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Jul

2023

How to Build Wealth In Your 30s

By Rebecca Lake | Growing Wealth, invest, Investing | No Comments

While you may be established in your career once you reach your 30s, it’s still not that easy to build wealth. Suddenly you’ve often got a host of other financial priorities like paying down debt, saving for your first home, and paying for childcare.

However, making sure your money is working for you now matters, especially when it comes to building wealth over the long term. Saving money is a good start, but more importantly, your 30s are a prime time to develop a consistent investing habit.

Think of this decade as a great opportunity to learn new money skills and establish better money habits.

What Does Wealth Mean to You?

One way to motivate yourself to build wealth in your 30s is by thinking about the opportunities that it can create. Retiring early or being able to enjoy bucket-list vacations with your family, for example, are the kinds of things you’ll need to build up wealth to enjoy.

Beyond that, building wealth means that you don’t have to stress about covering unexpected expenses or how you’ll pay the bills if you’re unable to work for a period of time.

Investing in your 30s, even if you have to start small, can help create financial security. The more thought you give to how you manage your money in your 30s, the better when it comes to improving your financial health.

So if you haven’t selected a target savings number for your retirement goals yet, run the numbers through a retirement calculator to get a ballpark figure. Then you can formulate a plan for reaching that goal.

💡 Quick Tip: Before opening an investment 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.

6 Tips For Building Wealth in Your 30s

Curious about how to build wealth in your 30s? These tips can help you figure out how to save money in your 30s, even if you’re starting from zero.

1. Set up a Rainy Day Fund

Life doesn’t always go as planned. It’s important to have a nice cushion of cash to land on, should any bad news come your way, such as a job loss, a medical emergency, or a car repair.

Not having the money for these unexpected expenses can threaten your financial security. To prevent such shocks, sock away at least three-to-six months’ worth of savings that can budget for your everyday living expenses, from rent on down.

2. Pump Up Your 401(k)

If your company offers a 401(k) plan, consider it an opportunity for investing in your 30s while potentially reducing your current taxes. This is especially true if your employer offers a match (though matching is typically only offered if you contribute a certain amount). The match is essentially free money, so you should take full advantage of it, if possible.

Aim to increase your contributions on a regular basis. This could be once a year or twice a year, and especially whenever you get a bonus or a raise. Some plans allow you to do this automatically at certain pre-decided intervals.

3. Consider Other Retirement Funds

If you don’t have access to a 401(k), there are other options that can help fund your future and help you with building wealth in your 30s.

And even if you contribute to a 401(k), you may benefit from these additional options. For example, if you’re already maxing out your 401(k), you might continue saving for retirement with an Individual Retirement Account (IRA)

Depending on your income, you may qualify to contribute to a Roth IRA, which lets you contribute after-tax income (that means you can’t write it off) up to a certain amount each year. You can withdraw IRA and 401(k) funds without penalty starting at 59 ½.

In addition to tax-advantaged accounts, you might consider opening a taxable investment account to make the most of your money in your 30s. With taxable accounts, you don’t get the same tax breaks that you would with a 401(k) or IRA. But you’re not restricted by annual contribution limits or restrictions around withdrawals, so you can continue growing wealth in your 30s at your own pace as your income allows.

4. Open a Health Savings Account (HSA)

If you have access to a Health Savings Account this could be a valuable resource for building wealth in your 30s. For those who qualify, this is a personal savings account where you can sock away tax-advantaged money to pay for out-of-pocket medical costs. These could include doctor’s office visits, buying glasses, dental care, and prescriptions.

The money you save is pre-tax, and it grows tax-free. Also, you don’t have to pay taxes on any money you withdraw from your HSA, as long as it’s for a qualified medical expense.

You’ll need to be enrolled in a high deductible health plan to be eligible for an HSA. If your company offers health insurance, talk to your plan administrator or benefits coordinator to find out whether an HSA is an option.

5. Give Yourself Goals

One of the best ways to build wealth in your 30s involves setting clear financial goals. For example, you might use the S.M.A.R.T. method to create money goals that are specific, measurable, achievable, timely and realistic.

Then, start working toward those goals, whether it’s sticking to a budget or paying down your credit card or auto loan. Once you experience the satisfaction of meeting these goals, you’ll be able to think bigger or longer term for your next goal.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

6. Check Your Risk Level

Investing is about understanding risk, knowing how much risk you’re prepared to take, and choosing the types of investments that are right for you.

If you’re working out how to build wealth in your 30s, consider two things: Risk tolerance and risk capacity. Your risk tolerance reflects the amount of risk you’re comfortable taking. Risk capacity, meanwhile, is a measure of how much risk you need to take to meet your investment goals.

As a general rule of thumb, the younger you are the more risk you can take on. That’s because you have more time until retirement to smooth out market highs and lows. Investing consistently through the ups and downs using dollar-cost averaging can help you generate steady returns over time.

If you’re not sure what level of risk you’re comfortable with, taking a free risk assessment or investing risk questionnaire can help. This can give you a starting point for determining which type of asset allocation will work best for your needs, based on your age and appetite for risk.

The Takeaway

Investing in your 30s to build wealth can seem intimidating, but once you set clear goals for yourself and start taking steps to reach them, it can get easier.

Watching your savings grow through budgeting, paying down debt, and investing for retirement can motivate you to keep working toward financial security and success.

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

Invest with as little as $5 with a SoFi Active Investing account.

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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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Jul

2023

How Much Debt Does the U.S. Have and Who Owns It?

How Much Debt Does the United States Have and Who Owns It?

By Ashley Kilroy | Financial Independence, Growing Wealth, invest, Investing | Comments Off

When consumers spend more than they make, they often find themselves in debt. The same is true for countries, and the United States is no exception. When the United States spends more than it earned through taxes and other revenue sources, it creates a deficit.

The United States borrows money, typically by issuing Treasury securities, such as treasury bills (T-Bills), notes (T-Notes) and bonds (T-Bonds), to cover that difference. Every year the United States cannot pay the deficit between revenue and expenses, the national debt grows.

Here’s everything you need to know about the national debt, how it impacts the American economy, and who owns US debt.

How Much Debt Does the US Have?

As of July 2023, the United States is $32.47 trillion in debt and that number continues to climb. Some economists prefer to look at national debt as a percentage of gross domestic product (GDP). At 118.5%, the current US debt level is higher than the country’s GDP.

Who Is the US in Debt to?

There are generally two categories of debt: intragovernmental holdings and debt from the public. The debt that the government owes itself is known as intragovernmental debt. In general, this debt is owed to other government agencies such as the Social Security Trust Fund.

Because the Social Security Trust Fund doesn’t use all its generated capital, it invests the excess funds into U.S. Treasuries. If the Social Security Trust Fund needs money, it can redeem the Treasuries. As of June 2023, intergovernmental debt hovers around $6.87 trillion, making the US government the largest single owner of US debt.

The public debt consists of debt owned by individuals, businesses, governments, and foreign countries. Foreign countries own roughly one-third of U.S. public debt, with Japan owning the largest chunk of American debt hovering around $1.1 trillion. US debt to China ranks second, with that country owning roughly $859 billion of American debt.

What is The History of the National Debt?

Since the founding of the United States and the American revolution, debt has been a grim reality in America. When America needed funding for the Revolutionary War in 1776, it appointed a committee, which would later become the Treasury, to borrow capital from other countries such as France and the Netherlands. Thus, after the Revolutionary War in 1783, the United States had already accumulated roughly $43 million in debt.

To cover some of this debt obligation Alexander Hamilton, the first Secretary of the Treasury, rolled out federal bonds. The bonds were seemingly profitable and helped the government create credit. This bond system established an efficient way to make interest payments when the bonds matured and secure the government’s good faith state-side and internationally.

The debt load steadily grew for the next 45 years until President Andrew Jackson took office. He paid off the country’s entire $58 million debt in 1835. After his reign, however, debt began to accumulate again into the millions once again.

Flash forward to the American Civil war, which ended up costing about $5.2 billion. Because the war dragged on, the U.S. was strained to revamp the financial systems in place. To manage some of the debt at hand, the government instituted the Legal Tender Act of 1862 and the National Bank Act of 1863. Both initiatives helped lower the debt to $2.1 billion.

The government borrowed money again to fuel World War I, and then substantially more money to pay for public works projects and attempt to stem deflation during the Great Depression, and even more to pay for World War II, reaching $258 billion in 1945.

Since 1939, the United States has had a “debt ceiling,” which limits the total amount of debt that the federal government can accumulate. The Treasury can continue to borrow money to fund government operations, but the total debt cannot exceed the prescribed limit. However, Congress regularly raises the ceiling. The latest change came in June 2023, when President Biden signed a bill that suspended the limit until January 2025 in exchange for imposing some cuts on federal spending.

Since the debt ceiling was first introduced, American debt’s growth continued growing, with the pace accelerating in the 1980s. US debt tripled between 1980 and 1990. In 2008, quantitative easing during the Great Recession more than doubled the national debt from $2.1 trillion to $4.4 trillion.

More recently, the national debt has increased substantially, with Covid-related stimulus and relief programs adding nearly $2 trillion to the national debt over the next decade.

💡 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.

Why The National Debt Matters to Americans

As the national debt continues to skyrocket, some policymakers worry about the sustainability of rising debt, and how it will impact the future of the nation. That’s because the higher the US debt, the more of the country’s overall budget must go toward debt payments, rather than on other expenses, such as infrastructure or social services.

Those worried about the increase in debt also believe that it could lead to lower private investments, since private borrowers may compete with the federal government to borrow funds, leading to potentially higher interest rates that can affect investments and lower confidence.

In addition, research shows that countries confronted with crises while in great debt have fewer options available to them to respond. Thus, the country takes more time to recover. The increased debt could put the United States in a difficult position to handle unexpected problems, such as a recession, and could change the amount of time it moves through business cycles.

Additionally, some worry that continued borrowing by the country could eventually cause lenders to begin to question the country’s credit standing. If investors could lose confidence in the US government’s ability to pay back its debt, interest rates could rise, increasing inflation or other investment risks. While such a shift may not take place in the immediate future, it could impact future generations.

The Takeaway

The national debt is the amount of money that the US government owes to creditors. It’s a number that’s been steadily increasing, which some investors and policymakers worry could have a negative impact on the country’s economic standing going forward.

Some economists believe that the growing national debt could lead to higher interest rates and lower stock returns, so it’s a trend that investors may want to factor into their portfolio-building strategy, especially over the long-term.

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Jul

2023

Purchasing Power 101: Examining the Value of the US Dollar

By Colin Dodds | invest, Investing, Preparing for Retirement | Comments Off

Purchasing power is a concept used to express the amount of goods and services a consumer or business can buy with a given unit of currency. In the United States, purchasing power is directly linked to the value of the dollar.

Due to inflation, a dollar today typically won’t go as far as it did last year. And a dollar next year won’t buy the same things that it did this year. This fluctuation in US dollar purchasing power is constant, and goes unnoticed, except in times of extreme inflation.

How Does Purchasing Power Impact Investors?

Once you understand the purchasing power definition, you can start to understand its context for investing. The purchasing power of a dollar affects investors because it makes an impact on virtually every aspect of the broader economy. When the dollar buys less, it changes the shopping decisions of consumers, the hiring practices of employers, the strategic decisions of corporations, and the monetary policy of the Federal Reserve.

One way to track inflation and purchasing power of a dollar is the Consumer Price Index (CPI), a statistic compiled by the US Bureau of Labor Statistics (BLS), which reports the figure every month. The statistic measures the average of prices of a set of goods and services in sectors such as transportation, food, and healthcare. Economists consider it a valuable gauge of the ever-changing cost of living, though it does exclude some important spending categories, including real estate and education.

Investors, executives and policymakers use CPI as a lens through which to scrutinize other economic indicators, including sales numbers, revenues, earnings and so on. It also determines the payments made to the millions of people on Social Security, which gets adjusted for the cost of living every year, and retirees drawing a pension from the military or the Federal Civil Services.

💡 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.

Why Does the Value of the Dollar Change?

A number of factors drive the value of the US dollar, including large scale factors having to do with economic cycles, government politics and international relations. But the dollar has also experienced inflation for most of the last century.

Inflation rose after World War I amid increased demand for food and other raw materials, which raised prices of most consumer goods up until the Great Depression, in which the country experienced prolonged deflation.

That’s when President Franklin Roosevelt stepped in with a surprising policy decision: He banned private ownership of gold, and required people to sell their holdings to the government. That allowed the Federal Reserve to increase the money supply and stop deflation in its tracks.

Since 1933, through World War II, the Cold War, and a host of changing monetary and economic policies, the US dollar has seen various rates of inflation. It reached its peak during the late 1970s and early 1980s oil and gas shortages exacerbated existing inflation and led to a gas shortage, and an increase in the price of manufacturing and shipping of nearly every single consumer good.

Inflation rose at a more steady pace through the 1990s, falling to historically low levels in the past decade. One reason for the ongoing inflation is that the Federal Reserve continually increased the money supply via economic stimulus. The logic is simple supply and demand: If there are more dollars, then each one is worth less in terms of purchasing power.

In response to the Covid-19 pandemic and the ensuing lockdowns, the Federal Reserve injected trillions into the economy. That, along with other stimulus measures, has had many investors worried about the impact on the purchasing power of the dollar, and what that might mean for the broader economy. In 2022, inflation rose at the fastest pace in 40 years, making prices more expensive and resulting in many consumers having less money to spend.

What Purchasing Power Means for Investors

Generally, investors consider inflation a headwind for the markets, as it drives up the costs of materials and labor, boosts the cost of borrowing and tends to reduce consumer spending. That all tends to translate to lower earnings growth, which can depress stock prices.

But after decades of steady inflation, the markets have priced in a certain amount of shrinkage when it comes to the purchasing power of the dollar. Inflation has a great impact when it occurs suddenly and unexpectedly.

But inflation can have benefits for investors as well. During an economic upswing, inflation is a reliable side effect of prosperity, since economic booms produce higher profits, which drives up the markets. Historically, some experts say that the decades when the S&P 500 Index has delivered the highest returns have been when inflation has been between 2% to 3% annually.

Investors saving for long-term goals, such as retirement, must take declining purchasing power into account when determining how much they’ll need to reach those goals.

💡 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.

How Does Inflation Influence Stocks?

Inflation impacts different types of stocks differently, and there are several strategies that investors can use to hedge against inflation. During periods of high inflation, growth stocks tend to underperform, simply because so much of their value is tied up in the expectation of future earnings, and inflation diminishes those expectations.

Value stocks, on the other hand, typically boast steadier earnings, and are valued in line with those earnings. As a result, value stocks, as a category, tend to hold up better during periods of high inflation.

Other investments to consider during periods of high inflation include dividend-paying utility stocks and REITs, gold and other commodities. And because periods of high inflation usually brings higher interest rates, it can be a good time to buy bonds, especially government bonds

The Takeaway

The value of the dollar, in terms of what it can buy, changes over time, but inflation isn’t always bad news for investors. Some stocks may perform better than others in an inflationary environment, and higher interest rates may be good news for bond investors and savers.

Invest with as little as $5 with a SoFi Active Investing account.

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Jul

2023

How to Use Social Media for Investing Tips: The Smart Way

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

Social media has become an important news source for many people, including investors looking for ideas to guide their strategy. That said, social media users must be careful when sifting through the vast quantities of information on the web to make sure they’re relying on legitimate sources.

There are a variety of social media platforms that investors use for information, including Twitter, Facebook, LinkedIn, Stocktwits, and even TikTok. While there are potential benefits to using social media to invest, there are also plenty of pitfalls.

Why Understanding Social Media Investing Is Important

In 2013, the Securities and Exchange Commission (SEC) allowed companies to start using social media platforms like Facebook and Twitter to communicate information to investors. As long as companies tell investors which website to check, they can use social media to announce information like company metrics that may influence stock price. Individuals interested in investing in a particular company may want to follow that company directly to stay abreast of breaking news.

Social media can also be an important place to gather information from analysts and financial bloggers who post their thoughts about stocks and news events or upcoming IPOs. Since these folks are typically reacting to news, following them may be a way to stay on top of popular investment trends. More than a third of young investors say that they now use social media to look into possible investments, making it their most popular source of investing information ideas.

Recommended: 10 Popular Investing Trends

Recently, social media has entered the investment space in a new way with the rise of meme stocks. Meme stocks are companies that experience increased volume in trades due to hype on social media. Perhaps the original, and most famous, meme stock is GameStop. Retail investors encouraged each other to buy shares of the company over the subreddit message board r/wallstreetbets to force a short squeeze among hedge fund investors betting against the stock. Together these retail investors drove the share price up nearly 8,000% by late January 2021 to $86.88 a share.

Because investor sentiment, rather than company fundamentals, often fuels meme stock price increases, they can be extremely volatile. While meme stock investing can be exciting, it can also expose investors to large amounts of risk. As of July 2023, GameStock was down to $23.50 a share.

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

How to Use Social Media When Investing

Individuals aren’t the only ones using social media to guide their investing decisions. Fully 80% of institutional investors said that social media is part of their regular workflow. If you want to use social media as a way to inform your investment decisions, there are a few strategies to consider.

1. Follow Companies in Which You Invest (or Want to Invest)

Directly following a company’s social media accounts ensures the information you receive is timely and accurate.

2. Follow Informed Experts

Follow news sources, journalists, and analysts who cover the companies and sectors, such as healthcare or electric vehicles, in which you’re interested. Consider people who have large followings, a good clue that they provide information that is useful to a broad range of investors.

3. Use Tech Tools

Some brokerages offer social media tools such as social sentiment trackers that aggregate and analyze information that’s posted on social media sites. For example, some firms use software to compile information from Tweets, blog posts, and messages. Others offer in-house social media platforms that allow investors to communicate with each other to discuss trading ideas. Or they may offer crowd-sourced research and analysis, using a website or app to gather ideas and opinions from the public at large. For example, analysts, investors and academics might weigh in with their thoughts on earnings estimates.

It’s important for investors to beware that these tools can be inaccurate or misleading. Data gathered from social media may be old, or contain hidden agendas. Read all disclosures offered by social sentiment tools to understand how they collect data and any risks or conflicts of interest.

Recommended: Understanding Market Sentiment

Social Media Investing Mistakes to Avoid

While social media can be a helpful tool for investors, it also has several pitfalls that investors should understand.

1. Impulsive Decisions

Information driven by social media, such as discussion boards or buy/sell indicators based on social sentiment can drive investors toward emotional investing, especially when information appears in real time. Impulsive investments carry additional risks. Trading securities without proper due diligence can lead you to buy stocks as prices are peaking, or sell as prices tumble, locking in losses and missing out on potential rebounds. Avoid allowing social media to feed the tendency to time the market.

2. Failing to Do Your Own Research

Think of information you get from social media as a jumping-off point, something that sparks your interest and leads you to do more research.

For example, if someone posts about how great they think a stock is, take a look at the company’s financials yourself. Look at past and present earnings reports to understand trends. You can find out this and other information on a company’s quarterly report. Look at the annual report as well. It will let you know about any risks the company foresees in its future. In addition, look at what a number of analysts are predicting the company’s earnings will be in the future.

You may also want to consider broader economic indicators or market measures, such as the Fear & Greed Index.

3. Trusting Bots

Bots are programs—not humans—built to engage on social media. It’s not always clear what their agenda is, and they certainly don’t have your best interests in mind. There are several signs that an account could be a bot, including:

• No profile picture

• Strange numbers of characters in the account name

• Posting at irregular hours

• Repetitive, formulaic language

• Repeated posting on the same subject or the the link

The Takeaway

Social media has become an important way to gather investment information. But learning to recognize reliable sources is critical to finding accurate and useful information to create a strategy whether you’re investing in stocks, bonds, options, or other financial securities. What’s more, investors must understand the behavioral biases that social media investing can trigger, namely the temptation to time the market.

To avoid this pitfall, create and follow a long-term financial plan. Use social media to research stocks and funds that fit your plan, including your time horizon and tolerance for risk.

Invest with as little as $5 with a SoFi Active Investing account.

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Jul

2023

What Is a Divestiture?

By Brian Nibley | Financial Independence, Growing Wealth, invest, Investing | Comments Off

A divestiture, also known as a divestment, involves the liquidation of a company’s assets, such as building or intellectual property, or a part of its business, such as a subsidiary. This can occur through several different means, including bankruptcy, exchange, sale, or foreclosure.

Divestitures can be partial or total, meaning some or all of the company could be spun off or otherwise divested, depending on the reason for the company getting rid of its assets. Corporate mergers and acquisitions are a common example of one type of divestiture.

What Are Reasons a Company Would Divest Itself?

Often a divestiture reflects a decision by management that one part of the business no longer helps it meet its operational goals. A divestiture can be an intelligent financial decision for a business in certain situations.

If one aspect of a business (e.g., a product line or a subsidiary) isn’t working, has become unprofitable, or is likely to soon consume more capital than it can create, then instead of letting that be a continued drain on resources, a company can divest.

This not only does away with the troublesome aspect of the company, but also frees up some money the company can put toward more productive endeavors, such as new research and development, marketing, or new product lines.

There are many other potential reasons for a company to divest itself of a particular aspect of its business as well. The growth of a rival may prove overwhelming and insurmountable, in which case divesting might make more sense than continuing to compete.

A company may choose to undergo a divestment of some sort, such as closing some store locations, in order to avoid bankruptcy, to take advantage of new opportunities, or because new market developments might make it difficult for part of the company to survive.

Companies also sometimes must divest some of their business because of a court order aimed at breaking up monopolies. This can happen when a court determines that a company has completely cornered the marketplace for its goods or services, preventing fair competition.

💡 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.

What Happens in a Divestiture?

When a divestiture involves the sale of part or all of a company, the process has four parts. The first two parts involve planning for the actual divestment transaction itself. Once management decides which part of the company to divest and who will be buying it, the divestment can begin.

1. Monitoring the Portfolio

When pursuing an active divestiture strategy, the company’s management team will review each business unit and try to evaluate its importance to the company’s overall business strategy. They’ll want to understand the performance of each part of the business, which part needs improvement, and if it might make sense to eliminate one part.

2. Identifying a Buyer

Once the business identifies some or all of the company as a potential divestment target, the team moves on to the next problem that logically follows: Who will buy it?

The goal is to find a buyer that will pay enough for the business to cover the estimated opportunity cost of not selling the business unit in question. If the buyer does not have the liquidity to make the purchase with cash, they might offer an equity deal or borrow money to cover the cost.

3. Executing the Divestiture

The divestiture involves many aspects of the business, including a change of management, company valuation, legal ownership, and deciding which employees will remain with the company and which ones will have to leave.

4. Managing the Financials

Once the sale closes, attention turns to managing the transition. The transaction appears on the company’s profit-and-loss statement. If the amount that the company receives for the asset it sells is higher than the book value, that difference appears as a gain. If it’s less the company will record it as a loss.

The company will typically share the net impact of the divestiture in its earnings report, following the transaction.

What Are The Different Types of Divestitures?

There are several different ways companies can define divest for themselves. A few of these options include:

• An equity carve-out, when a company can choose to sell a portion of its subsidiaries through initial public offerings but still retain full control of them.

• A split-up demerger, when a company splits in two, and the original parent company ceases to be.

• A partial sell-off, where a business sells one of its subsidiaries to another company. The funds from the sale then go toward newer, more productive activities.

• A spin-off demerger, in which a company’s division becomes a separate business entity.

What Causes a Company to Divest?

A divestiture strategy can be part of an overall retrenchment strategy, when a company tries to reinvent itself by slimming down its activities and streamline its capital expenditures. When that happens, the company will divest those parts of the business that are not profitable, consuming too much time or energy, or no longer fit into the company’s big-picture goals.

Factors that could influence a company to adopt a divestiture strategy can be lumped into two broad groups:

External Developments

External developments include things outside the company, such as changing customer behavior, new competition, government policies and regulations, or the emergence of new disruptive technologies.

Internal Developments

Internal developments include situations arising from within the company, such as management problems, strategic errors, production inefficiencies, poor customer service, etc.

Divestiture Strategy Example

Imagine a fictitious company called ABC was the parent of a pharmaceutical company, a cosmetic company, and a clothing company. After some time and analysis, ABC’s management determines that the company’s financials have begun deteriorating and they need to make a change in the business.

Following the four-step process above, they begin by finding the weakest points of business. Eventually, they decide that the pharmaceutical branch of the company is under-performing and would also be the easiest for the company to divest. It makes more sense to stick to clothing and cosmetics.

After identifying a buyer (perhaps a larger pharmaceutical company or a promising startup looking to expand), the divestment transaction occurs. The employees who work in the pharmaceutical branch either lose their jobs, or they get roles working for the new owner of that part of the business. The cash infusion that ABC gets as a result of the sale of its pharmaceutical branch will go toward new marketing efforts and creating new product lines.

The Takeaway

Divesting is essentially the opposite of investing. It involves a company selling off parts of its business. A divestiture can have some positive outcomes on the value of a company, and there are several business reasons that a company would choose to divest. Depending on the circumstances, this process could theoretically be either a positive or a negative for shareholders.

Investors could see news of a divestment as a sign that a company is struggling, leading them to sell the stock. While this initial reaction could be one likely outcome, the company could eventually wind up doing even better than before if it manages itself better as a leaner company. In either case, the divestiture is one factor that investors can use in their analysis of that company’s stock.

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What Is a Divestiture?

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What Happens in a Divestiture?

1. Monitoring the Portfolio

2. Identifying a Buyer

3. Executing the Divestiture

4. Managing the Financials

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External Developments

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