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Apr

2023

How to Find a Financial Advisor

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

Deciding you’re ready to consult with a financial advisor is a first and important step in reaching your financial goals — but finding the right professional for your needs takes some time and effort, starting with a closer look at what you need, exactly.

A financial advisor can do many things. Generally, they examine a client’s current financial picture, from debt to savings and investments; discuss financial goals (whether retirement, saving for college, or another goal); and create a plan to help the client get there.

Some financial professionals simply offer guidance or a basic plan; others may completely manage a client’s portfolio, while others may offer services that fall somewhere in between. Finding the right person hinges on whether their services match your needs, whether their cost structure makes sense, in addition to other considerations.

Benefits of Using a Financial Advisor

Financial advisors can help their clients create a financial plan that allows them to save and invest for future goals while still meeting the obligations of today. In other words, they can help craft a comprehensive plan to guide people through multiple stages of life in a way that dovetails with their unique goals. Typically, the plan has some degree of personalization.

Plus, advisors can help their clients stay the course, saving and investing for the long term. Creating a financial plan is a key step, but then it’s crucial to stick with the plan. This isn’t always easy when, for example, the market is volatile and emotions are triggered. But that’s when an experienced advisor may come in handy; they can provide perspective and help clients stay focused.

Some financial advisors help clients to become more financial savvy. Some may make trades for their clients, while many monitor investments made to help ensure that a client’s portfolio is on track. Some help with tax issues as well, e.g. whether to use a strategy like tax-loss harvesting, and more complex financial matters like estate planning.

By looking at these benefits, which seem most important to you? Sometimes making a list of requirements can be helping when trying to find a financial advisor. Under some circumstances you may even want to consider hiring a wealth advisor.

Seeking an Advisor

Next step in finding an advisor is to obtain some recommendations. To get a list of advisors to consider:

Friends and Family Recommendations

• Ask friends and family if they’ve used or are using an advisor. If so, what services are they receiving? How happy are they? Are there any concerns about any of the advisors they’re using? Ideally you want to take recs from people in similar circumstances to your own.

• Do the same with business colleagues, or people who belong to the same organizations that you do.

By looking at the websites of these advisors, do they seem like a potential match?

Industry Associations

Another option when seeking an advisor is to consult industry associations and trade groups.

• The National Association of Personal Financial Advisors website (NAPFA focuses on fee-only financial planners).

• Financial Planning Association. Advisors in this network are CERTIFIED FINANCIAL PLANNERS® (CFP®s) and you can search by location, area of specialty, how they’re paid and any asset minimums that may exist.

• Garrett Planning Network. All advisors in this network charge hourly.

Finding the Right Fit

Just as you wouldn’t buy the first car you test-drove, or the first pair of shoes you tried on, you don’t have to commit to working with the first financial planner you talk to. Many advisors offer a free consultation so you can find out more about them. While the selection process does take a little extra time, it’s worth investing that time for your future.

Questions to Consider

Some people may find that the same names keep cropping up when asking for recommendations and exploring online sites. It can therefore make sense to create a short list of financial advisors from those findings and explore those options in more depth.

Questions to ask those advisors can include:

• What specific services do you offer?

• What processes do you use to create a plan for me?

• What qualifications do you have?

• How often would we meet or otherwise communicate?

• What is your overall investment philosophy?

If you’re a beginning investor, it can help to ask about the financial advisor’s experience in getting new people started with planning and investing in a basic portfolio.

Fiduciary Rules

Another key question: is a financial advisor a fiduciary? If so, the advisor must work in the best interests of a client and either disclose conflicts of interest or avoid them. If an advisor is not a fiduciary, he or she is required only to make recommendations that are considered suitable.

In 2013, the U.S. Department of Labor tried to mandate that all financial advisors needed to follow a fiduciary standard with retirement accounts. But in 2018, the Fifth Circuit Court overruled the standard. Although this issue may be revisited, for now, investors who want a fiduciary must find out what standard a particular financial advisor follows.

Advisors who follow a fee-based payment structure are, by definition, fiduciaries. Those who get paid a commission when clients make certain investments may or may not be. When an advisor isn’t a fiduciary, they might recommend investments because they’re right for the client, but they could also be recommended because the advisor gets paid a commission.

Also, when comparing advisors, what will services for each of them cost?

Common Financial Advisor Charges

Financial advisors’ fees can be structured in a number of ways, and what you pay for a financial advisor depends on a number of factors. In general, financial advisors are either paid a flat fee (such as a retainer or a fee-for-services), commissions on products and investments they sell you (such as insurances and/or mutual funds), or a hybrid.

Retainer

Some advisors charge fixed retainer fees, due monthly, quarterly, or annually. The fees can range significantly; annually, the low end may be $2,000, with the high end at $7,500. Investors can ask an advisor to explain what they get for paying the retainer.

Commission

In this scenario, advisors get paid based on the products they sell to clients. Some advisors may receive a percentage of the assets of a client before the investments are made. Others can be paid by a financial institution after the transaction has occurred, while others may charge clients each time that a stock is bought or sold.

Advisory Fees

This can be a percentage of the assets being managed by the financial advisor. Generally speaking, paying 1% annually is reasonable under this structure when including both the fees of a financial advisor and any investment fees. When considering an advisor who charges these fees, it can make sense to ask for a breakdown and the reasoning behind the fee structure.

Planning Fees

This could be an upfront fee for a financial plan or for ongoing advice. There can also be a subscription-based fee structure, similar to a retainer. Fees for these services vary widely, so be sure to ask what your all-in costs would be when working with any advisor.

Hourly Fees

This would involve a straight hourly fee for services provided. For example, setting up your retirement portfolio might cost $X, while setting up a 529 college savings plan for your kids might cost $Y.

Robo Advising vs Financial Advisors

It may also make sense to consider an online robo-advisor, or automated investing platform. This is an algorithm-driven digital platform that provides clients with basic financial guidance and pre-set portfolio options.

First, the investor responds to a questionnaire by inputting their goals and time horizon. Typical questions may also include risk tolerance. (Here’s a helpful risk tolerance quiz.)

Based on the investor’s preferences, the technology on the backend comes up with a basic plan and a recommended portfolio option (e.g. one that’s more aggressive or more conservative).

Because most automated portfolios are built with low-cost index or exchange-traded funds (ETFs), these services are considered efficient and low cost compared with using a human advisor.

Robo portfolios often involve an annual fee, perhaps 0.25% to 1% of the account balance. In some instances, a robo advisor may charge a small monthly dollar amount for lower balances, e.g. $4 per month, instead of a percentage. Remember, these costs are in addition to the fees for the underlying funds in your portfolio.

Automated investing platforms may not be the right choice for people who need advice for complex financial situations, such as tax planning. It also wouldn’t fit the needs of investors who simply prefer to sit down with a human advisor, of course.

Just like with human advisors, different robo advisor programs offer different services. So if the idea of robo advising sounds appealing, it can help to check more than one option.

Free Financial Advice

Some companies offer complimentary financial advice for their customers. In some cases this feature is only offered if your account balance is high enough. But even though an advisory service might be touted as ‘no cost’, remember that different investment products always come with a fee, such as an expense ratio. Topics discussed can include how to:

• Set and reach financial goals, based on the current financial landscape.

• Create a budget and practice good spending habits.

• Leverage debt strategically by balancing repayment of debt with saving for long-term goals.

• Build an emergency fund and save for the future.

• Create an investment strategy that dovetails with personal risk tolerance and goals.

The Takeaway

Deciding to work with a financial advisor is an exciting step toward taking control of your financial future. Finding the right person, however, takes time and diligence. Financial advisors can come with a range of qualifications and specialties. The services they offer and the fees they charge also vary.

Fortunately, there are a number of organizations that can help you do a search for someone who is the right fit. And you can also consider taking a more tech-driven route and using a robo-advisor.

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), and members can access complimentary financial advice from a professional.

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®

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Apr

2023

What Is the Dow Jones?

By Matthew Zeitlin | Growing Wealth, invest, Investing, Terminology | Comments Off

The Dow Jones Industrial Average is one of the earliest examples of a stock index, a collection of 30 blue-chip company stocks that are calculated into one number that’s supposed to represent the U.S. stock market as a whole or a subset of it.

Now there are hundreds of indices, which represent everything from smaller companies (The Russell 2000), to specific industries, like the KBW Bank Index, to the S&P 500 — the oft-cited index that represents a broad cross-section of America’s largest companies. But the Dow is still watched, domestically and worldwide, as a leading market indicator.

What Is the Dow Jones Industrial Average?

The Dow Jones Industrial Average is based on the performance of 30 companies that represent the industry leaders in the world economy: Apple, Microsoft, JP Morgan Chase, Nike, Coca-Cola, Walmart, Disney, along with companies like Dow or Caterpillar that you may not be as familiar with, but are massive and play an important role in business in the United States and around the world.

The Dow is considered an index of blue-chip companies, which signals not only some of the largest companies, but also the most solid and well established.

Nonetheless, the companies on the Dow Jones Industrial Average change regularly, reflecting changes in the U.S. economy.

It’s important for investors to follow the Dow, as it’s one of the leading stock market indicators. And while it’s certainly not the only one, understanding the Dow’s movements in addition to other indicators can help inform your investing strategy.

What Makes the Dow Jones Industrial Average Different?

The Dow Jones Industrial Average is just one of many collections of stocks whose value is represented in a single number. The Dow Jones Industrial Average isn’t just distinct because of its age, but because of how it’s calculated.

The other two major stock indices that are frequently cited as bellwethers of the overall market, the S&P 500 and the Nasdaq Composite, are both “market capitalization weighted,” whereas the Dow Jones Industrial Average is “price-weighted.”

That means that the Dow Jones Industrial Average’s “points” are calculated from the per-share price of every stock in the index, as opposed to the company’s overall value. As such, the DJIA doesn’t reflect the overall stock market return, but rather it can be used as a gauge of market trends and/or investor sentiment.

In a market-weighted index, the influence any given stock has over the index’s overall value is determined by a company’s market capitalization or market cap. A company’s market cap is determined by multiplying the number of shares by the value of the stock.

In this type of index, the influence of a company is determined by how valuable the company is, not solely by the price of a stock.

Example of How Stock Price Can Skew an Index

Apple only joined the Dow Jones Industrial Average after it did a stock split, lowering its per share price from around $650 to under $100, but increasing the number of shares by seven. Had it split its stock before joining the Dow, it would have entered the index with a price of nearly $900, as opposed to around $126, giving the company an outsize role on the index.

Because the Dow Jones Industrial Average is price weighted, adding companies with hefty per-share price tags could cause problems. That’s the main reason that companies like Alphabet, the parent company of Google, and Amazon, aren’t included in the index. On the other hand, Microsoft, which is worth over $1 trillion, is priced at below $200 a share and is a member of the Dow Jones Industrial Average.

The Dow Divisor

Today’s economy is far different from the late 19th century or the late 1920s — the number of industries in which the U.S. has large, established companies has grown, and the size of those companies is bigger.

In order to account for some of these changes over time, the Dow Divisor is used to determine the value of the Dow Jones Industrial Average. Using the Dow Divisor can help in historical comparisons and account for differences that may arise due to a stock split or other factors.

How the Dow Jones Industrial Average Changed Over Time

The Dow Jones Industrial Average is intimately tied up with the history of the markets and American financial journalism. The Dow Jones Industrial Average is just eight years younger than the Wall Street Journal, which was founded in 1889, while the Dow Jones Industrial Average was founded as a 12-company index in 1896.

The Dow Jones Industrial Average was originally developed by Charles Dow and Edward Jones.

But it wasn’t the first ever stock index; that title belongs to the Dow Jones Transportation Average, a collection of railroad stocks that Dow came up with in 1884.

The 12 companies initially included in 1896 were companies that reflected the shape of the American economy — largely manufacturing and agricultural companies and the transportation networks that helped move goods. The companies included in that first year were:

• American Cotton Oil

• American Sugar

• American Tobacco

• Chicago Gas

• Distilling & Cattle Feeding

• General Electric

• Laclede Gas

• National Lead

• North American

• Tennessee Coal & Iron

• U.S. Leather

• U.S. Rubber

The Dow Jones Industrial Average in the 20th Century

The index was expanded to its current number of 30 in 1928, and by 1932 the Index started to resemble the American economy as we might recognize it today, with a mixture of manufacturing (General Motors, Chrysler), retail (Sears, Woolworth), consumer (Coca-Cola, Procter & Gamble) technology (IBM) and energy (multiple descendants of John Rockefeller’s Standard Oil).

The first companies associated with the personal computer revolution came much later (IBM being an exception), with Hewlett-Packard getting added in 1997, Intel and Microsoft added in 1999, and Apple only joining the Dow in 2015, when it replaced AT&T.

Walmart was added to the index in 1997. America’s entertainment industry, one of its leading export industries, was only represented in the index in 1991, when Disney was added.

Right now the Dow Jones Industrial Average “covers all industries except transportation and utilities,” according to S&P Dow Jones Indices.

While the Dow Jones Industrial Average is managed by S&P Dow Jones Indices, it still retains a connection with the Wall Street Journal and its publishing company, Dow Jones. The editor of the paper is part of the committee that determines membership in the Dow Jones Industrial Average.

The Takeaway

Investors can look to the Dow Jones Industrial Index as an overall indicator of how the largest companies in the U.S. are performing. Historically, the Dow Jones Industrial Average has shown similar returns to the S&P 500, which tracks 500 large-cap U.S. companies.

Indexes, like the Dow Jones Industrial Index, can provide helpful insight for investors. They can be used to help investors compare current and past stock prices, to determine the market performance. Understanding this information can be helpful to investors as they review their own portfolio and adjust their investing strategy.

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 commission, but other fees apply (full fee disclosure here), and members can access complimentary financial advice from a professional.

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

What Is a Fiduciary Financial Advisor?

By Amanda Holden | Growing Wealth, invest, Investing | Comments Off

Fiduciary financial advisors are professionals who have a legal obligation to manage assets or give retirement advice with their client’s best interest in mind.

Among the guidelines fiduciary financial advisors need to abide by are avoiding conflicts of interest, being transparent (about fees and investments choices), acting in good faith, and being as accurate as possible.

Financial advisors aren’t the only professionals who can have fiduciary responsibilities. Lawyers, bankers, board members, accountants and executors can all be considered fiduciaries.

Fiduciary financial advisors cannot recommend investments or products simply because they would pay them bigger commissions. They can be held civilly responsible if they give advice that isn’t in the best interest of their clients.

What Is a Fiduciary?

A fiduciary is someone who manages property or money on behalf of someone else. “When you are named a fiduciary, you are required by law to manage the person’s money and property for their benefit, not yours,” according to the Consumer Financial Protection Bureau (CFPB), a government watchdog agency.

The CFPB provides an example of this, along with the requirements of being a fiduciary:

“For example, a friend of yours may name you her fiduciary through a power of attorney (POA). This means that you are responsible for her finances if she becomes sick or injured.”

As a fiduciary, your four basic duties are to act only in your friend’s best interest, manage her money and property carefully, keep her money and property separate from your own, and keep good records. Basically, you are to do your very best to manage her finances honestly.

In this sense, a person who is named as a fiduciary may not have any particular financial planning expertise. Therefore, they may still choose to hire out the actual work of managing the money to a financial expert. In doing this, they are exercising fiduciary responsibility.

What Is the Fiduciary Responsibility in Financial Planning?

Someone who acts with fiduciary responsibility will act in the customer’s best interest.

There is no universal standard for fiduciary responsibility because there are multiple agencies that act as regulatory bodies in the financial services industry.

The U.S. Department of Labor (DOL) is one, and the Securities and Exchange Commission (SEC) is another. Additionally, the organizations offering certifications, like the board of Certified Financial Professionals (CFPs), may provide their own guidance on fiduciary responsibility and code of conduct.

In 2016, the Labor Department issued what was called the “fiduciary rule,” requiring that any advisors offering retirement advice must act in their clients’ best interest. The rule was widely challenged from within the industry and subsequently overturned in the courts in 2018.

While there has been subsequent discussion about the DOL restoring the fiduciary rule, as of early 2023 there are no plans to do so. Rather, investors interested in working with financial fiduciaries are encouraged to inquire directly with various professionals, as there are still some guidelines in effect.

Broker-Dealer Fiduciary Obligations

In June of 2019, the SEC passed its own version of the fiduciary rule, called Regulation Best Interest (RBI). It says that all broker-dealers (which includes brokers) must act in the best interest of the retail customer when making recommendations, without placing their financial interest ahead of the customer’s.

According to the SEC, broker-dealers must adhere to the following obligations:

Disclosure Obligation: provide certain required disclosure before or at the time of the recommendation, about the recommendation and the relationship between you and your retail customer;

Care Obligation: exercise reasonable diligence, care, and skill in making the recommendation;

Conflict of Interest Obligation: establish, maintain, and enforce written policies and procedures reasonably designed to address conflicts of interest; and

Compliance Obligation: establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

Not everyone is convinced that the new RBI standards do enough to protect the consumer. Additionally, the new RBI rules may have actually weakened the need for some Registered Investment Advisors to work in a fiduciary capacity.

Questions to Ask a Fiduciary Financial Advisor

Because the rules of fiduciary responsibility remain somewhat up for interpretation, the waters remain a bit murky for some retail customers, and the responsibility for finding a fiduciary requires effort on the consumer’s part.

Ask questions, carefully consider investment recommendations, and challenge possible conflicts of interest. It is good to be in the habit of asking the person you intend to work with whether they’ll be acting with fiduciary responsibility. Do not hesitate to ask them outright, “Are you a fiduciary?”

Then, ask them to clarify what fiduciary responsibility means to them, their title, and the institution that they represent. Also, consider how they are being compensated, i.e. what does the financial advisor charge? Much, although not all, can be sussed out via the compensation model.

The Fiduciary Versus Suitability Standard

Previously, broker-dealers may have adhered to what is called the “suitability rule,” as opposed to a fiduciary rule. Although broker-dealers are now technically held to a fiduciary standard, it’s an important word to know, just in case you work with someone who does not fall under the SEC’s regulatory purview. Suitability is not the same fiduciary responsibility.

The rule by the Financial Industry Regulatory Authority (FINRA), a non-governmental regulatory organization, requires that a firm or associated person have “a reasonable basis to believe” that a financial or investment recommendation is suitable for the customer.

The firm needs to make this determination based on the customer’s “investment profile,” which can include age, other investments, financial situation and needs, taxes, liquidity and risk tolerance, among other factors.

How to Find a Fiduciary Financial Advisor

Finding a financial professional that assumes fiduciary responsibility is a great start.

That said, there is more to finding a trusted financial advisor than simply adhering to fiduciary standards. Being a fiduciary doesn’t guarantee that a financial professional offers the right service for you, or even that they’re someone that you’ll want to work with.

For example, a doctor may have a license to practice, but not a good bedside manner. Or, you may need a dermatologist, so making an appointment with a pediatrician won’t do.

Here are a handful of the services offered in the financial help space, along with their respective adherence to fiduciary guidelines.

Registered Investment Advisors (RIAs)

Generally, RIAs manage investment portfolios on behalf of customers. They may or may not offer other services, such as comprehensive financial planning.

Previously, all RIAs were held to a fiduciary standard. Counterintuitively, this may have changed with the new RBI standards, which may have loosened standards for RIAs.

Brokers

Brokers, such as a stock broker, are professionals who buy and sell securities on behalf of clients. Typically, a broker works on some form of commission from the sale of securities.

Before the RBI, brokers were not held to a fiduciary standard. They are now held to the new standards, though it remains to be seen exactly how this will shake out within the industry.

Certified Financial Planners (CFPs)

CFP^® may offer more holistic financial services, such as financial planning, budgeting, and personalized investment advice. Not all financial planners are CFPs — you may want to ask about the credentials of the professional you want to work with.

The CFP Board “supports a uniform fiduciary standard of conduct for all personalized investment advice. This fiduciary standard of conduct should put the interests of the client first, and should include both a duty of care and a duty of loyalty.”

Again, it is important to seek out the professional that will best serve your needs.

If a financial professional suggests a product or strategy, do not be afraid to ask questions.

How Are Fiduciary Financial Advisors Compensated?

Financial professionals are compensated in several different ways:

Fee-only

In this case, you would pay a financial professional, such as a CFP^®, a fee to sit down and discuss a financial plan or roadmap. This could be a one-time meeting, or meetings could take place at regular intervals (such as quarterly or annually). If a financial planner is fee-only, then they will not receive any additional commissions on products being sold.

Fee-based

An advisor who is fee-based may charge a fee and collect commissions. This fee could be a one-time or annual fee, or it could be measured as a percentage of assets under management. For example, an investment advisor could charge a 1% annual fee.

Assets under management

Similarly, some investment advisors and planners who manage an investment portfolio may charge a percentage on top of assets that are being managed.

Hourly

Some financial professionals may charge by the hour. This may be more common for financial coaching and planning than wealth management.

Commissions

Commissions typically come in the form of payments to the financial professional, from the company that creates the product. Commissions are common on insurance products, like annuities and life insurance, and some actively managed mutual funds.

It is possible that a financial professional be compensated in multiple ways. Be sure to ask.

A popular choice for those just getting started is a fee-only fiduciary financial planner. To find a fee-only fiduciary financial planner, you may want to check a database like XY Planning.

The Takeaway

Fiduciary financial advisors are professionals who are legally obligated to invest money or give retirement advice that’s in the best interest of their clients.

Among the requirements fiduciary financial advisors need to abide by are minimizing conflicts of interest and being transparent about how they are compensated. Acting in good faith and giving accurate financial advice are also guidelines that fiduciaries are supposed to follow.

Investors looking for trusted help should try to find a fiduciary financial advisor. Some robo-advisors and online investing platforms offer access to a financial planner who can answer questions for investors.

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). Also, members can access complimentary financial advice from a professional.

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

What Is a Good 401(k) Expense Ratio?

By David Wolinsky | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

A 401(k) plan doesn’t have an expense ratio, per se, but the overall cost of the plan includes the expense ratios of the funds in an investor’s account, as well as other charges like plan administration fees and the like.

So what is a good 401(k) expense ratio? Ideally, the lower the fees for the plan the better, including the expense ratios of the investments in the account, because fees can lower portfolio growth substantially over time.

While investors don’t have control over the basic costs of their 401(k) plan, they can opt to choose investments with lower expense ratios, e.g. under 0.50% if possible.

What Are Reasonable Fees for a 401(k)?

To determine the amount you’re paying for a 401(k) plan, divide the total plan cost (usually available on your 401(k) statement) by your total investment.

Expense ratios can vary among plans for a variety of reasons, including how the 401(k) account is managed, the administrative fees, the record-keeping costs, and so on. While investors don’t have any say over the built-in costs of the 401(k) plan — that’s set by the plan administrator and/or your employer — investors can manage their own investment costs.

Choosing Lower-Cost Funds

In passively managed funds (where a portfolio mirrors a market index like the S&P 500), the expense ratio is typically lower as compared to actively managed funds, which might charge between 0.5% and 1.0% or more. Actively managed funds have a fund manager who employs different buying and selling strategies. Generally, this is because more work is being done on the manager’s part in an active strategy vs. a passive strategy.

Note that active investing can refer to individual investors, but the philosophy of making trades to exceed market returns also drives actively managed funds.

Passive strategies generally have expense ratios under 0.50%. Exchange-traded funds (ETFs) usually follow a passive strategy and can have expense ratios under 0.25%.

Why Fees Matter

Over time, just one or even half a percentage point could potentially make an impact on a retirement account. That impact could in turn mean the difference between retiring when planned, vs. working a few more years until the overall investment grows. A lower expense ratio could help an investor maximize their 401(k).

For example, a well-known Government Accountability Office analysis from 2006 found that someone who invests $20,000 every year for 20 years in a 401(k) plan that costs 1.5% per year to operate is likely to end up with 17% less than someone whose plan costs just 0.50%. The analysis concluded that after 20 years, that half a percentage point meant the difference of more than $10,000. Similar studies on the impact of fees have found similar results.

Until relatively recently 401(k) expense ratio information wasn’t public, and even now it can be somewhat difficult to locate.

How to Reduce Your Expense Ratio

Before an investor can attempt to reduce their expense ratio, they need to be familiar with what it is.

Until relatively recently 401(k) expense ratio information was not public, and even now it can be somewhat difficult to locate. In 2007, the Securities and Exchange Commission (SEC) approved an amendment requiring the disclosure of these fees and expenses in mutual fund performance and sales materials.

Today, there are a few ways to get the information — and take action:

• Read the fine print. Look closely at 401(k) participant fee disclosure notices, which participants should receive at least annually with any plan. Or look for the current information in a funder’s prospectus on their website. Building on the 2007 amendment, the DOL introduced a rule in 2012 to improve transparency around the fees and expenses to workers in 401(k) retirement plans.

• Ask outright. Investors seeking more information might also choose to call their fund’s client services number directly to get the most up-to-date information on plan costs. Investors who work with a financial advisor can also ask their advisor for this information, as well as their opinions on these expenses.

◦ Evaluate your funds. It can also be helpful to look at the funds being offered by an employer, provider, or broker to see if there is a similar fund that comes with lower expenses. Investors may be able to find the investments they want at a cheaper price, even within their current 401(k) plan.

For investors whose 401(k) plan is not through a current full-time employer — a common situation when people change jobs — they may want to consider a rollover IRA in order to pay lower fees and gain access to a wider array of investments.

The Takeaway

There’s no magic number that indicates a 401(k) expense ratio is too high or just right, and all plans are different. But if you take into account the cost of your investments in addition to the plan itself, you shouldn’t be paying much more than about 1.0% to 1.50%, all in.

Under federal law, employers have a fiduciary duty to offer reasonably priced options and to monitor the quality of the 401(k) plan they offer. The more an investor knows about their current plan, the better equipped they are to make compelling arguments for how to improve their plan.

If you’re thinking about investing for retirement, or doing a rollover of an old 401(k), you may want to consider all your options. It’s easy to get started with SoFi invest. You can invest in stocks, exchange-traded funds (ETFs), open an IRA or do a rollover, and more. SoFi doesn’t charge commission, but other fees apply (full fee disclosure here), and members can access complimentary financial advice from a professional.

Easily manage your retirement savings with a SoFi IRA.

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Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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SOIN0423022

Apr

2023

How Are Employee Stock Options and RSUs Different?

By Amanda Holden | Building Your Career, Growing Wealth, invest, Investing | Comments Off

Employee stock options (ESOs) and restricted stock units (RSUs) are two different types of equity compensation. An employee stock option gives an employee the option to buy company stock at a certain price, by a certain date. By contrast, an RSU is the promise that on a future date the employee will receive actual company stock.

Sometimes, employees get a choice between ESOs and RSUs. Understanding how each stock plan works, how they differ — particularly when it comes to vesting schedules and taxes — can help you make a decision that best aligns with your financial goals.

What Are Employee Stock Options (ESOs)?

Employee stock options (ESOs) give an employee the right to purchase their company’s stock at a set price — called the exercise, grant, or strike price — by a certain date, assuming certain terms are met, usually according to a vesting schedule.

If the employee doesn’t exercise their options within that period, they expire.

Companies may offer stock options to employees as part of a compensation plan, in addition to salary, 401(k) matching funds, and other benefits. ESOs are considered an incentive to help the company succeed, so that (ideally) the stock options are worth more when the employee chooses to exercise them.

In an ideal scenario, exercising stock options allows an employee to purchase shares of their company’s stock at an exercise price lower than the current market price — and realize a profit.

Note that while some of the terminology used with regard to employee stock options may sound similar to standard stock options, don’t get the two confused. Options are derivatives traded based on the value of underlying securities, e.g. stocks, bonds, ETFs.

How do ESOs Work?

Generally, ESOs operate in four stages — starting with the grant date and ending with the exercise date, i.e. actually buying the stock.

1. The grant date

This is the official start date of an ESO contract. You receive information about how many shares you’ll be issued, the strike price (or exercise price) for those shares, the vesting schedule, and any requirements that must be met along the way.

2. The cliff

If a compensation package includes ESOs, they’re generally not available on day one. Contracts often include requirements that must be met first, such as working full time for at least a year.

Those 12 months when you are not yet eligible to exercise your employee stock options is called the cliff. If you remain an employee past the cliff date, you get to level up to the vesting period.

Some companies include a 12-month cliff to incentivize employees to stay at least a year. Other companies may have a vesting schedule.

3. The vest

The vesting period is when you start to take ownership of your options and the right to exercise them. Vesting can either happen all at once or take place after a cliff (as noted above), or gradually over several years, depending on your company’s plan.

One common vesting schedule is a one-year cliff followed by a four-year vest. On this timeline, you’re 0% vested the first year (meaning you aren’t eligible for any options), 25% vested at the two-year mark (you can exercise up to 25% of the total options granted), and so on until you own 100% of your options. At that point, you’re considered fully vested.

4. The exercise

This is when you pull the financial trigger and actually purchase some or all of your vested shares.

ESO’s Expiration Date

While the expiration date of stock options isn’t always front and center, it’s important to bear in mind. The strike price you’re given as part of your options package expires on a certain date if you don’t exercise your shares.

One common timeline is 10 years from grant date to expiration date, but specific terms will be in the contract, and it’s important to vet the timing of your ESOs — as part of your career as well as your tax and your long-term financial plan. Again, if you let your stock options expire, you lose the right to buy shares at that price.

Pros and Cons of Employee Stock Options (ESOs)

If you land a job with the right company and stay until you’re fully vested, exercising your employee stock options could potentially lead to gains.

For example, if your strike price is $30 per share, and at the time of vesting the stock is trading at $100 or more per share, you’re getting a great deal on shares.

On the other hand, if your strike price is $30 per share and the company is trading at $10 per share, you might be better off not exercising your employee stock options until the price goes up (when and if it does; there are no guarantees).

That’s why ESOs are considered a form of employee incentive: You may work harder to help the company grow, if you know your efforts could translate to a bigger stock price.

Tax Implications of Employee Stock Options

Given that stock options can generate gains, it’s important to know how they are taxed so you can plan accordingly.

Generally speaking, employers offer two types of stock options: nonqualified stock options (NSOs or NQSOs) and incentive stock options (ISOs).

Nonqualified Stock Options

NSOs are the most common and often the type offered to the general workforce. NSOs have a less favorable tax treatment, because they’re subject to ordinary income tax on the difference between the exercise price and the market price at the time you exercise your options and purchase the stock.

NSOs are then taxed again at the capital gains rate when you sell the shares.

Your individual circumstances, tax filing status, and the terms of your stock options may also play into how you’re taxed, so you may want to consult a professional.

Incentive Stock Options

ISOs are “qualified,” meaning you don’t pay any taxes when you exercise the options — unless you’re subject to the alternative minimum tax (AMT).

You will owe taxes, however, if you sell them at a profit later on. (If you don’t sell, and if the stocks gain or lose value, those are considered unrealized gains and losses.) Any money you make when you sell your shares later would be subject to capital gains tax. If you hold your shares less than a year, the short-term capital gains tax rate equals your ordinary income tax rate, which could be up to 37% for the highest tax bracket.

For assets held longer than a year, the long-term rate is lower: 0%, 15%, or 20%, depending on your taxable income and filing status.

What Are Restricted Stock Units (RSUs)?

Restricted stock units, or RSUs, simply grant employees a certain number of shares stock by a certain date. When employees are granted RSUs, the company holds onto the shares until they’re fully vested.

The company determines the vesting criteria — it can be a time period of several years, a key revenue milestone, and/or personal performance goals. Like ESOs, RSUs can vest gradually or all at once. When the employee gets their shares, they own them outright; employees don’t have to buy RSUs.

How Do Restricted Stock Units (RSUs) Work?

RSUs are priced based on the fair market value of the stock on the day they vest, or the settlement date. The company stocks you receive from your company will be worth just as much as they would be if you purchased them on your own that same day.

If the stock is worth $40 per share, and you have 100 shares, you would get $4,000 worth of shares (assuming you’re fully vested and have met other terms).

Again, the main difference between stock options and restricted stock units is that you don’t have to purchase RSUs.

As long as the company’s common stock holds value, so do your RSUs. Upon vesting, you can either keep your RSUs in the form of actual shares, or sell them immediately to take the cash equivalent. Either way, the RSUs you receive will be taxed as income.

And, of course, if you later sell your shares you may realize a gain or a loss and there will be tax implications accordingly.

Pros and Cons of Restricted Stock Units (RSUs)

One good thing about RSUs, similar to ESOs, is the incentive to stay with the company for a longer period of time. If your company grows during your vesting period, you could see a substantial windfall when your settlement date rolls around.

But even if the stock falls to a penny per share, the shares still awarded to you on your settlement date. Since you don’t have to pay for them, it’s still money in your pocket.

In fact, you may only lose out on money with RSUs if you leave the company and have to forfeit any units that aren’t already vested, or if the company goes out of business.

Tax Implications of RSUs

When your RSU shares or cash equivalent are automatically delivered to you on your settlement date(s), they’re considered ordinary income and are taxed accordingly. In fact, your RSU distributions are actually added to your W-2.

For some people, the additional RSU income may bump them up a tax bracket (or two). In those cases, if you’ve been withholding at a lower tax bracket before your vesting period, you could owe the IRS more money.

As with ESOs, if you sell your shares at a later date and make a profit, you’ll be subject to capital gains taxes.

	ESOs	RSUs
Definition	An employee can buy company stock at a set price at a certain date in the future.	An employee receives stock at a date in the future (does not have to purchase them).
Pricing	The strike price is set when ESOs are offered to an employee, and they pay that price when they exercise their shares.	The share price is based on the fair market value of the stock on the day the shares vest, and employees get the full-value shares.
Tax implications	The difference between the strike price and the stock’s value on exercise is considered earned income and added to your W-2, where it’s taxed as income. If you sell your shares later at a profit, you may also be subject to capital gains tax.	RSU shares (or cash equivalent) are considered ordinary income as soon as they are vested, and are taxed accordingly. If you sell the shares later, capital gains tax rules would apply.

The Takeaway

Employee stock options (ESOs) and restricted stock units (RSUs) are two different types of equity or share-based compensation, and they each have their pros and cons.

An employee stock option gives an employee the option to buy company stock at a certain price, by a certain date. An RSU is the promise that on a future date the employee will receive actual company stock (without having to purchase the shares).

Because these types of compensation are often considered incentives, they’re designed to encourage employees to stay with the company for a certain amount of time. As such, employees often don’t get their options (in the case of ESOs) or the actual shares (in the case of RSUs) until certain terms are met. There may be a vesting schedule or company benchmarks or other terms.

Having the option to own stock in your employer company has the potential to provide attractive financial benefits, especially if you believe in the company and its future. This belief in a company’s growth potential is what may drive investors to buy a company’s stock, even if they don’t work there.

If you’re interested in owning and trading stock, it’s easy when you set up an Active Invest account with SoFi Invest®. Members can trade stocks and ETFs.

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.

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The Dow Divisor

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Choosing Lower-Cost Funds

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How to Reduce Your Expense Ratio

The Takeaway

How Are Employee Stock Options and RSUs Different?

What Are Employee Stock Options (ESOs)?

How do ESOs Work?

1. The grant date

2. The cliff

3. The vest

4. The exercise

ESO’s Expiration Date

Pros and Cons of Employee Stock Options (ESOs)

Tax Implications of Employee Stock Options

Nonqualified Stock Options

Incentive Stock Options

What Are Restricted Stock Units (RSUs)?

How Do Restricted Stock Units (RSUs) Work?

Pros and Cons of Restricted Stock Units (RSUs)

Tax Implications of RSUs

The Takeaway

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