Aug
03
2023
Unrealized Gains & Losses, Explained
An unrealized gain or loss is the change in market value of an asset from its purchase price, before it is sold.
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SoFi
Student Loan Consolidation and Refinancing
Aug
03
2023
What Causes a Stock Market Bubble?
What Is a Stock Market Bubble?
A stock market bubble is often caused by speculative investing. As investors bid up the stock price, it becomes detached from its real value. Eventually, the bubble bursts, and investors who bought high and didn’t sell fast enough are left holding shares they overpaid for.
Stock market bubbles are notoriously difficult to spot, but they’re famous for potentially causing large-scale consequences, such as market crashes and recessions.
For investors on an individual level, entering the market in the later stages of a bubble could mean painful losses. But misdiagnosing a stock market bubble or exiting from positions too early can result in an investor missing out on potential gains.
Here’s a deeper dive into what causes stock market bubbles and how they develop.
Five Stages of a Market Bubble
Modern-day investors and market observers typically categorize market bubbles based on the principles of Hyman P. Minsky, a 20th century economist whose financial-instability hypothesis became widely cited after the 2008 financial crisis.
Minsky debunked the notion that markets are always efficient. Instead, he posited that underlying forces in the financial system can push actors–such as bankers, investors and traders–toward making bad decisions.
Minsky’s work discussed how bubbles tend to follow a pattern of human behavior. Below is a closer look at the five stages of a bubble cycle:
1. Displacement
Displacement is the phase during which investors get excited about something — typically a new paradigm such as an invention like the Internet, or a change in economic policy, like the cuts to short-term interest rates during the early 2000s by Federal Reserve Chair Alan Greenspan.
For instance, one example of displacement can be the enthusiasm for cryptocurrencies that picked up in 2017. While the cryptocurrency market technically began back in 2009, mainstream institutional and retail investors started gravitating toward crypto coins and tokens like Bitcoin in a bigger way in 2017.
2. Boom
That excitement for a new paradigm next leads to a boom. Prices for the new paradigm rise, gradually gathering more momentum and speed as more and more participants enter the market. Media attention also rapidly expands about the new investing trend.
This phase captures the initial price increases of any potential bubble. For instance, after Greenspan cut interest rates in the early 2000s, real-estate prices and new construction of homes boomed. Separately, after the advent of the Internet in the 1990s, shares of technology and dot-com companies began to climb.
💡 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.
3. Euphoria
The boom stage leads to euphoria, which in Minsky’s credit cycle has banks and other commercial lenders extending credit to more dubious borrowers, often creating new financial instruments. In other words, more speculative actions take place as people who are fearful of missing out jump in and fuel the latest craze. This stage is often dubbed as “froth” or as Greenspan called it “irrational exuberance.”
For instance, during the dot com bubble of the late 1990s, companies went public in IPOs even before generating earnings or sales. In 2008, it was the securitization of mortgages that led to bigger systemic risks in the housing market.
4. Profit-Taking
This is the stage in which smart investors or those that are insiders sell stocks. This is the “Minsky Moment,” the point before prices in a bubble collapse even as irrational buying continues.
History books say this took place in 1929, just before the stock market crash that led to the Great Depression. In the decade prior known as the “Roaring 20s,” speculators had made outsized risky bets on the stock market. By 1929, some insiders were said to be selling stocks after shoeshine workers started giving stock tips–which they took to be a sign of overextended exuberance.
💡 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).
5. Panic
Panic is the last stage and has historically occurred when monetary tightening or an external shock cause asset values to start to fall. Some firms or companies that borrowed heavily begin to sell their positions, causing greater price dips in markets.
After the Roaring 20s, tech bubble, and housing bubble of the mid-2000s, the stock market experienced steep downturns in each instance–a period in which panic selling among investors ensued.
Recommended: Should I Take My Money Out of the Stock Market?
The Takeaway
One of the prevailing beliefs in the financial world is that markets are efficient. This means that asset prices have already accounted for all the information available. But market bubbles show that sometimes actors can discount or misread signs that asset values have become inflated. This typically happens after long stretches of time during which prices have marched higher.
Stock market bubbles are said to occur when there’s the illusion that share prices can only go higher. While bubbles and boom-and-bust cycles are part of markets, investors should understand that stock volatility is usually inevitable in stock investing.
Investing has historically been an important part of wealth-building for individuals, and the benchmark S&P 500 Index has an average market return of 7% annually after adjusting for inflation.
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).
Photo credit: iStock/fizkes
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOIN0723031
Read moreAug
02
2023
What Is a Stock Warrant? Guide to Exercising Stock Warrants
Stock warrants are similar to options: A stock warrant offers investors the right, but not the obligation, to buy or sell a stock at a specific price by a set date.
That said, while it’s fairly easy to come by stock options, stock warrants are less common, especially in the U.S. Some investors may be familiar with stock warrants because they’re typically part of SPAC deals (special purpose acquisition company).
Although warrants and options do have some similarities (e.g. there are put warrants and call warrants), they also have substantial differences. Here’s what you need to know about how stock warrants work.
What Is a Stock Warrant?
Like a stock option, a stock warrant is a derivative contract that gives the holder the right, but not the obligation, to buy or sell the underlying security at the agreed-upon strike price on or before the expiration date of the contract.
Stock warrants are issued by the company that has the stock. They’re typically used as a way to raise capital, because the cost of the warrant (the premium) and the cost per share both flow to the company.
With U.S. warrants, the expiration date is the last date investors can exercise the warrant; with European-style warrants, the expiration date is the only date when investors can exercise their warrants. In the U.S. stock warrants typically don’t expire for a period of several years.
Investors pay a premium per share for the stock warrant (typically a fraction of the share price). Investors generally buy one warrant per one share of stock, but warrants can also be sold at a certain ratio, e.g. 4 to 1 (e.g. four warrants represent one share of the underlying security).
It’s important to know the terms of the warrant, so that you know what you’re buying, how much you’re paying, what it’s worth, and when the warrant expires.
Two Main Types of Warrants
Similar to options trading, investors can buy a call warrant or a put warrant. A call warrant allows investors to purchase shares from the company by the expiration date.
A put warrant allows them to sell the shares back to the company.
Stock warrants in general aren’t common in the U.S., especially with the decline of the SPAC market (more on that below). Put warrants tend to be less common than call warrants.
💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.
The Value of Warrants
Warrants have intrinsic value and time value, similar to options. Intrinsic value is how profitable the stock warrant would be if the investor exercised it now.
The time value of a warrant, put simply, is a function of how volatile the underlying shares are, and how much time is left until expiration. The more time the warrant has until it expires, the more time it has (potentially) to rise in value.
That’s why stock warrants can be traded on the secondary market.
When an investor exercises a stock warrant in order to purchase shares, the company issues new shares, which are dilutive to the existing shareholders.
Pros of Stock Warrants
The primary advantage of stock warrants is that for a relatively small upfront investment, investors have the right to purchase shares of stock — which, if they are lucky, may increase in value and deliver a substantial profit. The downside is that the warrant can expire worthless.
However, there is an advantage in terms of time: Stock warrants are often long-term — some are five, 10, or even 15 years. Ideally then, investors can wait for the best time to exercise their warrants.
Given the longer time horizon before warrants typically expire, investors can trade warrants on the secondary market, assuming the warrant still has value.
Cons of Stock Warrants
The leverage offered by a warrant cuts both ways, giving investors the potential for big gains or big losses — so these contracts can be quite risky.
Also, an investor may be entitled to dividends or have voting rights when they purchase actual shares of stock. That’s not true when investors buy warrants. Warrants don’t pay dividends and don’t offer voting rights.
Profits from selling stock warrants are taxed as ordinary income, which can be a higher tax rate for investors vs. the capital gains rate.
| Pros | Cons |
|---|---|
| The low price of warrants can lead to big gains. | Warrants can be risky, and a modest price drop in the underlying stock price can render the warrant worthless. |
| The longer time horizon gives investors the chance to buy/sell at the right time. | Stock warrants don’t pay dividends and don’t come with voting rights. |
| Investors can trade their warrants on the secondary market before they expire, if they still have value. | Profits from selling a stock warrant are taxed as income, not as capital gains. |
The Complexity of Stock Warrants
Investors should bear in mind that, above all, stock warrants are not as simple as they can seem at first. In some ways the terms of stock warrants are more opaque than stock options.
If a stock pays dividends, that may lower the price of the stock warrant (as an inducement to investors, who won’t see dividends, but may see a higher payoff). But a stock warrant can also be structured so the share price incrementally rises over time, which may not be favorable to the investor.
Stock warrants are typically not considered very liquid, because there are so few of them.
💡 Quick Tip: If you’re an experienced investor and bullish about a stock, buying call options (rather than the stock itself) can allow you to take the same position, with less cash outlay. It is possible to lose money trading options, if the price moves against you.
Stock Warrants vs Stock Options
Warrants differ from options in a few important ways:
1. A stock option is a contract entered into by two investors, whereas a warrant is issued by the company that issues the stock.
2. Stock warrants also differ from options in that they can have expiration dates as far as 15 years in the future. Most options last for much shorter periods, and rarely more than three years.
3. Warrants are a source of capital for the issuing company, whereas options are instruments traded between entities.
4. Call warrants and options give the holder the right to buy a stock; puts give the holder the right to sell a stock. But there is a difference between put options and put warrants in that put options may be more advantageous because their price goes up when the stock price goes down. If you buy a put warrant from a company and the price goes down to zero, you may not be able to sell your stock back to the company.
| Warrants | Options |
|---|---|
| Issued directly by a company | Traded between investors |
| Expiration dates as long as 15 years | Expiration dates typically less than a year |
| Source of capital for the company | Potential profit or loss for investors, not the underlying company/entity |
| Put warrants may be more risky than put options | Put options may be more advantageous than put warrants |
How Do SPAC Warrants Work?
SPACs, which stands for special purpose acquisition companies, are shell companies that raise money by listing shares on a stock exchange, and then merging with private companies that wish to go public.
When it comes to SPACs, investors who buy in during the pre-listing process are given “units.” Each “unit” includes a share and a warrant or a fraction of a warrant. The warrants are meant to be additional compensation to pre-listing SPAC investors for agreeing to have their capital held in a trust until the merger.
SPAC Market Declines
While SPACs once saw considerable interest from investors only a few years ago, with billions flowing into these deals, SPACs are less common today. In 2022 alone, the number of SPAC mergers dropped by 22% — and the number of canceled SPACs doubled to about 55 last year.
In addition, institutional investors — hedge funds, mutual funds, and pensions — historically have had greater access to SPAC units, since units are allocated during the private placement stage of a SPAC deal.
This has been one of the criticisms lobbed at SPACs, with detractors arguing that it gives institutional investors a better risk-reward proposition than retail traders, who typically just buy regular shares in the market without the added potential value warrants can offer.
Recommended: SPAC vs. IPO
Example of Exercising SPAC Warrants
The SPACs’ shares “separate” from the warrants usually 52 days after the initial public offering or IPO. This allows unitholders to trade the warrants and shares separately. The fees for exercising or trading warrants can be more sizable than the fees for trading shares.
Here’s a case example of how an investor may exercise their SPAC warrant. A merger between the SPAC and the target company is completed, and 52 days later, the warrants become exercisable at their strike price, which is typically $11.50 in SPACs.
So let’s say the shares of the combined company are trading at $15, so higher than the strike price of $11.50. That means investors can exercise their warrants and buy additional shares at $11.50 and immediately sell them for $15.
The investor would then pocket the difference between the exercise price of $11.50 and the current share price of $15 for a tidy profit.
But if the share price is trading lower than the exercise price, the investor is in a wait-and-see situation — and if the share price never rises above the strike price, the warrants are essentially worthless.
Recommended: What to Know About SPACs Before You Invest in Them
Important Things to Know About SPAC Warrants
While SPAC warrants can be a lucrative opportunity, it’s also important to be aware that each SPAC and the terms of the warrant contracts need to be evaluated by investors on a case-by-case basis.
Remember, warrants offer an opportunity but they can also expire when worthless. For instance, it’s possible shares of the combined company never rise above the strike price of $11.50, making it impossible for investors to exercise the warrants.
Furthermore, the regulation of SPACs and their warrants could change. In April 2021, the Securities and Exchange Commission (SEC) changed how SPAC companies can classify warrants on their balance sheet. Many SPACs have considered warrants as equity. But under the new guidelines, in certain circumstances, SPAC companies need to classify warrants as liabilities.
Many SPACs in the pipeline have had to reevaluate their financial statements in order to make sure they’re in compliance with the new regulatory guidelines. Market observers interpreted the SEC’s move as an attempt to cool the red-hot SPAC market.
Why Do Companies Issue Warrants?
The reason that companies issue stock warrants is to raise capital without selling other bonds or stock. Selling warrants also protects the company’s stock from becoming diluted, as would happen with the issuing of new stock — unless or until investors exercise them.
Call warrants will dilute the shares on the market when investors exercise them.
Recommended: Understanding Stock Dilution
Because warrants are less expensive than the underlying stock, unproven companies will use them to entice new shareholders. The company makes money on the warrant sale, and on the exercise of the call warrant if the owner buys the underlying shares. And if the warrant expires, the company keeps the purchase price of the warrant.
A company may issue call warrants as a show of confidence for shareholders who want to hedge their holdings of that company’s stock. The company offers the hedge of the call warrant to reassure shareholders while raising capital from the sale of the warrant.
Sometimes, companies will also issue warrants as a way to raise capital during periods of turbulence. For example, some companies issue warrants if they’re headed for bankruptcy.
How to Find Warrants to Invest In
Not every publicly traded company offers warrants. In the U.S. the companies that tend to issue warrants are not big Fortune 500 corporations. Instead, they tend to be smaller, more speculative companies.
While there are some online databases of warrants, they’re not necessarily comprehensive and up-to-date. But if an investor has a company they’re interested in investing in via warrants, they can contact that company’s investor relations department. Investors can also go to the company website and search for the word “warrant,” or the company’s ticker symbol, followed by “WT.”
Some warrants can also be traded under the symbol that includes the underlying stock symbol with either a “W” or “WS” before it. Once an investor finds a warrant, most online brokerage accounts will allow them to buy and sell the warrant.
How to Use Warrants
For an investor who owns warrants, the first decision is when to exercise the warrant. For a call warrant, that’s when the stock price has risen above the warrant’s strike price. If it’s a put warrant, then it means the stock is trading below the strike price.
But a warrant holder has another option, which is to sell the warrant on the open market because warrants can be traded like options. This is one thing to consider if a call warrant is below the strike price. Even if it’s below the strike price, the call warrant may still have intrinsic value right up until it expires, though the market may offer you less for the warrant than you paid for it.
Even if the current stock price is higher than the strike price, an investor may choose to hold onto the warrant. That’s because the price could rise even higher before the warrant expires.
Whether buying, selling, or exercising a warrant, most brokers can help an investor get it done. Once purchased, a warrant will appear in a trading account just like a stock or option. But with warrants, like most financial derivatives, most brokers charge higher transaction fees. After the broker contacts the company that issued the warrants and exercises them, the stock will replace the warrants in the trading account.
Other Important Things to Know About Warrants
It’s important to remember that every company that issues warrants does it differently. One company may issue warrants in which five warrants can be exercised to obtain one share of stock. Another company may set the ratio at ten to one or twenty to one.
Some companies can adjust the strike price of their call warrants if the company pays out dividends. This is a twist that can benefit the buyer because warrants with a lower strike price are more likely to be exercised at a profit.
But not every contractual term in a warrant is necessarily to an investor’s benefit. There are some call warrants whose structure allows the issuing company to force investors to sell their warrants if the stock price rises too high above the warrant’s strike price. There are even some warrants whose strike price is designed to rise higher over time, which makes it less likely that an investor will be able to exercise the warrant at a profit.
While it makes sense to study and understand the fine print before buying a warrant or any investment, it’s especially important to double-check those terms and conditions when getting out of the investment, by exercising a warrant, for example.
The Takeaway
Stock warrants are a bit like their cousin, the stock option — but there are some key differences to know. These often-overlooked securities can offer investors an inexpensive way to bet on the long-term success of a company. But they come with potential pitfalls, particularly when it comes to the fact that they can expire if investors don’t exercise them.
Warrants have become more topical since they’re issued in SPACs, which have seen an equally dramatic rise and fall in popularity over the last few years. In SPACs, early investors often get a share plus a warrant or partial warrant. However, investors should evaluate each SPAC and warrant carefully given the potential volatility of these arrangements.
All of that said, stock warrants are relatively uncommon as investment vehicles in the U.S.
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).
FAQ
What is an example of exercising a stock warrant?
Let’s say a stock is trading at $5 per share. The company decides to sell call warrants for a strike price of $5.50 per share. If the stock price rises to $6 per share before the expiration date, an investor could exercise their stock warrants to make $0.50 per share. If the stock price drops to $4.75/share, investors would have to wait rather than take the loss — and hope for a price increase before the warrant expires.
What is the purpose of a stock warrant?
Stock warrants are generally issued by a corporation as a means of raising capital. The company sells the warrants to investors, who have a specified period of time in which to exercise the warrant (say, five years). In the above example, the company would raise $0.50 per share by selling call warrants at a slightly higher price-per-share.
How can you find a stock warrant to invest in?
Trying to find a stock warrant over-the-counter from the issuing company isn’t impossible, but it can be difficult, especially because most companies don’t offer warrants. The easiest way to find stock warrants on the secondary market is to purchase them through your brokerage account. Warrants are indicated with a W or WS added to the ticker.
Photo credit: iStock/PeopleImages
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.
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.
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.
SOIN0623088
Aug
02
2023
How to Trade ETFs: A Guide for Retail Investors
Trading ETFs is, in many ways, similar to trading stocks or other securities, and can be done on most stock-trading platforms or brokerages. And while conventional wisdom suggests investors are limited in what they can do with an exchange-traded fund (ETF), an investor can almost certainly buy into a fund based on portfolio needs.
But investors have different goals and strategies, and that may include trading or otherwise buying and selling ETFs frequently. Trading ETFs is fairly simple, though, and investors would do well to know how to trade ETFs.
What Is an ETF (Exchange-Traded Fund)?
An exchange-traded fund is a popular investment vehicle that enables investors to buy a group of stocks in one bundle, thus promoting investment diversity and efficiency. They’re widely available, usually through major investment fund companies.
ETFs aren’t mutual funds, although they originate from the same fund investment family. The primary differences between the two is that mutual funds are usually more expensive than exchange traded funds.
Another benefit of ETFs is that whereas mutual funds can only be traded after the end of the market day, ETFs can be traded during open market sessions at any point in the day. ETFs have become wildly popular, too, over the years.
💡 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.
Different Types of ETFs
ETFs come in a variety of different types, including the following:
• Stock ETFs: This type of ETF is composed of various equity (stock) investments.
• Bond ETFs: Bond funds hold different types of bond vehicles, like U.S. Treasury bonds, utility bonds, and municipal bonds.
• Commodities: Commodity ETFs are popular with investors who want gold, silver, copper, oil, and other common global commodities.
• International ETFs: Global-based ETFs usually include country-specific funds, like an Asia ETF or a Europe ETF, which are made up of companies based in the country featured in the ETF.
• Emerging market ETFs: This type of ETF is composed of stocks from up-and-coming global economies like Indonesia and Argentina.
• Sector ETF: A sector ETF focused on an economic sector, like manufacturing, health care, climate change/green companies, and semiconductors, among others.
Recommended: Tips on How to Choose The Right ETF
4 Reasons to Consider Trading ETFs
Trading ETFs offers the same advantages (and risks) associated with trading common stocks. These features and benefits are at the top of the list.
1. ETFs Provide Liquidity
In a multi-trillion dollar market, there is likely no shortage of investors looking to buy and sell ETFs. By and large, the bigger the market, the more liquidity it provides, and the easier it is to move in and out of positions.
2. There are Different Investment Options
With ETFs widely available in categories like stocks, bonds, commodities, and more recently, green industries and others, ETF traders have plenty of investment options.
3. ETFs Offer Portfolio Diversity
Investment specialists often extol the virtue of a diverse portfolio, i.e. one made up of both conservative and more aggressive investments that can balance one another and help reduce risk. With so many classes of ETFs available, it’s relatively easy to build an ETF trading portfolio that has different asset classes included.
4. ETFs Are Relatively Inexpensive to Trade
Exchange-traded funds are typically inexpensive to buy — the average fee for buying an ETF is just under 0.20 percent of the total asset purchased. Some brokerage platforms may offer commission-free ETFs.
What Are the Risks of Trading ETFs?
The main risk associated with trading ETFs is the same as with trading stocks — you could lose money. While shedding cash is always a threat when trading any security, the liquidity associated with exchange-traded funds makes it relatively easy to sell out of a position if needed. A candid conversation with a financial advisor may help investors deal with ETF investment trading risks.
How to Trade ETFs
Just as you can trade stocks, you can trade ETFs, too, by taking these steps.
Step 1. Choose a Trading Platform
Traditionally, investors trade stocks through a brokerage house or via an online broker more recently, on alternative trading platforms where investors can buy partial shares of a stock. As with most things in life, it’s generally a good idea to look around, kick some proverbial tires, and choose a broker with the best ETF trading services for you.
Investors can choose from different categories of ETF trading accounts, ranging from standard trading accounts with basic trading services to retirement accounts, specialty accounts, or managed portfolio accounts that offer portfolios managed by professional money managers.
Step 2. Select an ETF Trading Strategy
The path to successful ETF trading flows through good, sound portfolio construction and management.
That starts with leveraging two forms of investment strategy — technical or fundamental analysis.
• Technical analysis: This investment strategy leverages statistical trading data that can help predict market flows and make prudent ETF trading decisions. Technical analysis uses data in the form of asset prices, trading volume, and past performance to measure the potential effectiveness of a particular ETF.
• Fundamental analysis: This type of portfolio analysis takes a broader look at an ETF, based upon economic, market, and if necessary, sector conditions.
Fundamental analysis and technical analysis can be merged to build a trading consensus, typically with the help of an experienced money manager.
Any trading strategy used to build ETF assets will also depend on the investor’s unique investment needs and goals, and will likely focus on specific ETF portfolio diversification and management. For example, a retiree may trade more bond ETFs to help preserve capital, while a young millennial may engage in more stock-based ETF portfolio activity to help accumulate assets for the long haul.
Step 3. Make the Trade
Executing ETF trades is fairly straightforward for retail investors. It may be best to consider starting out with small positional trading, so that any rookie mistakes would be smaller ones, with fewer risks for one’s portfolio.
Here are two trading mechanisms that can get you up and running as an ETF trader:
• Market order. With market order trading, you buy or sell an ETF right now at the current share price, based on the bid and the ask — the price attached to a purchase or a sale of a security. A bid signifies the highest price another investor will pay for your ETF and the ask is the lowest price an ETF owner will sell fund shares. The difference between the two is known as the trading “spread.”
A word of caution on market trades. ETFs tend to have wider trading spreads than sticks, which could complicate you’re getting the ETF shares at the price you want. Share trading spreads of 10% are not uncommon when trading ETFs.
• Limit trade orders. An ETF limit order enables you to dictate terms on an ETF purchase or sale. With a limit order, you can set the top price you’ll pay for an ETF and the lowest price you’ll allow when selling an ETF.
For investors who have qualms about buying or selling an ETF at a fixed price, limit orders can be a viable option, as they allow the investor to set the terms for a trade and walk away from an ETF trade if those terms aren’t met.
💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.
The Takeaway
Historically, exchange traded funds have been used primarily as passive, “buy and sell investments.” But as asset trading grows more exotic in the digital age, trading ETFs has become increasingly popular. It’s fairly simple to trade ETFs, too, as most investors simply need access to an online trading platform or brokerage.
As with any investment, though, there are risks to consider. While ETFs can be a great starting point for many investors, they’re not entirely safe investments, and investors should do their research before buying shares of any specific ETF, as they would with any other type of security.
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).
Photo credit: iStock/PeopleImages
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.
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Aug
02
2023
Rollover IRA vs Traditional IRA: What’s the Difference?
If you’re leaving a job, you may hear the term “rollover IRA.” But exactly what is a rollover IRA? Employees have the option of moving their retirement savings from their employer-sponsored 401(k) plan to an individual retirement account, or IRA, at another financial institution when they leave a job. This IRA, where they transfer their 401(k) savings to, is called a rollover IRA. If the 401(k) plan was not a Roth 401(k), you’ll likely want to open what’s called a traditional IRA.
In this scenario, a rollover IRA is also a traditional IRA. But they aren’t always the same. You can have a traditional IRA that is not a rollover IRA. Read on for the differences worth noting between a rollover IRA and a traditional IRA.
Key Points
• A rollover IRA is an individual retirement account created with funds rolled over from a qualified retirement plan, like a 401(k), usually when someone leaves a job.
• A traditional IRA is funded by direct contributions by the account holder, and contributions are tax-deductible up to a cap and subject to eligibility limitations.
• Directing rollover funds from an employer-sponsored plan to a traditional IRA that holds your direct contributions is called commingling funds, which you may not want to do, especially if you want to transfer the rollover funds to a new employer’s plan.
• Withdrawals from either type of IRA before age 59.5 are subject to both income taxes and an early withdrawal penalty, except for certain eligible expenses.
• The IRS requires owners of both types of IRAs to start making withdrawals at age 73 (for people born in 1951 or later); these withdrawals are also called required minimum distributions (RMDs).
Is There a Difference Between a Rollover IRA and a Traditional IRA?
When it comes to a rollover IRA vs. traditional IRA, the only real difference is that the money in a rollover IRA was rolled over from an employer-sponsored retirement plan. Otherwise, the accounts share the same tax rules on withdrawals, required minimum distributions, and conversions to Roth IRAs.
💡 Recommended: Here’s a complete list of retirement plans to compare.
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What Is a Rollover IRA?
A rollover IRA is an individual retirement account created with money that’s being rolled over from a qualified retirement plan. Generally, rollover IRAs happen when someone leaves a job with an employer-sponsored plan, such as a 401(k) or 403(b), and they roll the assets from that plan into a rollover IRA.
In a rollover IRA, like a traditional IRA, your savings grow tax-free until you withdraw the money in retirement. There are several advantages to rolling your employer-sponsored retirement plan into an IRA, vs. into a 401(k) with a new employer:
• IRAs may charge lower fees than 401(k) providers.
• IRAs may offer more investment options than an employer-sponsored retirement account.
• You may be able to consolidate several retirement accounts into one rollover IRA, simplifying management of your investments.
• IRAs offer the ability to withdraw money early for certain eligible expenses, such as purchasing your first home or paying for higher education. In these cases, while you’ll pay income taxes on the money you withdraw, you won’t owe any early withdrawal penalty.
There are also some rollover IRA rules that may feel like disadvantages to putting your money into an IRA instead of leaving it in an employer-sponsored plan:
• While you can borrow money from your 401(k) and pay it back over time, you cannot take a loan from an IRA account.
• Certain investments that were offered in your 401(k) plan may not be available in the IRA account.
• There may be negative tax implications to rolling over company stock.
• An IRA requires that you start taking Required Minimum Distributions (RMDs) from the account at age 73, even if you’re still working, whereas you may be able to delay your RMDs from an employer-sponsored account if you’re still working.
• The money in an employer plan is protected from creditors and judgments, whereas the money in an IRA may not be, depending on your state.
Recommended: This guide can help you financially prepare for retirement.
What Is a Traditional IRA?
Now that you know the answer to the question of what is a rollover IRA?, you’ll want to familiarize yourself with a traditional IRA. To understand the difference between a rollover IRA vs. traditional IRA, it helps to know some IRA basics.
From the moment you open a traditional IRA, your contributions to the account are typically tax deductible, so your savings will grow tax-free until you make withdrawals in retirement.
This is advantageous to some retirees: Upon retirement, it’s likely one might be in a lower income tax bracket than when they were employed. Given that, the money they withdraw will be taxed at a lower rate than it would have when they contributed.
A Side-by-Side Comparison of Rollover IRA vs Traditional IRA
| Rollover IRA | Traditional IRA | |
|---|---|---|
| Source of contributions | Created by “rolling over” money from another account, most typically an employer-sponsored retirement plan, such as 401(k) or 403(b). For the rollover amount, annual contribution limits do not apply. | Created by regular contributions to the account, not in excess of the annual contribution limit, although rolled-over money can also be contributed to a traditional IRA. |
| Contribution limits | There is no limit on the funds you roll over from another account. If you’re contributing outside of a rollover, the limit is $6,500 for tax year 2023, plus an additional $1,000 if you’re 50 or older. | Up to $6,500 for tax year 2023, plus an additional $1,000 if you’re 50 or older. |
| Withdrawal rules | Withdrawals before age 59 ½ are subject to both income taxes and an early withdrawal penalty (with certain exceptions , like for higher education expenses or the purchase of a first home). | Withdrawals before age 59 ½ are subject to both income taxes and an early withdrawal penalty (with certain exceptions , like for higher education expenses or the purchase of a first home). |
| Required minimum distributions (RMDs) | You’re required to withdraw a certain amount of money from this account each year once you reach age 73 (thanks to the SECURE 2.0 Act of 2022). | You’re required to withdraw a certain amount of money from this account each year once you reach age 73 (again, thanks to the SECURE 2.0 Act). |
| Taxes | Since contributions are from a pre-tax account, all withdrawals from this account in retirement will be taxed at ordinary income rates. | If contributions are tax deductible, all withdrawals from this account in retirement will be taxed at ordinary income rates. (If contributions were non-deductible, you’ll pay taxes on only the earnings in retirement.) |
| Convertible to a Roth IRA | Yes | Yes |
Can You Contribute to a Rollover IRA?
By now you’re probably wondering, can I contribute to a rollover IRA?, and the answer is yes. You can make contributions to a rollover IRA, up to IRA contribution limits. For tax year 2023, individuals can contribute up to $6,500 (with an additional catch-up contribution of $1,000 if you’re 50 or older). If you do add money to your rollover IRA, however, you may not be able to roll the account into another employer’s retirement plan at a later date.
Can You Combine a Traditional IRA With a Rollover IRA?
A rollover IRA is essentially a traditional IRA that was created when money was rolled into it. Hence, you can combine two IRAs by having a direct transfer done from one account to another, or by rolling money from one IRA to the other IRA.
There’s one important aspect of the transfer or rollover process that will help prevent the money from counting as an early withdrawal or distribution to you—and that’s being timely with any transfers. With an indirect rollover, you typically have 60 days to deposit the money from the now-closed fund into the new one.
A few other key points to remember: As mentioned above, if you add non-rollover money to a rollover account, you may lose the ability to roll funds into a future employer’s retirement plan. Also keep in mind that there’s a limit of one rollover between IRAs in any 12-month period. This is strictly an IRA-to-IRA limit and does not apply to rollovers from a retirement plan to an IRA.
How to Open a Traditional or Rollover IRA Account
Opening a traditional IRA and a rollover IRA are identical processes — the only difference is the funding. Open a traditional or rollover IRA by doing the following:
• Decide where to open your IRA. For instance, you can choose an online brokerage firm where you can choose your own investments, or you can select a robo-advisor that will offer automated suggestions based on your answers to a few basic investing questions. (There’s a small fee associated with most robo-advisors.)
• Open an account. From the provider’s website, select the type of IRA you’d like to open — traditional or rollover, in this case — and provide a few pieces of personal information. You’ll likely need to supply your date of birth, Social Security number, and contact and employment information.
• Fund the account. You can fund the account with a direct contribution via check or a transfer from your bank account, transferring money from another IRA, or rolling over the money from an employer-sponsored retirement plan. Contact your company plan administrator for information on how to do the latter.
The Takeaway
Both a rollover IRA and a traditional IRA allow investors to put money away for retirement in a tax-advantaged way, with very little difference between the two accounts.
One of the primary questions anyone considering a rollover IRA should consider is, will you keep contributing to it? If so, that would prevent you from rolling the rollover IRA back into an employer-sponsored retirement account in the future.
Whether it’s a rollover IRA you’ve created by rolling over an employer-sponsored retirement account or a traditional IRA you’ve opened with regular contributions, either account can play a key role in your retirement game plan.
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).
FAQ
Can you take money out of a rollover IRA?
You can, but if you take money from a rollover IRA (or a traditional IRA for that matter) before age 59½, those withdrawals are subject to income tax and an early withdrawal penalty of 10%. There are certain exceptions, however. If you withdraw the money for certain higher education expenses or to buy your first home, for example, the penalty may not apply.
Why would you rollover an IRA?
A rollover is when you move money between two different types of retirement plans. Typically, you might roll over an IRA if you leave a job with an employer-sponsored plan, such as a 401(k) or 403(b). You would roll the assets from that plan into a rollover IRA where your savings grow tax-free until you withdraw the money in retirement. You could instead choose to leave the money in your former employer’s plan, if that’s allowed, or roll it over into your new employer’s 401(k) or 403(b) plan, if they have one. However, a rollover IRA may offer you more investment choices and lower fees and costs than an employer-sponsored plan.
Can I roll over assets into my traditional IRA?
Yes, rolled over money can be contributed to a traditional IRA. It’s also worth noting that you can also combine a traditional IRA and a rollover IRA. You can do this with a direct transfer from one account to another, or by rolling money from one IRA to another, for instance. Just keep in mind that there is a limit of one rollover between IRAs in any 12-month period.
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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.
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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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