invest Archives | Page 136 of 182

May

2023

What Are Convertible Bonds?

By Colin Dodds | Financial Independence, Growing Wealth, invest, Investing, Terminology | Comments Off

Convertible bonds are a form of corporate debt that also offers the opportunity to own the company’s stock. Like regular bonds, they offer regular interest payments. But they also allow investors to convert the bonds into stock according to a fixed ratio. As such, they’re often referred to as “hybrid securities.”

Most convertible bonds give investors a choice. They can hold the bond until maturity, or convert it to stock. This structure protects investors if the price of the stock falls below the level when the convertible bond was issued, because the investor can choose to simply hold onto the bond and collect the interest.

How Do Convertible Bonds Work?

Companies will often choose to issue convertible bonds to raise capital in order to not alienate their existing shareholders. That’s because shareholders often react badly when a company issues new shares, as it can drive down the price of existing shares, often through a process called stock dilution.

Convertible bonds are also attractive to issue for companies because the coupon — or interest payments — on them tend to be lower than for regular bonds. This can be helpful for companies who are looking to borrow money more cheaply.

Every convertible bond has its own conversion ratio. For instance, a bond with a conversion ratio of 5:1 ratio would allow the holder of one bond to convert that security into five shares of the company’s common stock.

Every convertible bond also comes with its own conversion price, which is set when the conversion ratio is decided. That information can be found in the bond indenture of convertible bonds.

Convertible bonds can come with a wide range of terms. For instance, with mandatory convertible bonds, investors must convert these bonds at a pre-set price conversion ratio. There are also reverse convertible bonds, which give the company — not the investor or bondholder — the choice of when to convert the bond to equity shares, or to keep the bond in place until maturity.

But it also allows the investor to convert the bond to stock when they’d make money by converting the bond to shares of stock when the share price is higher than the value of the bond, plus the remaining interest payments.

How Big Is the Convertible Bond Market?

In 2022, the size of the global convertible bond market was estimated to be about $375 billion. Securities have been issued by hundreds of companies. But note that these numbers are miniscule compared to the U.S. equity market, which has trillions in value and thousands of stocks.

The total size of the convertible bond market does expand and contract, though, often with the cycling of the economy. As such, it’s likely that the market could be bigger or smaller a year from now.

Reasons to Invest in Convertible Bonds

Why have investors turned to convertible bonds? One reason is that convertible bonds can offer a degree of downside protection from the bond component during stock volatility. The companies behind convertibles are obligated to pay back the principal and interest.

Meanwhile, they can also offer attractive upside, since if the stock market looks like it’ll be rising, investors have the option to convert their bonds into shares. Traditionally, when stocks win big, convertibles can deliver solid returns and outpace the yields offered by the broader bond market. However, when stocks retreat, convertibles tend to deliver short-term losses.

For example, In 2020, the U.S. convertibles market returned a blockbuster 43%, making it one of the top performing global asset classes. The convertibles market also did well in 2009, just as the global economy was recovering from the financial crisis, when it returned 49%.

Downsides of Convertible Bonds

One of the biggest disadvantages of convertible bonds is that they usually come with a lower interest payment than what the company would offer on an ordinary bond. And the chance to save on debt service is a big reason that companies issue convertibles. So for investors who are primarily interested in income, convertibles may not be the best fit.

There are also risks. Different companies issue convertible debt for different reasons, and they’re not always good. Convertible financing is sometimes labeled “death spiral financing.”

The death spiral is when convertible bonds drive the creation of an increasing number of shares of stock, which drives down the price of all the shares on the market. The death spiral tends to occur when a convertible allows buyers with a large premium to convert into shares at a fixed conversion ratio in which the buyer has a large premium.

This can happen when a bond’s face value is lower than the convertible value. That can lead to a mass conversion to stock, followed by quick sales, which drives the price down further.

Those sales, along with the dilution of the share price can, in turn, cause more bondholders to convert, given that the lower share price will grant them yet more shares at conversion. Being one of the shareholders who makes something out of such a catastrophe can be a matter of close study and good timing.

How to Invest in Convertible Bonds

Most convertibles are sold through private placements to institutional investors, so retail or individual investors may find it difficult to buy them.

But individual investors who want to jump into the convertibles market can turn to a host of mutual funds and exchange-traded funds (ETFs) to choose from. But because convertibles, as hybrid securities, are each so individual when it comes to their pricing, yields, structure and terms, each manager approaches them differently. And it can pay to research the fund closely before investing.

For investors, one major advantage of professionally managed convertible bonds funds is that the managers of those funds know how to optimize features like embedded options, which many investors could overlook. Managers of larger funds can also trade in the convertible markets at lower costs and influence the structure and price of new deals to their advantage.

Recommended: How to Trade Options

The Takeaway

Convertible bonds are debt securities that can be converted to common stock shares. These hybrid securities offer interest payments, along with the chance to convert bonds into stock.

While convertible bonds are complex instruments that may not be suitable for all investors, they can offer diversification, particularly during volatile periods in the equity market. Investors can gain exposure to convertible bonds by putting money into mutual funds or ETFs that specialize in them.

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

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

SoFi Invest®

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

May

2023

Value vs Growth Stocks

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

Generally speaking, value stocks are shares of companies that have fallen out of favor and are valued less than their actual worth. Growth stocks are shares of companies that demonstrate a strong potential to increase revenue or earnings thereby ramping up their stock price. The terms value and growth refer to both two categories of stocks and two investment “styles” or approaches of investing in stock.

Each style has pros and cons. When value investing, investors can buy shares or fractional shares of a company that has strong fundamentals at bargain prices. However, investors must be careful not to fall in a “value trap”—buying stocks that appear cheap, but are actually trading at a discount due to poor fundamentals.

What Are Value Stocks?

When investors hunt for value stocks, they are looking for stocks that are relatively cheap, unfashionable, or that they believe aren’t receiving a fair market valuation. Value investors try to identify value stocks by examining quarterly and annual financial statements and comparing what they see to the price the stock is getting on the market.

Investors will also look at a number of valuation metrics to determine whether the stock is cheap relative to its own trading history, its industry, and other benchmarks, such as the S&P 500 index.

For example, investors often look at price-to-earnings (P/E) ratio, which is the ratio of price per share over earnings per share. Some experts say that a value stock’s P/E should be 40% less than the stock’s highest P/E in the previous five years.

Investors may also look at price-to-book, which is the price per share over book value per share. A stock’s book value is a company’s total assets minus its liability and provides an estimate of a company’s value if it were liquidated.

Value investors are hoping to buy a quality stock when its price is in a temporary lull, holding it until the market corrects and the stock price goes up to a point that better reflects the underlying value of the company.

What Could Make a Stock Undervalued?

There are a number of reasons that a stock could be undervalued.

• A stock could be cyclical, meaning it’s tied to the movements of the market. While the company itself might be strong, market fluctuations may temporarily cause its price to dip.

Recommended: Cyclical vs Non Cyclical Stocks

• An entire sector of the market could be out of favor, causing the price of a specific stock to dip. For example, a pharmaceutical company with an effective new drug might be priced low if the health care sector is generally on the outs with investors.

• Bad press could cause share prices to drop.

• Companies can simply be overlooked by investors looking in a different direction.

What Are Growth Stocks?

Growth stocks are shares of companies that demonstrate the potential for high earnings or sales, often rising faster than the rest of the market. These companies tend to reinvest their earnings back into their business to continue their company’s growth spurt, as opposed to paying out dividends to shareholders. 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.

There are also a number of metrics growth investors may examine to help them identify growth stocks. First, investors may look at price-to-sales (P/S), or price per share over sales per share. Not all growth companies are profitable, and P/S allows investors to see how quickly a company is expanding without factoring in its costs.

Investors may also look at price-to-earnings growth (PEG), which is P/E over projected earnings growth. A PEG of 1 or more typically suggests that investors are overvaluing a stock, while PEG of less than one may mean the stock is relatively cheap. PEG is a useful metric for investors who want to consider both value and growth investing.

Investors jumping into growth stocks may be buying a stock that is already valued relatively high. In doing so, they run the risk of losing a potentially significant amount of money if an unforeseen event causes prices to tumble in the future.

How Are Growth and Value Strategies Similar?

While growth and value investing are two different investment strategies, distinctions between the two are not hard and fast — there can be quite a bit of overlap. Investors may see that stocks listed in a growth fund are also listed in a value fund depending on the criteria used to choose the stock.

What’s more, growth stocks may evolve into value stocks, and value stocks can become growth stocks. For example, say a small technology company develops a new product that attracts a lot of investor attention and it starts to use that capital to grow its business more quickly, shifting from value to growth.

Investors practicing growth and value strategies also have the same end goal in mind: They want to buy stocks when they are relatively cheap and sell them again when prices have gone up. Value investors are simply looking to do this with companies that are already on solid financial footing, and hopefully, see stock price appreciation should rise as a result. And growth investors are looking for companies with a lot of potential whose stock price will hopefully jump in the future.

Using Growth and Value Strategies Together

The stock market goes through natural cycles during which either growth or value stocks will be up. Investors who want to capture the potential benefits of each may choose to employ both strategies over the long term. Doing so may add diversity to an investor’s portfolio and head off the temptation to chase trends if one style pulls ahead of the other.

Investors who don’t want to analyze individual stocks for growth or value potential can access these strategies through growth or value funds. Because of the cyclical nature of growth and value investing, investors may want to keep a close eye on their portfolios to ensure they stay balanced — and consider rebalancing their portfolio if market cycles shift their asset allocation.

The Takeaway

Growth and value are different strategies for investing in stocks. Investing in growth stocks is considered a bit riskier, though it also may provide potentially higher returns than value investing. That said, growth stocks have not always outperformed value stocks.

As a result, some investors may choose to build a diversified portfolio that includes each style so they have a better chance of reaping benefits when one is outperforming the other.

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

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

SoFi Invest®

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

May

2023

Why Index Fund Returns Vary from Fund to Fund

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

The performance of index funds can vary based on which index the fund tracks and how the stock market performs as a whole. Index funds can offer a simplified approach to portfolio building when the primary goal is to meet, rather than beat, the market’s performance.

In simple terms, these mutual funds or exchange-traded funds (ETFs) seek to track the performance of a particular stock market index or benchmark. While these funds can offer some insulation against volatility, it’s important to understand which factors drive index funds returns.

What are Index Funds, Exactly?

An index fund is a type of mutual fund that’s designed to track the performance of a stock market index, by investing in some or all of the securities tracked by that particular index.

An index represents a collection of securities, which may include stocks, bonds, and other assets. Stock indexes can cover one particular sector of the market or a select grouping of companies. Examples of well-known stock indices include the S&P 500 Index and the Russell 2000 Index.

What Determines Index Fund Returns?

Even though they tend to have a similar purpose and function inside a portfolio, the return on index funds isn’t identical from one fund to the next. Some index funds can lose money, too. Factors that can influence index funds’ returns include:

• Which specific index they track

• Whether that index is:

◦ Cap-weighted, in which each security is weighted by the total market value of their shares.

◦ Price-weighted, in which the per share price of each security in the index determines its value.

◦ Equal-weighted, in which all of the securities being tracked are assigned an equal weight for determining value.

• Number of securities held by the fund

• Geographic classification of fund securities

• Expense ratio and fees

• Overall market conditions

• Tracking error

Together, these factors can influence how well one index fund performs versus another.

Index Tracking

First, consider which benchmark an index fund tracks. There can be significant differences in the makeup of various indexes. For instance, the S&P 500 covers the 500 largest publicly traded companies while the Russell 2000 Index includes 2000 small-cap U.S. companies.

Large-cap stocks can perform very differently from small-cap stocks, which translates to differences in index fund returns. Between the two, large-cap companies tend to be viewed as more stable while smaller-cap companies are seen as riskier. Large-cap companies may fare better during periods of increased market volatility but in an extended downturn, small-cap companies may outperform their larger counterparts.

Index Weighting

Cap-weighted, price-weighted, and equal-weighted indexes all have the potential to perform differently, because each company’s stock may have different weight in each of these types of funds. For example, if a stock in an equal-weighted index filled with 500 stocks performs poorly, those shares represent 1/500th of performance. On the other hand, if the same stock performs poorly in a cap-weighted fund and it happens to have a very high market cap, it may represent a larger percentage of performance.

For these reasons, it’s also important to know how many securities are held by the fund. The more financial securities in a given fund, the greater the likelihood that a poorly performing one will be balanced by others.

Geographic Classification

Even when two index funds both follow the same formula with regard to market capitalization, returns can still differ if each fund offers a different geographic exposure. For example, a fund that tracks a global market index and includes a mix of international and domestic stocks may not yield the same results as an index fund that focuses exclusively on U.S. companies.

Funds that track global indexes can also differ when it comes to how they characterize certain markets. For instance, what one fund considers to be a developed country may be another index fund’s emerging market. That in turn can influence index fund returns.

Expense Ratio and Fees

Index funds are generally passive, rather than active, since the turnover of assets inside the fund is typically low. This allows for lower expense ratios, which represent the annual cost of owning a mutual fund or ETF each year, expressed as a percentage of fund assets. Generally, index funds carry lower expense ratios compared to actively managed funds but they aren’t all the same in terms of where they land on the pricing spectrum.

The industry average expense ratio for index funds tends to be a bit more than 0.5%, though it’s possible to find index funds with expense ratios well below that mark. The higher the expense ratio, the more you’ll hand back in various fees to own that index fund each year, reducing your overall returns.

In terms of fees, some of the costs you might pay include:

• Sales loads

• Redemption fees

• Exchange fees

• Account fees

• Purchase fees

When comparing index fund costs, it’s important to keep the expense ratio, fees, and historical performance in mind. Finding an index fund with an exceptionally low expense ratio, for instance, may not be that much of a bargain if it comes with high sales load fees. But a fund that charges a higher expense ratio may be justifiable if it’s consistently outperformed similar index funds year over year.

Tracking Error

Tracking errors can significantly impact your return on index funds. This occurs when an index fund doesn’t accurately track the performance of its underlying index or benchmark.

Tracking errors are often tied to issues with the fund, rather than its index. For example, if a fund’s composition doesn’t accurately reflect the composition of the index it tracks then performance results are more likely to be skewed. Excessive fees or a too-high expense ratio can also throw a fund’s tracking off.

What Are Good Index Fund Returns?

What is a good return on investment for an index fund? Given that the return on index funds can vary, the simplest answer may be to look at the stock market’s historical performance as a whole.

The S&P 500 Index is often used as a primary market benchmark for measuring returns year over year. The average annualized return for the S&P 500 Index since its inception — including dividends and adjusted for inflation — is 8.7%. Following that logic, a good return on investment for an index fund would be around the same.

You could also use the fund’s individual index as a means of measuring its performance. Comparing the fund’s performance to the index’s performance month to month or year over year can give you an idea of whether it’s living up to its expected return potential.

Are Index Funds a Good Investment?

Index funds may appeal to one type of investor more than another, which is why it’s always important to do your research before determining what will be a good fit for your portfolio.

Investors who prefer a low-cost, passive approach may lean toward index investing for growing potential for wealth long-term. Index funds can offer several advantages, including simplified diversification and consistent returns over time.

For example, if your investment goals include keeping costs low while producing consistent returns with lower fees, then index investing maybe a good choice. You may also appreciate how easy it is to buy index funds or ETFs and use them to create a diversified portfolio.

Index funds can help with pursuing a goals-based investing approach, which focuses on investing to meet specific goals rather than attempting to beat the market. When comparing index funds, pay attention to the fund makeup, its costs, historical performance, turnover ratio and the potential for tracking errors.

The Takeaway

A number of factors helps explain why different index funds have different returns — including, but not limited to, which index they track and how it’s weighted, the geographic classification of the fund securities, expense ratios, and overall market conditions.

But keep in mind: Unless you have a crystal ball, there’s no way to predict exactly how an index fund will perform. But getting to know what differentiates one index fund or ETF from the next can help with making more informed decisions about which ones to buy.

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.

SoFi Invest®

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

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

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

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

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

SOIN0523080

May

2023

5 Smart Ways to Handle Supplemental Income

By Kelly Boyer Sagert | Budgeting & Goals, Growing Wealth, invest, Investing | Comments Off

Supplemental income is money that is earned above and beyond a person’s “regular” income, which, for most people, is earned through working a job.

Supplemental income could include income earned through a side hustle, or it could include money from a regular job that is extra: bonuses, overtime pay, tips, commissions, and so forth.

For many people, supplemental income can amount to “extra” money beyond what’s needed to cover their regular expenses. And there are some smart ways to handle that extra income, which may help people reach their financial goals sooner.

What Is Supplemental Income

As noted, supplemental income is money that is earned or otherwise accumulated beyond a typical income stream, like a paycheck. That can include bonuses or tips earned while working a job, too.

Supplemental income can also be earned in the form of a commission, by accumulating dividends on investments, or even by working a second job or side hustle.

There are numerous ways to tap into supplemental income streams, though that doesn’t mean that it’s necessarily easy. You should also know that there are generally two types of supplemental income: Active, and passive.

• Active income: This is often defined as trading time for money. The person puts in time, whether that’s through taking photographs for websites or walking dogs, and is paid for their services in exchange. It’s a typical job, in other words.

• Passive income: This kind of work involves little to no active investment in time once the gig is established. It could involve selling an uploaded ebook or affiliate marketing, as two examples.

For many people, a side hustle or second job is likely the quickest route to earning supplemental income. But there are government programs out there, too, that can help those in need, like the Supplemental Security Income program (SSI).

A Note About Supplemental Security Income

Supplemental Security Income (SSI) is a program administered by the Social Security Administration. SSI provides payments to people over the age of 65 who have a disability, including being blind or deaf. To qualify for Supplemental Security Income, people must also have limited financial resources, in addition to meeting the age and disability requirements. The purpose of the program is to help people meet their basic needs.

As the program is designed to help people meet their basic needs, some of the suggestions for handling supplemental income may not be applicable to those earning SSI benefits.That’s because those who do receive those benefits likely won’t have much room in their budget for additional spending, or the need to find ways to deploy that additional income — they’ll need it to cover their basic expenses.

Launching a Side Hustle

When choosing a side hustle or second job, it makes sense to pick one of interest to you; or, even better, one that inspires passion. This can help to prevent boredom and make it more likely that time and energy will continue to be invested in this income-generating activity. What hobbies, for example, can be monetized? Blogging? Making crafts or designing websites?

Ask yourself further questions: How much time can be invested in this side hustle? Can the required time ebb and flow as demands at the main job fluctuate? What resources are available to get started? And, perhaps most importantly, what’s the estimated earning potential?

Having a second job or side hustle isn’t terribly uncommon these days, as many people either need the extra money to make ends meet, or are looking for ways to pad their earnings to add to their savings or investment accounts.

One benefit of side hustles that are based on passive income is that, although work typically needs done up front to establish the side hustle, it shouldn’t need ongoing active involvement. And whether you’re renting out a room in your house, monetizing a blog, or writing ebooks to earn supplemental income, it’s important to keep some things in mind as you start to see that income roll in.

Tips for Using Your Extra Income

1. First, Manage Your Income Taxes

When working for an employer, relevant income taxes are typically withdrawn from each paycheck but, with a side hustle (one that doesn’t involve working for an employer and receiving a paycheck, that is), the worker is responsible for paying federal taxes, FICA, Medicare tax, and any state and local taxes on net income.

That’s because a “hustle” or “gig” is typically a form of self-employment. To help, the IRS has created a Gig Economy Tax Center with plenty of resources and pieces of important information, including that income taxes must be paid on side gig income of $400 or more annually.

Those earning money from a side gig may also need to pay estimated quarterly taxes. The deadline for these payments are:

• April 15 for payment period January 1–March 31

• June 15 for payment period April 1–May 31

• September 15 for payment period June 1–August 31

• January 15 for payment period September 1–December 31

At the tax-filing deadline, (typically mid-April), a Schedule C usually needs to be filed for people earning money in a self-employed side gig — and, when earning supplemental income, it’s important to deposit enough in a bank account so that funds don’t fall short when tax returns need to be filed. What’s left over after taxes are planned for can be spent in a variety of ways, some ideas might include:

• Paying off “bad” debt.

• Establishing an emergency savings fund.

• Saving and investing.

• Enjoying some discretionary spending.

2. Paying Off “Bad” Debt

Bad debt can be defined, in general, as debt you acquire that results in a net loss. For example, going into debt for a vacation, a big party, clothes and/or gadgets doesn’t add to your net worth. Going into debt for your education or home may gradually add to your net worth in the future.

Bad debt can also refer to loan or lines of credit with higher interest rates, and which are harder to pay off as a result. Supplemental income can be used to pay this debt down or off.

Debt management plans to pay off debt include the snowball or avalanche methods — and a combo of the two, the fireball method. Different strategies work better for different people, so it can be worth experimenting with them to make the best choice.

With the snowball method, list bad debts by the amount owed, from the smallest to the highest. Include credit card debts, personal loans, and so forth. Then, make the minimum payment on each but put extra funds on the one with the smallest balance to get it paid off. Once that balance is zero, home in on the debt with the second smallest balance and keep using this strategy until all bad debt is paid off. Avoid using credit cards during this time.

With the avalanche method, list bad debt in order of its interest rate, from highest to lowest. Make minimum payments on all of them and put extra funds on the one with the highest rate. Pay it off and then move to the next highest rate, and so forth.

With the fireball method, take “bad” debt with interest rates of 7% or more and then list them from smallest to largest. Make the minimum payment on all and then put excess on the smallest of the “bad” debts. Rinse and repeat.

3. Establishing an Emergency Savings Account

Another smart idea is to put supplemental income into an emergency savings account. This can be accomplished in conjunction with a debt payment plan (put half of the excess funds into an emergency account and use the other half to pay down bad debt, for example) or as a single focused goal.

Funds in this account are intended for use if a financial emergency occurs. This can be a leaky roof that requires immediate attention, a significant car repair, or unexpected medical bills. Having a robust emergency fund can help to prevent the need to rely on credit cards to address unanticipated expenses.

It is commonly suggested that emergency savings accounts should contain 3-6 months’ worth of expenses. So, add those monthly bills up and multiply by three — and also by four, five, and six. This gives a range of the rainy-day fund’s goal.

Recommended: Planning your emergency fund? Our emergency savings calculator can assist you in setting the right target.

4. Saving and Investing

You could save or invest your extra money! This can include saving for personal goals, from a down payment on a house to a vacation fund, and or for retirement. What’s important is to prioritize how it makes sense to use extra money being earned and then save and invest to help meet those goals. How you save or invest that money would be up to you, but you could look at some common investment choices including stocks, bonds, mutual funds, and alternative investments, and more.

5. Enjoy Some Discretionary Spending

Once the financial “need-to” items are checked off the list, it can be okay to use some supplemental income to have fun. You could update your wardrobe, buy a new video game, take in a movie, or even go out to a nice dinner. If it’s within your budget parameters, treating yourself every now and then can be a nice thing to do.

Plus, getting a taste of the finer things may help keep you motivated to make sure your spending stays in check and that you stick to your budget going forward.

The Takeaway

Supplemental income is extra income earned beyond your primary income stream, and finding ways to drive supplemental or secondary income can help you reach your financial goals sooner. It can also help you free up some room in your budget to potentially treat yourself every now and then.

You can also put that extra money to work, by saving it and earning interest, or investing it for the future.

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

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

SoFi Invest®

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

May

2023

overhead view of businessman working, looking at business charts and graphs

What Is the Wash-Sale Rule?

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

A wash sale occurs when an investor sells a security at a loss, and buys a very similar security within a 30-day window of the sale (30 days before or after). The wash-sale rule is an Internal Revenue Service (IRS) regulation that states an investor can’t receive tax deduction benefits if they sell an investment for a loss, then purchase the same or a “substantially identical” asset within 30 days before or after the sale.

While investors may find themselves in a position in which it may be beneficial to sell securities to harvest losses, it’s important to know the wash-sale rule in and out to avoid triggering penalties.

Which Investments are Subject to the Wash-Sale Rule?

The wash-sale rule applies to most common investments, including:

• Stocks

• Bonds

• Mutual funds

• Options

• Exchange-traded funds (ETFs)

• Stock futures contracts

Transactions in an individual retirement account (IRA) can also fall under the wash-sale rule. The wash-sale rule does not apply to commodity futures or foreign currency trades. The rule also applies if an investor sells a security that has increased in value and within 30 days buys an identical security. They will need to pay capital gains taxes on the proceeds.

What Happens When You Trigger a Wash Sale?

Investors commonly choose to sell assets at a loss as part of their tax or day trading strategy, or they may regret selling an asset while the market was down, and decide to buy back in.

The intent of the wash-sale rule is to prevent investors from abusing the tax benefits of selling at a loss, and claiming artificial losses.

In the event that an investor does trigger a wash sale, they will not be allowed to write off the loss when they do their tax reporting to the IRS. This means the investor won’t receive any tax benefit for selling at a loss. The rule still applies if an investor sells an investment in a taxable account and buys it back in a tax-advantaged account, or if one spouse sells an asset and then the other spouse purchases it that also counts as a wash sale.

It’s important for investors to understand the wash-sale rule so that they account for it in their investment and tax strategy. If investors have specific questions, they might want to ask their tax advisor for help.

Recommended: Investing 101 for Beginners

Avoiding a Wash Sale

Unfortunately, the guidelines regarding what a “substantially identical” security is are not very specific. The easiest way to avoid wash sales is to create a long-term investing strategy involving few asset sales and not trying to time the market. Creating a diversified portfolio is generally a good strategy for investors.

Another important thing to keep in mind is the wash-sale rule applies across an investor’s accounts. As such, investors need to keep track of their sales and purchases across their entire portfolio to try and make sure that the wash-sale rule doesn’t affect any investment choices.

What to Do After Selling an Asset at a Loss

The safest option is to wait more than 30 days to purchase an asset after selling a similar one at a loss. An investor can also invest funds into a different asset–a different enough asset, that is–for 30 days or more and then move the funds back into the original security after the wash sale window has passed.

There are benefits to selling an asset at either a profit or a loss. If an investor sells at a profit, they make money. If they sell at a loss, they can declare it on their taxes to help offset their capital gains or income. If an investor has significant capital gains to report, they may decide to sell an asset that has decreased in value to help lower their tax bill. However, if they hoped to reinvest in an asset later, a wash sale can ruin those plans.

In some cases, simply selling a stock from one corporation and purchasing one from another, different corporation is fine. Even selling a stock and buying a bond from the same company may not trigger a wash sale.

Investing in ETFs or Mutual Funds Instead

If an investor wants to reinvest funds in a similar industry while avoiding a wash sale, one option would be to switch to an ETF or mutual fund. There are ETFs and mutual funds made up of investments in particular industries, but they are often diversified enough that they wouldn’t be considered to be too similar to an individual stock or bond. It’s possible that an investor could sell an individual stock and reinvest the money into a mutual fund or ETF within a similar market segment without violating the wash-sale rule.

However, if an investor wants to sell an ETF and buy another ETF, or switch to a mutual fund, this can be more challenging. It may be difficult to figure out which ETF or mutual fund swaps will count as wash sales, and which won’t.

Wash-Sale Penalties and Benefits

If the IRS decides that a transaction counts as a wash sale, the investor can’t use the loss to reduce their taxable income or offset capital gains on their taxes for that year.

However, there can be an upside to wash sales. Investors can end up with a higher cost basis for their new investment, because the loss from the sale is added to the cost basis of the new purchase. In addition, the holding period of the sold investment is added to the holding period of the new investment.

The benefit of having a higher cost basis is that an investor can choose to sell the new investment at a loss and have a greater loss for tax reporting than they would have. Conversely, if the investment increases in value and the investor sells, they will have a smaller capital gain to report. Having a longer holding period means an investor may be able to pay long-term capital gains taxes on a sale rather than short-term gains, which have a higher rate.

The Takeaway

The wash-sale rule is triggered when an investor sells a security at a loss, but then turns around and buys a similar security within 30 days–either before, or after. It’s a bit of an opaque rule, but there can be consequences for triggering wash sales. That’s why understanding regulations like the wash-sale rule is an important part of being an informed investor.

Part of making solid investing decisions is planning for taxes and understanding what the benefits and downsides may be for any particular transaction. This is just one aspect of tax-efficient investing that investors might want to consider.

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.

SoFi Invest®

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

What Are Convertible Bonds?

How Do Convertible Bonds Work?

How Big Is the Convertible Bond Market?

Reasons to Invest in Convertible Bonds

Downsides of Convertible Bonds

How to Invest in Convertible Bonds

The Takeaway

Value vs Growth Stocks

What Are Value Stocks?

What Could Make a Stock Undervalued?

What Are Growth Stocks?

How Are Growth and Value Strategies Similar?

Using Growth and Value Strategies Together

The Takeaway

Why Index Fund Returns Vary from Fund to Fund

What are Index Funds, Exactly?

What Determines Index Fund Returns?

Index Tracking

Index Weighting

Geographic Classification

Expense Ratio and Fees

Tracking Error

What Are Good Index Fund Returns?

Are Index Funds a Good Investment?

The Takeaway

5 Smart Ways to Handle Supplemental Income

What Is Supplemental Income

A Note About Supplemental Security Income

Launching a Side Hustle

Tips for Using Your Extra Income

1. First, Manage Your Income Taxes

2. Paying Off “Bad” Debt

3. Establishing an Emergency Savings Account

4. Saving and Investing

5. Enjoy Some Discretionary Spending

The Takeaway

What Is the Wash-Sale Rule?

Which Investments are Subject to the Wash-Sale Rule?

What Happens When You Trigger a Wash Sale?

Avoiding a Wash Sale

What to Do After Selling an Asset at a Loss

Investing in ETFs or Mutual Funds Instead

Wash-Sale Penalties and Benefits

The Takeaway

CATEGORIES

JOIN THE COMMUNITY

Student Loan Refinancing

Personal Loans

Online Investments

Other

Student Loan
Refinancing

Personal
Loans

Online
Investments