down or up, to reap the long-term average gains.

3. Loss Mitigation

Some investors turn to this strategy to help dig out of the very hole that the lower price has put them into. That’s because a stock that has lost value has to grow proportionally more than it fell in order to get back to where it started. Again, an example will help:

Let’s say you purchase 100 shares at $75 per share, and the stock drops to $50, that’s a 33% loss. In order to regain that lost value, however, the stock needs to increase by 50% (from $50 to $75) before you can see a profit.

Averaging down can change the math here. If the stock drops to $50 and you buy another 100 shares, the price only needs to increase by 25% to $62.50 for the position to be profitable.

Pros and Cons of Averaging Down

As you can see, averaging down stocks is not a black-and-white strategy; it requires some skill and the ability to weigh the advantages and disadvantages of each situation.

Pros of Averaging Down

The primary benefit to averaging down is that an investor can buy more of a stock that they want to own anyway, at a better price than they paid previously — with the potential for gains.

Whether to average down should as much be a decision about the desire to own a stock over the long-term as it is about the recent price movement. After all, recent price changes are only one part of a stock’s analysis.

If the investor feels committed to the company’s growth and believes that its stock will continue to do well over longer periods, that could justify the purchase. And, if the stock in question ultimately turns positive and enjoys solid growth over time, then the strategy will have been a success.

Cons of Averaging Down

The averaging down strategy requires an investor to buy a stock that is, at the moment, losing value. And it is always possible that this fall is not temporary — and is actually the beginning of a larger decline in the company and/or its stock price. In this scenario, an investor who averages down may have just increased their holding in a losing investment.

Price change alone should not be an investor’s only indication to buy more of any stock. An investor with plans to average down should research the cause of the decline before buying — and even with careful research, projecting the trajectory of a stock can be difficult.

Another potential downside is that the averaging down strategy adds to one particular position, and therefore can affect your asset allocation. It’s always wise to consider the implications of any shift in your portfolio’s allocation, as being overweight in a certain asset class could expose you to greater risk of loss.

💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

Tips for Averaging Down on Stock

If you are going to average down on a stock you own, be sure to take a few preparatory steps.

• Have an exit strategy. While it may be to your benefit to buy the dip, you want to set a limit should the price continue to fall.

• Do your research. In order to understand whether a stock’s price drop is really an opportunity, you may need to understand more about the company’s fundamentals.

• Keep an eye on the market. Market conditions can impact stock price as well, so it’s wise to know what factors are at play here.

The Takeaway

To recap: What is averaging down in stocks? Simply put, averaging down is a strategy where an investor buys more of a stock they already own after the stock has lost value.

The idea is that by buying a stock you own (and like) at a discount, you lower the average purchase price of your position as a whole, and set yourself up for gains if the price should increase. Of course, the fly in the ointment here is that it can be quite tricky to predict whether a stock price has simply taken a dip or is on a downward trajectory — so there are risks to the averaging down strategy for this reason.

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Guide to Investing in a Bear Market: 8 Investing Strategies

How to Invest in a Bear Market: 8 Options

1. Invest Defensively

2. Consider Dollar-Cost Averaging

3. Use Short Strategies

4. Hold for the Long Haul

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5. Diversify Your Holdings

6. Focus on Dividend Stocks

7. Look Toward Growth

8. Consider Laying Low

What Causes a Bear Market and How Long Do They Last?

Bear Markets Run Short

Bear Market Investing vs Bull Market Investing

Invest With SoFi

Averaging Down Stocks: Meaning, Example, Pros & Cons

What Is Averaging Down?

Example of Averaging Down

Potential of Gain Averaging Down

Potential Risk of Averaging Down

Why Average Down on Stock

1. Value Investing

2. Dollar-Cost Averaging

3. Loss Mitigation

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Pros and Cons of Averaging Down

Pros of Averaging Down

Cons of Averaging Down

Tips for Averaging Down on Stock

The Takeaway

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