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Q: What Is Automated Tax Loss Harvesting?

Tax loss harvesting operates on the assumption that it’s valuable for individuals to delay paying taxes so that they could potentially earn an income in the meantime. It’s a strategy that takes into account the “time value of money,” the concept that money held now is worth more than the same sum in the future because of that money’s earnings potential.

Apr

2023

Is Automated Tax-Loss Harvesting a Good Idea?

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

Automated tax-loss harvesting can be a tool for tax-efficient investing because it involves using an algorithm to sell securities at a loss so as to offset capital gains and potentially lower an investor’s tax bill.

Standard tax-loss harvesting uses the same principle, but the process is complicated and an advisor might only harvest losses once or twice a year versus automated tax-loss harvesting which can be done more frequently.

That said, automated tax-loss harvesting — which is sometimes a feature of robo-advisor accounts — may give investors only limited (or possibly no) tax benefits. Here’s a breakdown of whether an automated tax-loss strategy makes sense.

Tax-Loss Harvesting: The Basics

First, a quick recap of how standard tax-loss harvesting works. Tax-loss harvesting is a way of selling securities at a loss, and then “harvesting” that loss to offset capital gains or other taxable income, thereby reducing federal tax owed.

The reason to consider this strategy is that capital gains are taxed at two different federal tax rates: long-term (when you’ve held an asset for a year or more) and short-term (when you’ve held an asset for under a year).

• Long-term capital gains are taxed at 0%, 15%, or 20%, depending on the investor’s tax bracket.

• Short-term capital gains are taxed at a typically higher rate based on the investor’s ordinary income tax rate.

The one-year mark is crucial, because the IRS taxes short-term investments at the higher marginal income tax rate of the investor. For high-income earners that can be 37% plus a 3.8% net investment income tax (NIIT). That means the taxes on those quick gains can be as much as 40.8% — and that’s before state and local taxes are factored in.

Example of Basic Tax-Loss Harvesting

For example, consider an investor in the highest tax bracket who sells security ABC after a year, and realizes a long-term capital gain of $10,000. They would owe 20%, or $2,000.

But if the investor sells XYZ security and harvests a loss of $3,000, that can be applied to the gain from security ABC. So their net capital gain will be $7,000 ($10,000 – $3,000). This means that they would owe $1,400 in capital gains tax.

The differences can be even greater when investors can harvest short-term losses to offset short-term gains, because these are typically taxed at a higher rate. In this case, using the losses to offset the gains can make a big difference in terms of taxes owed.

According to IRS rules, short-term or long-term losses must be used first to offset gains of the same type, unless the losses exceed the gains from the same type. When losses exceed gains, up to $3,000 per year can be used to offset ordinary income or carried over to the following year.

What Is Automated Tax-Loss Harvesting?

Until the advent of robo-advisor services some 15 years ago, tax-loss harvesting was typically carried out by qualified financial advisors or tax professionals in taxable accounts. But as robo-advisors and their automated portfolios became more widely accepted, many of these services began to offer automated tax-loss harvesting as well, though the strategy was executed by a computer program.

Just as the algorithm that underlies an automated portfolio can perform certain basic functions like asset allocation and portfolio rebalancing, some automated programs can execute a tax-loss harvesting strategy as well. SoFi’s automated platform does not offer automated tax-loss harvesting, but others may, for example.

So whereas tax-loss harvesting once made sense only for higher-net-worth investors owing to the complexity of the task, automation has enabled some retail investors to reap the benefits of tax-loss harvesting as well. The idea has been that automated tax-loss harvesting can be conducted more often and with less room for error, thanks to the precision of the underlying algorithm — which can also take into account the effects of the wash-sale rule.

The Wash-Sale Rule

It’s important that investors understand the “wash-sale rule” as it applies to tax-loss harvesting.

What Is the Wash-Sale Rule?

The wash-sale rule prevents investors from selling a security at a loss and buying back the same security, or one that is “substantially identical”, within 30 days. If you sell a security in order to harvest a loss and then replace it with the same or a substantially similar security, the IRS will disallow the loss — and you won’t reap the desired tax benefit.

In the example above, the investor who sells security XYZ in order to apply the loss to the gain from selling security ABC may then want to replace security XYZ because it gives them exposure to a certain market sector. While the investor can’t turn around and buy XYZ again until 30 days have passed, they could buy a similar, but not substantially identical security, to maintain that exposure.

That said, it can be tricky to follow this guidance because the IRS hasn’t established a precise definition of what a “substantially identical security” is. This is another reason why automated tax-loss harvesting may be more efficient: It may be simpler for a computer algorithm to make these choices based on preset parameters.

How ETFs Help With the Wash-Sale Rule

This is how the proliferation of exchange-traded funds (ETFs) has benefited the strategy of tax-loss harvesting. Exchange-traded funds, or ETFs, are baskets of securities that typically track an index of stocks, bonds, commodities or other assets, similar to a mutual fund. Unlike mutual funds, though, ETFs trade on exchanges like stocks.

In some ways, ETFs may make tax-loss harvesting a little easier. For instance, if an investor harvests a loss from an emerging-market stocks ETF, he or she can soon after buy a “similar” but non-identical emerging-market stocks ETF because the fund may have slightly different constituents.

Because most robo-advisors generate automated portfolios comprised of low-cost ETFs, this can also support the process of automated tax-loss harvesting.

Other Important Tax Rules to Know

Tax losses don’t expire. So an investor can apply a portion of losses to offset profits or income in one year and then “save” the remaining losses to offset in another tax year. Investors tend to practice tax-loss harvesting at the end of a calendar year, but it can really be done all year.

As noted above, another potential perk from tax-loss harvesting is that if the losses from an investment exceed any taxable profits from trades, the losses can actually be used to offset up to $3,000 of ordinary income per year.

How Much Does Automated Tax-Loss Harvesting Save?

It’s hard to say whether automated tax-loss harvesting definitively and consistently delivers a reduced tax bill to investors. A myriad of variables — such as the fluctuating nature of both federal tax rates and market price moves — make it difficult to calculate precise figures.

The Upside of Automated Tax-Loss Harvesting

One study of standard (not automated) tax-loss harvesting that was published by the CFA Institute in 2020 found that from 1926 to 2018, a simulated tax-loss harvesting strategy delivered an average annual outperformance of 1.08% versus a passive buy-and-hold portfolio.

Taking into account transaction costs and the wash-sale rule, the outperformance or “alpha” fell to 0.95%.

The study found the strategy did better when the stock market was volatile, such as between 1926 and 1949, a period which includes the Great Depression. The average outperformance was 2.13% a year during that period, as investors found more opportunities to harvest losses. Meanwhile, between 1949 and 1972 — a quieter period in the market as the U.S. underwent economic expansion after World War II — tax-loss harvesting only delivered an alpha of 0.51%.

The Downside of Automated Tax-Loss Harvesting

While the research cited above identifies some benefits of tax-loss harvesting, like many investment studies it’s based on historical data and simulations of a portfolio, not real-world investments.

Another fact to bear in mind: This study does not factor in the impact of automated tax-loss harvesting, which is typically conducted more frequently — and may not deliver a tax benefit.

Indeed, in 2018 the Securities and Exchange Commission (SEC) charged a robo-advisor for making misleading claims about the benefits of automated tax-loss harvesting in terms of higher portfolio returns. Investors should know that there could be no or little tax savings, or even a bigger tax bill, depending on how different securities perform after they’re sold (or bought back).

For instance, if the underlying algorithm that automates trades in a robo portfolio harvests a loss from one ETF (to offset the gains from a sale of another ETF), it might then purchase a replacement ETF that’s not substantially identical, per the wash-sale rule.

If the second ETF is sold later, the gains realized from this second sale could be so high that they cancel out or be greater than the tax benefits from selling the first fund to harvest the loss.

In that case, the investor could end up paying more taxes down the road — effectively deferring, not eliminating, the tax burden.

Continuously trading assets in automated tax-loss harvesting also means an investor may incur additional costs, such as more transaction fees.

Pros of Automated Tax-Loss Harvesting

1. Standard tax-loss harvesting is complex and time-consuming, but the benefits are well established. Therefore using automated tax-loss harvesting may be an efficient way to reap the benefits of this strategy because it can be done more automatically and consistently.

2. To realize the benefits of tax-loss harvesting investors must obey the IRS wash-sale rule, which imposes restrictions that can be tricky to follow. In this way, an automated strategy may limit the potential for human error and may increase the tax benefits for investors.

Cons of Automated Tax-Loss Harvesting

1. Because an algorithm performs tax-loss harvesting on an automated cadence, investors cannot choose which investments to sell and when and therefore have less control.

2. An automated tax-loss program may not be able to anticipate a security’s future gains that could reduce or eliminate the tax benefit of harvested losses.

3. Automated tax-loss harvesting could increase the amount an investor pays in transaction fees, which can lower portfolio returns.

The Takeaway

Automated tax-loss harvesting is a feature primarily offered by robo-advisors, which use a computer algorithm to automatically sell securities at a loss in order to potentially reduce the tax impact of capital gains realized from the sale of other securities.

While this practice can offer tax benefits in some cases, and academic studies have used portfolio simulations to gauge the potential for outperformance, it’s unclear whether automated tax-loss harvesting offers the same benefits. Because the strategy is carried out by an underlying algorithm, a computer program may not be capable of making more nuanced choices about which assets to sell and when.

Investors could potentially end up still owing capital gains taxes or paying more in transaction fees and brokerage fees.

If you’re ready to start investing, it’s easy to open an Active Invest account with SoFi Invest® and start trading stocks or set up an automated portfolio. SoFi’s automated portfolio does not offer tax loss harvesting. SoFi members have access to complimentary advice from a financial professional. Set up your portfolio today!

See why SoFi is this year’s top-ranked robo advisor.

SoFi Invest®

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

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

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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Apr

2023

Investing in the Pharmaceutical Industry

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

The pharmaceutical industry, with nearly $1.5 trillion in global sales a year, offers many opportunities for investors. Some pharma stocks provide dividends, while others have potential for significant growth. Beyond these potential upsides, investing in pharmaceuticals also helps expand health care for people around the world.

But as with any industry, pharmaceutical stocks have risks, and investors would be wise to research each company before they buy stock. Here’s some key information about the industry and ways to find pharmaceutical stocks for interested investors.

An Intro to the Pharmaceutical Industry

Pharmaceutical companies research, develop, make, and sell medications, including preventive medicines, treatments, and vaccines. Two segments of therapeutics make up the industry: pharmaceuticals and biologics. It’s also important to know the difference between pharmaceutical stocks and biotech stocks.

Pharmaceutical drugs are tablets or pills made out of synthetic or plant-based chemicals. Because they are small and fairly easy to make, companies can produce hundreds of thousands of them. When drugs are first approved, they generally have a patent or market exclusivity, meaning that only the pharma company that developed them can manufacture and sell the drugs.

Once the patent or exclusivity ends, other companies can create generic forms of the drug and begin to compete with the pharma company. The generic drugs are chemical copies of the original drug but sell at lower prices, making it hard for the original pharma company to compete. This can lead to its stock losing value.

Meanwhile, biologics are products such as vaccines, gene therapies, and medications for blood disorders that are large, protein-based molecules made out of living cells. Biologics are more complex to manufacture, which is one reason they’re more expensive.

They also have tighter restrictions on distribution than pharmaceuticals do. These factors make it more challenging for companies to enter this space and for competitors to succeed. If competitors do create a similar product, it is called a biosimilar. Unlike generics, biosimilars aren’t interchangeable, so biologics don’t have the same stock drop-off that pharmaceuticals do.

It takes about 10 years and an average of $1.3 billion to $2.8 billion to bring a new drug to market, but in special circumstances, the FDA can expedite approval.

Why Invest in Pharmaceuticals?

With pharmaceuticals, whether investors are looking for high growth potential, long-term value, or stable dividends, they can find a pharma stock that will fit the bill. There are hundreds of early-stage and established stocks, mutual funds, and exchange-traded funds out there.

About 10,000 Americans turn 65 every day, according to the AARP. And by 2030, the country will have more residents 65 and older than children, the Census Bureau has projected.

This means more people needing health care and pharmaceutical drugs, which in turn is expected to make pharma stocks grow. U.S. health spending is projected to reach nearly $6.8 trillion by 2030, according to the Centers for Medicare & Medicaid Services.

Pharmaceutical stocks don’t always follow the same trends as other stocks because people need medications no matter what is going on in the market. This doesn’t mean that pharma stocks always perform better than the broader market, but sometimes they don’t follow the same lines. Certain pharmaceutical exchange-traded funds (ETFs) have historically performed quite a bit better than the S&P 500 Index.

The health care sector can perform well during tough economic times, since people always need health care no matter what is going on in the world. About 49% of people in the U.S. report having used at least one prescription drug in the past 30 days, with 24% using three or more, according to the Centers for Disease Control and Prevention.

This translates to the companies that make those drugs consistently earning revenue even when the rest of the stock market is down. Larger companies have fairly consistent income streams, while smaller companies that show promise get funding from investors and sometimes get acquired by larger companies.

A few other reasons pharmaceutical stocks look promising as a long-term investment are:

• People are living longer, and the majority of elderly Americans take prescription medications. The longer people live, the more years they will be paying for those drugs.

• The health care sector is expanding in countries outside the United States.

• The government has been spending more on health care research.

• New types of therapies, such as gene therapy, are getting more sophisticated. Some of these are very expensive.

How to Choose Pharmaceutical Stocks

With so much potential in pharma, it can be difficult to navigate the hype and figure out what’s really a good investment. Billions of dollars are invested in medical research and drugs each year. But not every company becomes a success.

As with any stocks, investors will want to research pharma stocks before buying. Here are a few key factors to look at when evaluating stocks.

Growth Prospects

By looking at a company’s earnings and revenue, one can see how much it’s been growing and whether growth is slowing down. Investors can also look into each company’s pipeline to see how close to market a drug being developed is.

Pharma companies have to go through certain steps to develop, test, and get drugs approved. They often make pipelines available to the public, so investors can see which drugs are in the early stages of development, preclinical testing, going through clinical trials in humans, or getting FDA approval or other necessary regulatory approvals.

Drugs may get approval for treatment of certain diseases or for specific demographics, but the makers can then apply for approval for additional uses. If they get the expanded approval, this can lead to growth for the company.

Knowing when to buy stocks is challenging, and trying to time the market generally isn’t a good strategy. That said, investors can follow different pharmaceutical companies to see when they have the potential to grow and become successful. If a pharma company has patents that are close to expiring, for instance, this may slow down growth, as competitors can create generic forms of the same drugs.

The process companies go through to develop and bring drugs to market is generally as follows:

• Drug discovery: During this phase, drugs and the diseases they can potentially treat are discovered.

• Preclinical trials: Potential drugs get tested in test tubes or on live animals.

• Clinical trials: Small human trials determine a safe dosage and how humans react to it. Then, groups of 100 or more people test the drug to discover short-term side effects and optimal dosage. Finally, groups of hundreds or thousands of people test the drug to determine efficacy and safety. When drugs reach the clinical trial stage, this could be a good time for investors to keep an eye on them. If a drug makes it through trials, the company has potential for significant growth. But if the drug fails during testing, the stock is unlikely to do well.

• Regulatory approval: In the United States, the Food and Drug Administration’s Center for Drug Evaluation and Research assesses and approves new drugs, and in the EU, approval is completed by the European Medicines Agency. If the benefits of the drug outweigh the side effects and risks, and the drug is a good alternative or additional treatment for the disease it is targeting, these agencies will consider approving the drug.

Types of FDA Application

There are different types of pharmaceutical FDA applications, some of which give companies more potential for stock growth than others. The application types are:

• Investigational new drug application: This is the first application step that companies must go through.

• New drug application: This is an application to market and sell a new drug. Companies filing this application have the most potential for stock growth because they are introducing a new product to market.

• Abbreviated new drug application: Companies developing a generic form of an existing drug go through this application.

• Therapeutic biologics application: This is required under the PHS Act for biologics.

• Over-the-counter drug application: This is for companies looking to sell over-the-counter drugs, which are categorized as being safe to distribute without a prescription.

Dividends

Not all pharmaceutical companies pay dividends, but some of them do provide consistent payouts to investors. The dividends can add up.

Qualitative and Quantitative Metrics

The same rules apply to pharmaceutical stocks as to any other stock when it comes to evaluation. Investors should look at a company’s valuation, revenues, growth, leadership team, product pipeline, and other key metrics to decide whether to invest. Stock valuation ratios, such as price-to-earnings ratio and price-to-earnings-growth ratio, are very useful when comparing different stocks within the same industry.

However, some pharmaceutical companies are not yet profitable if they are in the drug development and trial phases. In this case, investors can look at the rate of cash burn: how much money the company is spending each quarter to develop a drug. It’s very expensive to develop a drug, so if a company is burning through cash and doesn’t have much left to work with, this might not bode well for the stock.

Another useful metric to look at is the price-to-sales ratio. This compares a company’s sales to the price of its stock. If the company doesn’t have sales yet, investors can make predictions about what those sales figures might look like.

Trends and Developments

Over time, trends in the types of diseases being targeted and the types of therapies being developed change. Investors can look into stocks in popular areas of treatment to find stocks with growth potential.

For instance, many drugs are in development to treat breast cancer and non-small-cell lung cancer. Treatments that are bringing in significant revenue globally include oncologics, antidiabetics, respiratory therapies, and autoimmune disease drugs. Additional lucrative treatment areas include antibiotics, anticoagulants, pain, and mental health.

Risks of Investing in Pharmaceutical Stocks

As with any type of investment, pharma stocks come with some risks. Some of the main risks to be aware of are:

• Clinical failure: Many drugs don’t make it through the phases of clinical trials. If a drug has made it to the final stage, it’s more likely to succeed, but even at this phase, drugs can fail.

• Inability to obtain approval: Just because a drug does well in trials doesn’t mean it will be approved by regulatory agencies.

• Difficulties getting reimbursement and pricing drugs: Health insurance companies, government programs, or individuals must cover the cost of drugs, and companies aren’t always able to secure the money they need. Sometimes, companies are pressured to lower the price of drugs to make them more accessible, and this can result in financial struggles for the company.

• Industry competition: As mentioned, when patents run out, pharma companies can struggle to keep up with competitors that develop cheaper generic versions of drugs. In addition, during the drug development phase, it’s not uncommon for multiple companies to be working on medications to treat the same illness. If one company can make it to trials or get approval first, this can put them way ahead of the competition, especially if it results in patent exclusivity.

• Litigation and liability: In the pharmaceutical industry, lawsuits are common. Drugs can also be recalled from the market if they’re found to be unsafe.

Investing in Pharmaceutical Stocks

If you’re looking to start investing in the pharmaceutical industry, you might consider buying pharmaceutical ETFs. Or, you could do your due diligence and choose individual stocks, aiming for stable dividends or growth potential. Before investing, it helps to familiarize yourself with the pharmaceutical industry to better understand how to choose pharma investments, and also ensure you understand the potential risks of investing in pharmaceutical stocks.

Online platforms are a great tool to use if you’re investing in ETFs and other stocks, whether in the pharmaceutical industry or elsewhere. SoFi Invest®, for instance, offers a suite of tools to track specific stocks, select individual stocks, trade fractions of stocks, or purchase ETFs.

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

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.

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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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Apr

2023

Can You Lose Money in an Index Fund?

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

As is the case with any investment, you can lose money in an index fund. Still, index funds allow investors to track the market in a low-cost, consistent way, according to most analysts and advisors. That’s because an index fund provides exposure to a diverse selection of publicly traded securities that are intended to perform identically to a market index.

However, index funds don’t always perform in an exact one-to-one ratio, as we will see. But in general, most high-quality index funds perform in close lockstep with their underlying indexes.

How Can You Lose Money in an Index Fund?

All investments carry risk. An index fund, like anything else, can potentially lose value over time.

That being said, most mainstream index funds are generally considered a conservative way to invest in equities (although there are lesser-known index funds that are thought to carry greater risk). This is largely due to the fact that index funds are greatly diversified, distributing risk throughout many securities. Risk is also lowered by reducing an individual’s responsibility in managing the funds — investors can simply buy and hold for years, or even decades.

As you weigh the risks, also keep in mind that most financial experts agree that the biggest risk is not investing at all. While saving money is important, inflation steadily eats away at savings over time.

How Does an Index Fund Work?

Index funds are part of a growing trend of what’s referred to as “passive investments.” Similar to an exchange-traded fund (ETF), an index fund is composed of many different assets packaged into a single security that investors can trade like a regular stock.

When you buy shares of an index fund, many people think that you are almost buying a tiny piece of a share of every company in that index all at once. An S&P 500 index fund, for example, gives investors exposure to most 500 companies in the S&P 500, or so the story goes. And some index funds do work this way.

But in reality, things are not always so straightforward. The goal of an index fund is to track the performance of a stock market index, and the fund can invest in any number of assets to achieve this end. That often does include a substantial amount of holdings of the stocks contained in a specific index, but there can be other assets included as well.

Some funds might not actually hold any of the assets that are present in the index they are supposed to be tracking. Instead, they might invest only in derivatives, like options and futures, that are intended to perform similarly to the index.

Some funds also provide leverage, meaning they are designed to provide returns or losses greater than what their respective index provides. If a fund has 3x leverage, for example, then it might produce a return or loss three times as high as what its index does. Leveraged bets of any kind are generally considered to be riskier and more speculative.

How Likely Are Index Funds to Go to Zero?

Index funds are generally not as volatile as individual stocks because of their diversification. But of course, if the underlying index is volatile, then the index fund will be, too, assuming it tracks the index’s performance well.

Investors who stick to well-established index funds that own real assets probably don’t have too much to worry about — but they aren’t 100% free of risk either.

Markets don’t go up or down in a straight line, so over the short term, funds will fluctuate. But index funds can provide a good option to gain exposure to broad swaths of the market without having to select individual stocks or manage a portfolio actively.

Although any index fund comes with risk of loss, like all investments, some funds may have a real possibility of losing a significant portion of investment capital. Leveraged funds and funds that invest in derivative products have a higher-than-average chance to produce suboptimal returns.

Over long periods of time, though, most indexes have seen large returns, as the large companies that are included in most indexes continue growing.

What Are the Benefits of Investing in Index Funds?

The benefits of index funds involve everything described so far. Low risk and high diversification provide an excellent way to grow wealth steadily over time. For this reason, index funds can be a reasonable option for most long-term portfolios.

For the most part, major index funds with an established track record don’t require much active management. That’s why they fall under the umbrella term “passive investments.” This is another reason why some investors like index funds: They don’t have to keep track of a bunch of different securities, their performance, or their latest news releases and company fundamentals.

Some Common Misconceptions About Index Funds

Not all index funds are created equal, and not all of them work in a simple, straightforward manner. While the general concept may be simple enough, in practice things don’t always work out the same way.

Here are a few notes about some of the most common misconceptions about index funds.

Index Funds Always Perform the Same

Sometimes, some index funds might provide returns less than the actual index they track. This can happen for a number of reasons. A high expense ratio, for example, might mean that there are hidden fees associated with owning the fund, making it more expensive.

To this end, it can be important for investors to make sure their funds won’t underperform. Index funds are generally a good way to minimize bad decisions, but only if someone chooses a fund that has broad exposure and low fees.

All Index Funds Are Low Risk

As mentioned, index funds tend to be on the lower end of the risk spectrum. But not all index funds are created the same. For investors looking for minimal risk, it might be wise to seek out a fund that directly owns shares of stocks, offers the most diversification possible, and has a long-standing track record of performance that mimics its underlying index.

Index Funds Work Well As Short-Term Investments

In general, some advisors suggest that index funds ought to be held for at least five years, if not 10 or more.

Funds of this type don’t make for good short-term investments because they usually don’t move a lot over short time periods, and the fees or commissions involved tend to eat into the meager profits investors might gain.

There are certain leveraged funds and ETFs that are better suited to short-term trading, but we won’t get into those here.

Try Investing With SoFi Invest

Can you lose money in an index fund? Of course you can. But index funds still tend to be an appealing choice for investors due to their built-in diversification and comparatively low risk. Just make sure to note that not all index funds always perform the same, and that now every index fund out there is low-risk.

If you’re beginning your portfolio-building journey you might consider getting started with SoFi Invest®. The platform offers educational content as well as access to financial planners. Plus, the Active Investing platform lets investors choose from an array of stocks, ETFs, or fractional shares.

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

Apr

2023

Participating Preferred Stock, Explained

By Becca Stanek | Growing Wealth, invest, Investing | Comments Off

You may have heard mention of preferred shareholders or preferred stocks in investment circles. And you may have wondered: How do I get preferred stocks? Preferred stocks are available to individual investors. That being said, there is a type of preferred stocks that may be out of reach to most, and that’s participating preferred stocks.

Here’s a look at what participating preferred stock is, as well as when one might have the option to own participating preferred stock and what the benefits of participating preferred stock are.

What Is Preferred Stock?

Preferred stock shares characteristics of both common stocks and bonds. Preferred stocks allow investors to own shares in a given company and also receive a set schedule of dividends (much like bond interest payments).

Because the payout is predictable and expected, there isn’t the same potential for price fluctuations as with common stocks — and thus there’s less potential for volatility. But, the shares may rise in value over time.

Recommended: Preferred Stock vs. Common Stock

How Preferred Stocks Work

Shares of preferred stock tend to pay a fixed rate of dividend. Preferred stocks have dividend preference; they’re paid to shareholders before dividends are paid out to common shareholders.

These dividends may or may not be cumulative. If they are, all unpaid preferred stock dividends must be paid out prior to common stock shareholders receiving a dividend.

For example, if a company has not made dividend payments to cumulative preferred stock shareholders for the previous two years, they must make two years’ worth of back payments and the current year’s dividend payments to preferred shareholders before common stock shareholders are paid any dividend at all.

Because of the fixed nature of the dividend, the investments themselves tend to behave more like how a bond works. When an investment pays a fixed and predictable rate of interest, they tend to trade in a smaller and more predictable bandwidth. Compare that to stocks, whose future income stream and total return on investment are less predictable, which lends itself to plenty of price disagreement in the short-term.

Preferred stockholders do not typically enjoy voting rights at shareholder meetings. But, preferred stock shareholders are paid out before common shareholders in a liquidity event.

Participating Preferred Stocks

Participating preferred stock takes on all of the above features, but they may receive some bonus benefits, such as an additional dividend payment. This additional payment may be triggered when certain conditions are met, often involving the common stock. For example, an additional dividend may be paid out in the event that the dividend paid to common shareholders exceeds a certain level.

Upon liquidation, participating preferred shareholders may receive additional benefits, usually in excess of what was initially stated. For example, they may have the right to get back the value of the stock’s purchasing price. Or, participating preferred shareholders may have access to some pro-rata cut of the liquidation proceeds that would otherwise go to common stock shareholders.

Non-participating preferred stocks do not get additional consideration for dividends or benefits during a liquidation event.

For those with access, participating preferred stock is an enticing investment. That said, the average individual investor may not have the chance to invest in participating preferred stock. This type of stock is typically offered as an incentive for private equity investors or venture capital firms to invest in private companies.

The Takeaway

Preferred stock offers some benefits that common stock does not — such as a regular dividend schedule and the potential to increase in value without threat of volatility. Participating preferred stock offers investors even more potential benefits, including additional dividends and the opportunity to participate in liquidity events. However, participating preferred stocks are generally an option only for private equity investors or venture capitalists.

Though an investor might not have the chance to get involved with this particular investment opportunity, there are other ways to trade stocks online and invest in the market. SoFi Invest® offers both active investing and automated investing options to suit every type of investor.

Take a step toward reaching your financial goals with SoFi Invest.

SoFi Invest®

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

Apr

2023

Swing Trading Explained

By Inyoung Hwang | Growing Wealth, invest, Investing, Terminology | Comments Off

What Is Swing Trading?

Swing trading is a type of stock market trading that attempts to capitalize on short-term price momentum in the market. The swings can be to the upside or to the downside, and typically occur within a range from a couple of days to a couple of weeks. While day traders typically stay invested in a position for minutes or hours, swing traders invest for several days or weeks. Still, swing trading is a more short-term strategy than investors who buy and hold onto stock for many months or years. But it’s important to bear in mind the potential risks, costs, and tax implications of this strategy.

Generally, a swing trader uses a mix of technical and fundamental analysis tools to identify short- and mid-term trends in the market. They can go both long and short in market positions, and use stocks, exchange-traded funds, and other market instruments that exhibit pricing volatility.

It is possible for a swing trader to hold a position for longer than a few weeks, though a position held for a month or more may actually be classified as trend trading.

Cost and Tax Implications

A swing trading strategy is somewhere in between a day-trading strategy and trend-trading strategy. They have some methods in common but may also differ in some ways — so it’s important to know exactly which you plan to utilize, especially because these shorter-term strategies have different cost and tax factors to consider.

Frequent trades typically generate higher trading fees than buy-and-hold strategies, as well as higher taxes. Unless you qualify as a full-time trader, your short-term gains can be taxed as income, rather than the more favorable capital gains rate (which kicks in when you hold a security for at least a year).

How Swing Trading Works

Swing trading can be a fairly involved process, utilizing all sorts of analysis and tools to try and gauge where the market is heading. But for simplicity’s sake, you may want to think of it as a method to capture short-to-medium term movements on share prices.

Investors are, in effect, trying to capture the “swing” in prices up or down. It avoids some day trading risks, but allows investors to take a more active hand in the markets than a buy-and-hold strategy.

With that in mind, swing trading basically works like this: An investor buys some stock, anticipating that its price will appreciate over a three-week period. The stock’s value does go up, and after three weeks, the investor sells their shares, generating a profit.

Conversely, an investor may want to take a short position on a stock, betting that the price will fall.

Either way there are no guarantees, and swing trading can be risky if the stocks the investor holds move in the opposite direction.

Day Trading vs Swing Trading

Like day traders, swing traders are highly interested in the volatility of the market, and hope to capitalize on the movements of different securities.

Along with day traders and trend traders, swing traders are active investors who tend to analyze volatility charts and price trends to predict what a stock’s price is most likely to do next. This is using technical analysis to research stocks–a process that can seem complicated, but is essentially trying to see if price charts can give clues on future direction.

The goal, then, is to identify patterns with meaning and accurately extrapolate this information for the future.

The strategy of a day trader and a swing trader may start to diverge in the attention they pay to a stock’s underlying fundamentals — the overall health of the company behind the stock.

Day traders aren’t particularly interested in whether a company stock is a “good” or “bad” investment — they are simply looking for short-term price volatility. But because swing traders spend more time in the market, they may also consider the general trajectory of a company’s growth.

Pros and Cons of Swing Trading

Pros and Cons of Swing Trading
Pros	Cons
Less time intensive	Expenses & taxes
Income potential	Time
May help to avoid market dips	Efficacy

Pros of Swing Trading

To understand the benefits of swing trading, it helps to understand the benefits of long-term investing — which may actually be the more suitable strategy for some investors.

The idea behind set-it-and-forget-it, buy-and-hold strategies is quite simply that stock markets tend to move up over long periods of time, or have a positive average annual return. Also, unlike trading, it is not zero-sum, meaning that all participants can potentially profit by simply remaining invested for the maximum amount of time possible.

1. Time and Effort

Further, long-term investing may require less time and effort. Dips in the market can provide the opportunity to buy in, but methodical and regular investing is generally regarded higher than any version of attempting to short-term time the market.

Swing trading exists on the other end of the time-and-effort continuum, although it generally requires much less effort and attention than day trading. Whereas day traders must keep a minute-by-minute watch on the market throughout the trading days, swing trading does not require that the investor’s eyes be glued to the screen.

Nonetheless, swing trading requires a more consistent time commitment than buy-and-hold strategies.

2. Income

Compared to long-term investing, swing trading may create more opportunity for an investor to actively generate income.

Most long-term investors intend to keep their money invested — including profits — for as long as possible. Swing traders are using the short-term swings in the market to generate profit that could be used as income, and they tend to be more comfortable with the risks this strategy typically entails.

3. Avoidance of Dips

Finally, it may be possible for swing traders to avoid some downside. Long-term investors remain invested through all market scenarios, which includes downturns or bear markets. Because swing traders are participating in the market only when they see opportunity, it may be possible to avoid the biggest dips. That said, markets are highly unpredictable, so it’s also possible to get caught in a sudden downturn.

Cons of Swing Trading

Though there is certainly the potential to generate a profit via swing trading, there’s also a substantial risk of losing money — and even going into debt.

As with any investment strategy, risk and reward are intrinsically related. For as much potential as there is to earn a rate of return, there is potential to lose money.

Therefore it is smart to be completely aware of — and comfortable with the risks, no matter which investing strategy you decide to use.

1. Expenses & Taxes

A good rule of thumb: Don’t trade (or invest) money that you can’t afford to lose.

Additionally, it can be quite expensive to swing trade, as noted above. Although brokerage or stock broker commissions won’t be quite as high as they would be for day traders, they can be substantial.

Also, because the gains on swing trades are typically short-term (less than a year), swing investors have to keep an eye on their tax bill as well.

In order to profit, traders will need to out-earn what they are spending to engage in swing trading strategies. That requires being right more often than not, and doing so at a margin that outpaces any losses.

2. Time

Swing trading might not be as time-consuming or as stressful as day trading, but it can certainly be both. Many swing traders are researching and trading every day, if not many times a day. What can start as a hobby can easily morph into another job, so keep the time commitment in mind.

3. Efficacy

Within the investing community, there is significant debate as to whether the stock market can be timed on any sort of regular or consistent basis.

In the short term, stock prices do not necessarily move on fundamental factors that can be researched. Predicting future price moves is nothing more than just that: trying to predict the future. Short of having a crystal ball, this is supremely difficult, if not impossible, to do.

Swing Trading Example

Here’s a relatively simple example of a swing trade in action.

An investor finds a stock or other security that they think will go up in value in the coming days or weeks. Let’s say they’ve done a fair bit of analysis on the stock that’s led them to conclude that a price increase is likely.

Going Long

The investor opens up a position by purchasing 100 shares of the stock at a price of $10 per share. Obviously, the investor is assuming some risk that the price will go down, not up, and that they could lose money.

But after two weeks, the stock’s value has gone up $2, and they decide to close their position and sell the 100 shares. They’ve capitalized on the “swing” in value, and turned a $200 profit.

Of course, the trade may not pan out in the way the investor had hoped. For example:

• The stock could rise by $0.50 instead of $2, which might not offer the investor the profit she or he was looking for.

• The stock could lose value, and the investor is faced with the choice of selling at a loss or holding onto the stock to see if it regains its value (which entails more risk exposure).

Going Short

Swing traders can also take advantage of price drops and short a stock that they think is overvalued. They borrow 100 shares of stock from their brokerage and sell the shares for $10 per share for a total of $1,000 (plus any applicable brokerage fees).

If their prediction is correct, and the price falls to $9 per share, the investor can buy back 100 shares at $9 per share for $900, return the borrowed shares, and pocket the leftover $100 as profit ($1,000 – $900 = $100).

If they’re wrong, the investor misses the mark, and the price rises to $11 per share. Now the investor has to buy back 100 shares for $11 per share for a total of $1,100, for a loss of $100 ($1,000 – $1,100 = -$100).

Swing Trading Strategies

Each investor will want to research their own preferred swing trading strategy, as there is not one single method. It might help to designate a specific set of rules.

Channel Trading

One such strategy is channel trading. Channel traders assume that each stock is going to trade within a certain range of volatility, called a channel.

In addition to accounting for the ups and downs of short-term volatility, channels tend to move in a general trajectory. Channels can trend in flat, ascending, or descending directions, or a combination of these directions.

When picking stocks for a swing trading strategy using channels, you might buy a stock at the lower range of its price channel, called the support level. This is considered an opportune time to buy.

When a stock is trading at higher prices within the channel, called the resistance level, swing traders tend to believe that it is a good time to sell or short a stock.

MACD

Another method used by swing traders is moving average convergence/divergence, or “MACD.” The MACD indicator looks to identify momentum by subtracting a 26-period exponential moving average from the 12-period EMA.

Traders are seeking a shift in acceleration that may indicate that it is time to make a move.

Other Strategies

This is not a complete list of the types of technical analysis that traders may integrate into their strategies.

Additionally, traders may look at fundamental indicators such as SEC filings and special announcements, or watch industry trends, regulation, etc., that may affect the price of a stock. Trading around earnings season may also present an opportunity to capitalize on a swing in value.

Similarly, they may watch the news or reap information from online sources to get a sense of general investor sentiment. Traders can use multiple swing trading methods simultaneously or independently from one another.

Swing Trading vs Day Trading

Traders or investors may be weighing whether they should learn swing trading versus day trading. Although the two may have some similarities, day trading is much more fast-paced, with trades occurring within minutes or hours to take advantage of very fast movements in the market.

Swing trading, conversely, gives investors a bit more time to take everything in, think about their next moves, and make a decision. It’s a middle-ground between day trading and a longer-term investing strategy. It allows investors to get into some active investing strategies, but doesn’t require them to monitor the markets minute by minute to make sure they don’t lose money.

Swing Trading vs Long-Term Investing

Long-term investing is likely the strategy that involves the least amount of risk. Investors are basically betting that the market, over the long term, will be higher several years from now, which is typically true, barring any large-scale downturns. But it doesn’t give investors the opportunity to really trade based on market fluctuations.

Swing trading does, albeit not as much as day trading. If you want to get a taste for trading, and put some analysis tools and different strategies to work, then it may be worth it to learn swing trading.

Is Swing Trading Right for You?

Whether swing trading is a good or wise investing strategy for any individual will come down to the individual’s goals and preferences. It’s good to think about a few key things: How much you’re willing to risk by investing, how much time you have to invest, and how much risk you’re actually able to handle on a psychological or emotional level — your risk tolerance.

If your risk tolerance is relatively low, swing trading may not be right for you, and you may want to stick with a longer-term strategy. Similarly, if you don’t have much to invest, you may be better off buying and holding, effectively lowering how much you’re putting at risk.

Active Investing With SoFi

Swing traders invest for days or weeks, and then exit their positions in an effort to generate a quick profit from a security’s short-term price movements. That differentiates them from day traders or long-term investors, who may be working on different timelines to likewise reap market rewards.

Swing trading has its pros and cons, too, but can be a way for investors to try out trading strategies at a slower pace than a day trader.

There are also different methods and strategies that swing traders can use. There is no one surefire method, but it might be best to find a strategy and stick with it if they want to give swing trading an honest try. Be aware, though, that it carries some serious risks — like all stock trading.

The SoFi Invest® stock trading app offers educational content as well as access to financial planners. The Active Investing platform lets investors choose from an array of stocks and ETFs. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. Please see terms and conditions 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.

FAQ

Is swing trading actually profitable?

Swing trading can be profitable, but there is no guarantee that it will be. Like day trading or any other type of investing, swing trading involves risk, though it can generate a profit for some traders.

Is swing trading good for beginners?

Many financial professionals would likely steer beginning investors to a buy-and-hold strategy, given the risks associated with swing or day trading. However, investors looking to feel out day trading may opt for swing trading first, as they’ll likely use similar tools or strategies, albeit at a slower pace.

How much do swing traders make?

It’s possible that the average swing trader doesn’t make any money at all, and instead, loses money. That said, some swing traders can make thousands of dollars. It depends on their skill level, experience, market conditions, and a bit of luck.

SoFi Invest®

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

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

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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

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.

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The Takeaway

Swing Trading Explained

What Is Swing Trading?

Cost and Tax Implications

How Swing Trading Works

Day Trading vs Swing Trading

Pros and Cons of Swing Trading

Pros of Swing Trading

1. Time and Effort

2. Income

3. Avoidance of Dips

Cons of Swing Trading

1. Expenses & Taxes

2. Time

3. Efficacy

Swing Trading Example

Going Long

Going Short

Swing Trading Strategies

Channel Trading

MACD

Other Strategies

Swing Trading vs Day Trading

Swing Trading vs Long-Term Investing

Is Swing Trading Right for You?

Active Investing With SoFi

FAQ

Is swing trading actually profitable?

Is swing trading good for beginners?

How much do swing traders make?

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