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May

2023

What Is a Financial Crisis?

By Austin Kilham | invest, Investing, Terminology | Comments Off

A financial crisis is a situation in which the financial sector and economy of a country, or the world, is thrown into a state of temporary upheaval. A financial crisis can have several causes, whether stock market crashes, political instability, and even global pandemics.

Financial crises are also not a new phenomena, and the United States has experienced many in its history.

Financial Crisis Definition

During a financial crisis, asset prices drop rapidly, usually over the course of days or a few weeks. This drop is often accompanied by a stock market crash as investors panic and pull money from the market. It may also be associated with bank runs in which consumers withdraw assets for fear they will lose value if they remain in the bank. This type of downturn may signal the beginning of a recession.

Recessions are a general period of economic decline during which unemployment may rise, income and consumer spending may fall, and business failures may be up. (To stay up-to-date on the current financial crisis and possible recession visit SoFi’s Recession Help Center.)

Common Causes of Financial Crises

There are a number of situations that can cause a financial crisis, including the bursting of financial bubbles (such as the dotcom bubble), defaults on debt, and currency crises.

Stock market bubbles occur when stock prices rise precipitously, often driven by speculation and investors overvaluing stocks. As more people jump on the bandwagon and buy stocks, prices are driven higher, a cycle that is not based on the stock’s fundamental value. Eventually, the situation can become unsustainable, and the bubble bursts. Investors sell and prices drop quickly.

A failure to meet debt obligations can also lead to a financial crisis. For example, a country may be unable to pay off its debts. This may happen as a country starts to face higher interest rates from lenders worried that the country may not be able to pay back their bonds. As lenders require higher bond yields to offset the risk of taking on a country’s debt, it becomes more and more expensive for that country to refinance. Eventually, the country could default on its debt, which can cause the value of its currency to drop.

A currency crisis occurs when a country’s currency experiences sudden volatility as a result of factors such as central bank policies or speculation among investors. For example, a currency crisis may occur when a country’s central bank pegs its currency to another country’s floating currency (one whose value depends on supply and demand) and fails to maintain that peg.

Examples of Financial Crises

Financial crises date back hundreds of years, and perhaps the first was the South Sea Bubble of 1720. Here’s a look at a handful of other well-known financial crises that have happened in the United States and around the world:

America’s First Financial Crisis

The United States’ first financial crisis occurred in 1790. At that time, the U.S. had few banks, and Alexander Hamilton wanted to model the U.S. financial system after the systems that existed in Britain and Holland. He created the first central bank, known as The First Bank of the United States (BUS). To get the bank off its feet, the public could buy shares in the bank with a mixture of cash and government bonds.

Two problems arose: The demand for government bonds to buy shares led some investors to try and corner the bond market by borrowing widely to buy bonds, and the BUS quickly grew, becoming the nation’s largest lender. Investors, flush with credit, began to use their newfound cash to speculate in futures contracts and short sales markets.

In spring of 1792, the BUS ran low on hard currency and cut lending. The BUS’ leadership was forced to take on new debt to pay off old debt, and tightening credit, led U.S. markets on a downward spiral.

With the system on the verge of collapse, Hamilton was forced to use public funds to buy back U.S. bonds and prop up the price of those bonds. Additionally, he had to direct money to failing lenders, and allowed banks with collateral to borrow as much as they wanted with a penalty rate of 7%. Not only was this America’s first financial crisis, it was also the first instance of a government bailout, setting a precedent for future financial crises.

The Stock Market Crash of 1929

Perhaps the granddaddy of financial crises, the 1929 stock market crash came at a time when stock speculation led to booming markets. At the same time, however, consumer prices were falling and some established businesses were struggling, creating tension within the economy.

The Federal Reserve raised interest rates, in an effort to slow the overheated markets. Unfortunately, the hike wasn’t big enough to slow the economy. It ended up further hurting already weakening businesses, and industrial production continued to fall.

The market crashed on October 28 and October 29, 1929. The 29th came to be known as Black Tuesday. By mid-November, the market was down 45%. By the next year, banks began to fail. Customers began withdrawing cash as fast as they could, causing bank runs.

The crisis devastated the economy, forcing businesses to close and causing many people to lose their life savings. It also sparked the Great Depression, the worst recession in U.S. history, and the Dow wouldn’t climb to its previous heights for 25 years.

The crash led to a number of financial reforms. The Glass-Steagall legislation separated regular banking, such as lending, from stock market operations. It also gave the government power to regulate banks at which customers used credit to invest.

The government also set up the Federal Deposit Insurance Commission (FDIC) to help prevent bank runs by protecting customer deposits. The creation of the FDIC helped stabilize the financial system, because individuals no longer felt they needed to withdraw their money from the bank at the slightest sign of economic trouble.

The 1973 OPEC Oil Crisis

In October 1973, the 12 countries that make up the Organization of Petroleum Exporting Countries (OPEC) agreed to stop exporting oil to the United States in retaliation for the U.S. decision to offer military aid to Israel. As a result of the embargo, the U.S. experienced gas shortages, and oil prices in the U.S. quadrupled.

Though the embargo ended in March of 1974, its destabilizing effects are largely blamed for the economic recession of 1973–1975. High gas prices meant American consumers had less money in their pockets to spend on other things, lowering demand and consumer confidence.

Other factors beyond the embargo, including wage-price controls and the Federal Reserve’s monetary policy, exacerbated the financial crisis. Wage-price controls forced businesses to keep wages high, keeping them from hiring new employees. In a series of monetary moves, the Federal Reserve quickly raised and lowered interest rates. Businesses unable to keep up with the changes protected themselves by keeping prices high, which contributed to inflation.

The period’s high unemployment, stagnant economic growth, and inflation came to be known as “stagflation.”

The Asian Financial Crisis of 1997–1998

The Asian financial crisis began in Thailand in July 1997. It spilled over to other East Asian nations and eventually had ripple effects in Latin American and Eastern Europe.

Before the crisis began, Thailand had pegged its currency to the U.S. dollar. After months of speculative pressure that depleted the country’s foreign exchange reserves, Thailand devalued its currency, allowing it to float on the open market. Malaysian, Indonesian and Singapore currencies were devalued as well, causing high inflation that spread to East Asian countries, including South Korea and Japan.

Growth fell sharply across Asia, investment rates fell, and some countries entered into recession.

The International Monetary Fund (IMF) stepped in, providing billions of dollars of loans to help stabilize weak Asian economies in Thailand, Indonesia, and South Korea.

In exchange for its loans, the IMF required new rules that led to better financial regulation and oversight. Countries that received the loans had to raise taxes, reduce public spending, and raise interest rates.

The Global Financial Crisis of 2007–2008

The origins of the global financial crisis of 2007 and 2008 are complicated. They started with government deregulation that allowed banks to use derivatives in hedge fund trading. To fuel this trading, the banks needed mortgages and began lending to subprime borrowers who had questionable credit. When interest rates on these mortgages reset higher, borrowers could no longer afford their payments.

At the same time, housing prices dropped as demand for homes fell, and borrowers who could no longer afford their payments were now unable to sell their homes to cover what they owed on their mortgage. The value of the derivatives collapsed and banks stopped lending to each other, resulting in a financial crisis and eventually the Great Recession.

As a result of the financial crisis, the government took over mortgage giants Fannie Mae and Freddie Mac, and bailed out investment banks on the verge of collapse. Additionally, Congress passed the Dodd-Frank Wall Street Reform Bill to prevent banks from taking on too much risk again in the future.

The European Sovereign Debt Crisis

The European Sovereign Debt Crisis followed swiftly on the heels of the global financial crisis in 2007 and 2008. The crisis largely began in Greece in 2009 as investors and governments around the globe realized that Greece might default on its national debt.

At that point the nation’s debt had reached 113% of its GDP. Debt levels within the European Union were supposed to be capped at 60%, and if the Greek economy slowed down it might have trouble paying off its debt. By 2010, the E.U. discovered irregularities in the Greek accounting system which meant that its budget deficits were higher than previously suspected. Bond rating agencies subsequently downgraded the country’s debt.

Investors were concerned that similar events might spread to other members of the E.U., including Ireland, Spain, Portugal and Italy, which all had similar levels of debt. In response to these concerns, investors in sovereign bonds from these countries demanded higher yields to make up for the increased risk they were taking on. That meant the cost of borrowing rose in these countries. And because rising yields lowers the price of existing bonds, eurozone banks that held these bonds began to lose money.

Eurozone leaders agreed on a €750 billion rescue package that eventually reached €1 trillion by 2012.

Investing During a Financial Crisis

Investing during a recession or financial crisis may not sound like a good idea. Watching stock prices plummet can give even the most seasoned investor reason for pause. But keeping an investment plan on track during a crisis is critical to future success. In the face of a financial crisis, there are a few considerations to make.

First, watching a market fall may inspire panic, tempting investors to pull their money out of a stock. However, that may be exactly the wrong instinct. Bear markets are typically followed by a recovery, although not always immediately, and selling assets may mean that investors lock in losses and miss out on subsequent gains.

Second, some investors engage in a strategy that involves buying more stock when markets are down. Purchasing stock when prices are low during a bear market may provide the opportunity for increased profits as the market turns around, though there are no guarantees.

The Takeaway

A financial crisis can have many causes, but usually leads to falling stock market prices, and often, a recession. There have been many financial crises around the world over the years, and in all likelihood, there will be more in the future. Down markets can be a good opportunity for investors to stress-test their risk tolerance, or to embrace more conservative strategies.

If you have questions about building a portfolio, allocating your wealth or how market conditions will affect your financial situations, it can help to talk to a financial professional.

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).

Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹

Photo credit: iStock/South_agency

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

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.

🛈 Currently, SoFi does not offer automated tax loss harvesting to members.

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.

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

Apr

2023

401(k) Hardship Withdrawals: What Are They and When Should You Use them?

By Austin Kilham | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

A hardship withdrawal is the removal of funds from your 401(k) in response to a pressing and significant financial need. For people who find themselves in a financial bind where they need a large sum of money but don’t expect to be able to pay it back, a 401(k) hardship withdrawal may be an appropriate option.

But before making a withdrawal from a 401(k) retirement account, it’s important to understand the rules and potential drawbacks of this financial decision.

Who Is Eligible for a Hardship Withdrawal?

According to the IRS, an individual can make a hardship withdrawal if they have an “immediate and heavy financial need.”

However, not all 401(k) plans offer hardship withdrawals, so if you’re considering this option talk to your plan administrator — usually someone in an employer’s human resources or benefits department. Another way to get clarity on a particular 401(k) account is to call the number on a recent 401(k) statement and ask for help.

If a retirement plan does allow hardship withdrawals, typically you’ll be expected to present your case to your plan administrator, who will decide if it meets the criteria for hardship. If it does, the amount you are able to withdraw will be limited to the amount necessary to cover your immediate financial need.

In general, a hardship withdrawal should be considered a last resort. To qualify, a person must not have any other way to cover their immediate need, such as by getting reimbursement through insurance, liquidating assets, taking out a commercial loan, or stopping contributions to their retirement plan and redirecting that money.

What Qualifies as a Hardship?

You may be qualified for a hardship withdrawal if you need cash to meet one of the following conditions:

• Medical care expenses for you, your spouse, or your dependents.

• Costs related to the purchase of a primary residence, excluding mortgage payments. (Buying a second home or an investment property is not a valid reason for withdrawal.)

• Tuition and other related expenses, including educational fees and room and board for the next 12 months of postsecondary education. This rule applies to the individual, their spouse, and their children and other dependents.

• Payments needed to prevent eviction from a primary residence, or foreclosure on the mortgage of a primary residence.

• Certain expenses to repair damage to a principal residence.

• Funeral and burial expenses.

• In certain cases, damage to property or loss of income due to natural disasters.

How Do You Prove Hardship?

A 401(k) provider may need to see proof of hardship before they can determine eligibility for a hardship withdrawal.

Typically, they do not need to take a look at financial status and will accept a written statement representing your financial need. That said, an employer cannot rely on an employee’s representation of their need if the employer knows for a fact that the employee has other resources at their disposal that can cover the need. In this case, the employer may deny the hardship withdrawal.

It’s important to note that employees do not have to use alternative sources if doing so would increase the amount of their financial need. For example, say an employee is buying a primary residence. They do not need to take on loans if doing so would hinder their ability to acquire other financing necessary to purchase the house.

How Much Can You Withdraw?

The amount a person can withdraw from their 401(k) due to financial hardship is limited to the amount that is necessary to cover the immediate financial need. The total can include money to cover the taxes and any penalties on the withdrawal.

In the past, hardship distributions were limited by the amount of elective deferrals that employees had contributed to their 401(k). In other words, employees couldn’t withdraw money that had come from their employer, and they couldn’t withdraw earnings.

However, under recent reforms, employers may allow employees to withdraw elective deferrals, employer contributions, and earnings. Employers are not required to follow these rules though, so it’s important to ask your provider which money in your 401(k) you can draw on.

What Are the Penalties of 401(k) Hardship Withdrawals?

Taking a hardship withdrawal can be a costly endeavor. You will owe income tax on the amount you withdraw, unless you are withdrawing Roth contributions.

Since you’re in your working years, your income tax bill may be considerably more than if you were to withdraw the same money after you retire. In addition, anyone under the age of 59 ½ will also likely pay a 10% early withdrawal penalty.

The IRS provides a list of criteria that can exempt you from the 10% penalty, including if you are disabled or if you’re younger than 65 and the amount of your unreimbursed medical debt exceeds 10 % of your adjusted gross income.

It’s important to know that a hardship withdrawal cannot be repaid to the plan. That means that whatever money you remove from your retirement account online is gone forever — no longer earning returns or subject to the benefits of tax-advantaged growth. The withdrawn amount will not be available to you in your retirement years.

Should You Consider a 401(k) Loan Instead?

Borrowing from your 401(k) may be an alternative to a hardship withdrawal. The IRS limits the amount that an individual can borrow to 50% of their vested account balance or $50,000, whichever is less.

However, if your vested account balance is less than $10,000, you may borrow up to that amount. There’s a reason for this: Your vested balance is the amount of money that already belongs to you. Some employers require you to stay with them for a set period of time before making their contributions available to you.

A person typically has five years to repay a 401(k) loan and usually must make payments each quarter through a payroll deduction. If repayments are not made quarterly, the remaining balance may be treated as a distribution, subject to income tax and a 10% early-withdrawal penalty.

While you do have to pay interest on a 401(k) loan, the good news is you pay it to yourself.

There are some drawbacks to taking out a 401(k) loan. The money you take out of your account is no longer earning returns, and even though it will get repaid over time, it can set back your retirement savings. Loans that aren’t paid back on time are considered distributions and are subject to taxes and early withdrawal penalties for people younger than 59 ½.

The Takeaway

A 401(k) hardship withdrawal can be an important tool for individuals who have exhausted all other options to solve their financial problem. Before deciding to make a hardship withdrawal, it’s a good idea to carefully consider the potential drawbacks, including taxes, penalties, and the permanent hit to a retirement savings account.

It’s also important to know that money in a 401(k) account is protected from creditors and bankruptcy. For anyone considering bankruptcy, taking money out of a 401(k) plan might leave it vulnerable to creditors.

Other options may make more sense, such as working with creditors to come up with an affordable payment plan, or taking out a 401(k) loan, which allows an individual to replace the borrowed income so that their retirement savings can continue to grow when the loan is repaid.

Visit SoFi Invest® to learn more about setting and meeting your financial goals for retirement.

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

Aug

2022

Guide to Writing Put Options

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing | Comments Off

Puts, or put options, are contracts between a buyer – known as the holder of an option – and a seller – known as the writer of an option – that gives the buyer the right to sell an asset, like a stock or exchange-traded fund (ETF), at a specific price within a specified time period. The seller of the put option is obligated to buy the asset at the strike price if the buyer exercises their option to sell.

Writing a put option is also known as selling a put option. When you sell a put option, you agree to buy the underlying asset at a specified price if the option buyer, also known as the option holder, exercises their right to sell the asset. The premium you receive for writing the put option is your maximum possible profit.

Generally, traders who buy put options have a bearish view of a security, meaning they expect the underlying asset’s price to decline. In contrast, the put option writer has a neutral to bullish outlook of a security. The put writer should be willing to take the risk of having to buy the asset if it falls below the strike price in exchange for the premium paid by the put option holder.

Writing put options is just one of numerous trading strategies investors use to build wealth, speculate, or hedge positions. While there is potential to generate income by writing put options, it can also be a risky way to enhance a portfolio’s return. Only investors with the knowledge of how to write put options and risk tolerance to take on this strategy should do so.

Writing Put Options

When writing a put option contract, the seller will initiate a trade order known as sell to open.

As mentioned above, the put option writer is selling a contract that gives the holder the right to sell a security at a strike price within a specified time frame. The put option writer will receive a premium from the holder for selling this option. If the price of the security falls below the strike price before the expiration date, the writer may be obligated to buy the security from the holder at the strike price.

There are two main reasons to write a put option contract: to earn income from the premium or to hedge a position.

A naked, or “uncovered,” put option is an option that is issued and sold without the writer setting aside any cash to meet the obligation of the option when it reaches expiration. This increases the writer’s risk.

Maximum Profit/Loss

The most a put option writer can profit from selling the option is the premium received at the start of the trade. Many traders take advantage of this profit as a way to generate regular income by writing put options for assets that they expect will not fall below the strike price.

However, this strategy can be risky because there can be significant losses if the asset’s price falls below the strike price. For example, if a stock’s price plummets because a company announces bankruptcy, the put option writer may be obligated to buy the stock when it’s trading near $0. The maximum loss will be equal to the strike price minus the premium.

Breakeven

The breakeven point for a put option writer can be calculated by subtracting the premium from the strike price. The breakeven point is the market price where the option writer comes away even, not making a profit or experiencing a loss (not including trading commissions and fees).

Writing Puts for Income

There are many options trading strategies. As noted above, many traders will write put options to generate income when they have a neutral to bullish outlook on a specific security. Because the writer of a put option receives a premium for opening the contract, they will benefit from that guaranteed payment if the put expires unexercised or if the writer closes out their position by buying back the same put option.

For example, if you believe an asset’s price will stay above a put option’s strike price, you can write a put option to take advantage of steady to rising prices on the underlying security. By keeping the option premium, you effectively add a stream of income into your trading account, as long as the underlying asset’s price moves in your favor.

However, with this strategy, you face the risk of having to buy the underlying asset from the option holder if the price falls below the strike price before the expiration date.

💡 Recommended: How to Sell Options for Premium

Put Writing Example

Let’s say you are neutral to bullish on shares of XYZ stock, which trade at $70 per share. You execute a sell to open order on a put option expiring in three months at a strike price of $60. The premium for this put option is $5; since each option contract is for 100 shares, you collect $500 in income.

If you wrote the put option contract for income, you’re hoping the price of XYZ stock will stay above $60 through the expiration date in three months, so the option holder does not exercise the option and requires you to buy XYZ. In this ideal scenario, your maximum profit will be the $500 premium you received for selling the put option.

At the very least, you hope the stock does not fall below $55, or the breakeven point ($60 strike price minus the $5 premium). At $55, you may be obligated to buy 100 shares at the $60 strike price:

$5,500 market value – $6,000 price paid + $500 premium earned = $0 return

If XYZ stock falls to $50, the put option holder will likely exercise the option to sell the stock. In this scenario, you will be obligated to buy the stock XYZ at the $60 strike price and incur a $500 loss in this trade:

$5,000 market value – $6,000 price paid + $500 premium earned = -$500 return

However, the further the price of XYZ falls, your potential loss risk increases. In the worst-case scenario where the stock falls to $0, your maximum loss would be $5,500:

$0 market value – $6,000 price paid + $500 premium earned = -$5,500 return

Put Option Exit Strategy

In the example above, it is assumed that the option is exercised or expires worthless. However, a put option writer can also exit a trade in order to profit or mitigate losses prior to the contract’s expiration.

A put writer can exit their position anytime using a trade order known as buy to close. In this scenario, the writer of the initial put option will buy back a put option to close out a position, either to lock in a profit or prevent further losses.

Using the example above, say that after two months, shares of XYZ have increased from $70 to $85. The value put contract you sold, which still has one more month until expiration and a $60 strike price, has collapsed to $1 because of a share price rise and perhaps a drop in expected volatility. Rather than wait for expiration, you decide to buy to close your put position, buying back the put contract at $1 premium, for a total of $100 ($1 premium x 100 shares). You are no longer obligated to buy shares of XYZ in the event the stock drops below $60 during the next month, and you lock in a profit of $400:

$500 premium earned to sell to open – $100 premium paid to buy to close = $400 return

A buy to close strategy can also be used to mitigate substantial losses. For example, if stock XYZ’s price starts dropping, the value of puts with a $60 strike price and a similar expiration date will rise. Rather than wait for expiration and be obligated to buy shares of a stock you don’t want, potentially losing up to $5,500, you may exit the position at any time. If option premiums for this trade are now $8, you can pay $800 ($8 premium x 100 shares) to buy to close the trade. This will result in a loss of $300, a potentially more manageable loss than the worst-case scenario:

$500 premium earned to sell to open – $800 premium paid to buy to close = -$300 return

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The Takeaway

Writing a put option is an options strategy in which you are neutral to bullish on the underlying asset. Potential profit is limited to the premium collected at the start of the trade. The maximum loss can be substantial, however. Finally, there is the risk that you will be liable to buy the stock at the option strike price if the holder exercises the option. Because of all these moving parts, writing put options should be left to experienced traders with the tolerance to take on the risk.

Looking to try different investment opportunities? SoFi’s intuitive and approachable options trading platform is a great place to start. You can access educational resources about options for more information and insights. Plus, you have the option of placing trades from either the mobile app or web platform.

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FAQ

What happens when you sell a put option?

Selling a put option is the same thing as writing a put option. You profit by collecting a premium for selling the option or when the put options decline in value, which usually happens when the underlying asset price rises. A significant risk of writing a put option is that you might be required to buy shares of the underlying asset at the strike price.

How would you write a put option?

You write a put option by first executing a sell to open order. You collect a premium at the onset of the trade without owning shares of the underlying asset. This strategy can be risky, so it generally requires high-level options trading knowledge.

When would you write a put option?

If a trader believes an asset’s price will stay flat or increase over a period of time, they may choose to write a put option. If the underlying asset’s price increases, the put option’s value will decline as it nears expiration. A profitable outcome occurs when the value of the put option is zero by expiration, or if the put writer buys to close the position before expiration. The put writer will profit by keeping the premium received at the initiation of the trade.

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.

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May

2022

Target Date Funds: What Are They and How to Choose One

By AJ Smith | invest, Investing, Preparing for Retirement | No Comments

A target date fund is a type of mutual fund designed to be an all-inclusive portfolio for long-term goals like retirement. While target date funds could be used for shorter-term purposes, the specified date of each fund — e.g. 2040, 2050, 2065, etc. — is typically years in the future, and indicates the approximate point at which the investor would begin withdrawing funds for their retirement needs (or another goal, like saving for college).

Unlike a regular mutual fund, which might include a relatively static mix of stocks and bonds, the underlying portfolio of a target date fund shifts its allocation over time, following what is known as a glide path. The glide path is basically a formula or algorithm that adjusts the fund’s asset allocation to become more conservative as the target date approaches, thus protecting investors’ money from potential volatility as they age.

If you’re wondering whether a target date fund might be the right choice for you, here are some things to consider.

What Is a Target Date Fund?

A target date fund (TDF) is a type of mutual fund where the underlying portfolio of the fund adjusts over time to become gradually more conservative until the fund reaches the “target date.” By starting out with a more aggressive allocation and slowly dialing back as years pass, the fund’s underlying portfolio may be able to deliver growth while minimizing risk.

This ready-made type of fund can be appealing to those who have a big goal (like retirement or saving for college), and who don’t want the uncertainty or potential risk of managing their money on their own.

While many college savings plans offer a target date option, target date funds are primarily used for retirement planning. The date of most target funds is typically specified by year, e.g. 2035, 2040, and so on. This enables investors to choose a fund that more or less matches their own target retirement date. For example, a 30-year-old today might plan to retire in 38 years at age 68, or in 2060. In that case, they might select a 2060 target date fund.

Investors typically choose target date funds for retirement because these funds are structured as long-term investment portfolios that include a ready-made asset allocation, or mix of stocks, bonds, and/or other securities. In a traditional portfolio, the investor chooses the securities — not so with a target fund. The investments within the fund, as well as the asset allocation, and the glide path (which adjusts the allocation over time), are predetermined by the fund provider.

Sometimes target date funds are invested directly in securities, but more commonly TDFs are considered “funds of funds,” and are invested in other mutual funds.

Target date funds don’t provide guaranteed income, like pensions, and they can gain or lose money, like any other investment.

Whereas an investor might have to rebalance their own portfolio over time to maintain their desired asset allocation, adjusting the mix of equities vs. fixed income to their changing needs or risk tolerance, target date funds do the rebalancing for the investor. This is what’s known as the glide path.

How Do Target Date Funds Work?

Now that we know what a target date fund is, we can move on to a detailed consideration of how these funds work. To understand the value of target date funds and why they’ve become so popular, it helps to know a bit about the history of retirement planning.

Brief Overview of Retirement Funding

In the last century or so, with technological and medical advances prolonging life, it has become important to help people save additional money for their later years. To that end, the United States introduced Social Security in 1935 as a type of public pension that would provide additional income for people as they aged. Social Security was meant to supplement people’s personal savings, family resources, and/or the pension supplied by their employer (if they had one).

💡 Recommended: When Will Social Security Run Out?

By the late 1970s, though, the notion of steady income from an employer-provided pension was on the wane. So in 1978 a new retirement vehicle was introduced to help workers save and invest: the 401(k) plan.

While 401k accounts were provided by employers, they were and are chiefly funded by employee savings (and sometimes supplemental employer matching funds as well). But after these accounts were introduced, it quickly became clear that while some people were able to save a portion of their income, most didn’t know how to invest or manage these accounts.

The Need for Target Date Funds

To address this hurdle and help investors plan for the future, the notion of lifecycle or target date funds emerged. The idea was to provide people with a pre-set portfolio that included a mix of assets that would rebalance over time to protect investors from risk.

In theory, by the time the investor was approaching retirement, the fund’s asset allocation would be more conservative, thus potentially protecting them from losses. (Note: There has been some criticism of TDFs about their equity allocation after the target date has been reached. More on that below.)

Target date funds became increasingly popular after the Pension Protection Act of 2006 sanctioned the use of auto-enrollment features in 401k plans. Automatically enrolling employees into an organization’s retirement plan seemed smart — but raised the question of where to put employees’ money. This spurred the need for safe-harbor investments like target date funds, which are considered Qualified Default Investment Alternatives (QDIA) — and many 401k plans adopted the use of target date funds as their default investment.

Today nearly all employer-sponsored plans offer at least one target date fund option; some use target funds as their default investment choice (for those who don’t choose their own investments). Approximately $1.8 trillion dollars are invested in target funds, according to Morningstar.

What a Target Date Fund Is and Is Not

Target date funds have been subject to some misconceptions over time. Here are some key points to know about TDFs:

• As noted above, target date funds don’t provide guaranteed income; i.e. they are not pensions. The amount you withdraw for income depends on how much is in the fund, and an array of other factors, e.g. your Social Security benefit and other investments.

• Target date funds don’t “stop” at the retirement date. This misconception can be especially problematic for investors who believe, incorrectly, that they must withdraw their money at the target date, or who believe the fund’s allocation becomes static at this point. To clarify:

◦ The withdrawal of funds from a target date fund is determined by the type of account it’s in. Withdrawals from a TDF held in a 401k plan or IRA, for example, would be subject to taxes and required minimum distribution (RMD) rules.

◦ The TDF’s asset allocation may continue to shift, even after the target date — a factor that has also come under criticism.

• Generally speaking, most investors don’t need more than one target date fund. Nothing is stopping you from owning one or two or several TDFs, but there is typically no need for multiple TDFs, as the holdings in one could overlap with the holdings in another — especially if they all have the same target date.

Example of a Target Date Fund

Most investment companies offer target date funds, from Black Rock to Vanguard to Charles Schwab, Fidelity, Wells Fargo, and so on. And though each company may have a different name for these funds (a lifecycle fund vs. a retirement fund, etc.), most include the target date. So a Retirement Fund 2050 would be similar to a Lifecycle Fund 2050.

How do you tell target date funds apart? Is one fund better than another? One way to decide which fund might suit you is to look at the glide path of the target date funds you’re considering. Basically, the glide path shows you what the asset allocation of the fund will be at different points in time. Since, again, you can’t change the allocation of the target fund — that’s governed by the managers or the algorithm that runs the fund — it’s important to feel comfortable with the fund’s asset allocation strategy.

How a Glide Path Might Work

Consider a target date fund for the year 2060. Someone who is about 30 today might purchase a 2060 target fund, as they will be 68 at the target date.

Hypothetically speaking, the portfolio allocation of a 2060 fund today — 38 years from the target date — might be 80% equities and 20% fixed income or cash/cash equivalents. This provides investors with potential for growth. And while there is also some risk exposure with an 80% investment in stocks, there is still time for the portfolio to recover from any losses, before money is withdrawn for retirement.

When five or 10 years have passed, the fund’s allocation might adjust to 70% equities and 30% fixed income securities. After another 10 years, say, the allocation might be closer to 50-50. The allocation at the target date, in the actual year 2060, might then be 30% equities, and 70% fixed income. (These percentages are hypothetical.)

As noted above, the glide path might continue to adjust the fund’s allocation for a few years after the target date, so it’s important to examine the final stages of the glide path. You may want to move your assets from the target fund at the point where the predetermined allocation no longer suits your goals or preferences.

Pros and Cons of Target Date Funds

Like any other type of investment, target date funds have their advantages and disadvantages.

Pros

• Simplicity. Target funds are designed to be the “one-stop-shopping” option in the investment world. That’s not to say these funds are perfect, but like a good prix fixe menu, they are designed to include the basic staples you want in a retirement portfolio.

• Diversification. Related to the above, most target funds offer a well-diversified mix of securities.

• Low maintenance. Since the glide path adjusts the investment mix in these funds automatically, there’s no need to rebalance, buy, sell, or do anything except sit back and keep an eye on things. But they are not “set it and forget it” funds, as some might say. It’s important for investors to decide whether the investment mix and/or related fees remain a good fit over time.

• Affordability. Generally speaking, target date funds may be less expensive than the combined expenses of a DIY portfolio (although that depends; see below).

Cons

• Lack of control. Similar to an ordinary mutual fund or exchange-traded fund (ETF), investors cannot choose different securities than the ones available in the fund, and they cannot adjust the mix of securities in a TDF or the asset allocation. This could be frustrating or limiting to investors who would like more control over their portfolio.

• Costs can vary. Some target date funds are invested in index funds, which are passively managed and typically very low cost. Others may be invested in actively managed funds, which typically charge higher expense ratios. Be sure to check, as investment costs add up over time and can significantly impact returns.

What Are Target Date Funds Good For?

If you’re looking for an uncomplicated long-term investment option, a low-cost target date fund could be a great choice for you. But they may not be right for every investor.

Good For…

Target date funds tend to be a good fit for those who want a hands-off, low-maintenance retirement or long-term investment option.

A target date fund might also be good for someone who has a fairly simple long-term strategy, and just needs a stable portfolio option to fit into their plan.

In a similar vein, target funds can be right for investors who are less experienced in managing their own investment portfolios and prefer a ready-made product.

Not Good For…

Target date funds are likely not a good fit for experienced investors who enjoy being hands on, and who are confident in their ability to manage their investments for the long term.

Target date funds are also not right for investors who are skilled at making short-term trades, and who are interested in sophisticated investment options like day-trading, derivatives, and more.

Investors who like having control over their portfolios and having the ability to make choices based on market opportunities might find target funds too limited.

The Takeaway

Target date funds can be an excellent option for investors who aren’t geared toward day-to-day portfolio management, but who need a solid long-term investment portfolio for retirement — or another long-term goal like saving for college. Target funds offer a predetermined mix of investments, and this portfolio doesn’t require rebalancing because that’s done automatically by the glide path function of the fund itself.

The glide path is basically an asset allocation and rebalancing feature that can be algorithmic, or can be monitored by an investment team — either way it frees up investors who don’t want to make those decisions. Instead, the fund chugs along over the years, maintaining a diversified portfolio of assets until the investor retires and is ready to withdraw the funds.

Target funds are offered by most investment companies, and although they often go by different names, you can generally tell a target date fund because it includes the target date, e.g. 2040, 2050, 2065, etc.

If you’re ready to start investing for your future, you might consider opening a brokerage account with SoFi Invest® in order to set up your own portfolio and learn the basics of buying and selling stocks, bonds, exchange-traded funds (ETFs), and more. Note that SoFi members have access to a complimentary 30-min session with a SoFi Financial Planner.

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

What Is a Financial Crisis?

Financial Crisis Definition

Common Causes of Financial Crises

Examples of Financial Crises

America’s First Financial Crisis

The Stock Market Crash of 1929

The 1973 OPEC Oil Crisis

The Asian Financial Crisis of 1997–1998

The Global Financial Crisis of 2007–2008

The European Sovereign Debt Crisis

Investing During a Financial Crisis

The Takeaway

Is Automated Tax-Loss Harvesting a Good Idea?

Tax-Loss Harvesting: The Basics

Example of Basic Tax-Loss Harvesting

What Is Automated Tax-Loss Harvesting?

The Wash-Sale Rule

What Is the Wash-Sale Rule?

How ETFs Help With the Wash-Sale Rule

Other Important Tax Rules to Know

How Much Does Automated Tax-Loss Harvesting Save?

The Upside of Automated Tax-Loss Harvesting

The Downside of Automated Tax-Loss Harvesting

Pros of Automated Tax-Loss Harvesting

Cons of Automated Tax-Loss Harvesting

The Takeaway

401(k) Hardship Withdrawals: What Are They and When Should You Use them?

Who Is Eligible for a Hardship Withdrawal?

What Qualifies as a Hardship?

How Do You Prove Hardship?

How Much Can You Withdraw?

What Are the Penalties of 401(k) Hardship Withdrawals?

Should You Consider a 401(k) Loan Instead?

The Takeaway

Guide to Writing Put Options

Writing Put Options

Maximum Profit/Loss

Breakeven

Writing Puts for Income

Put Writing Example

Put Option Exit Strategy

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

The Takeaway

FAQ

What happens when you sell a put option?

How would you write a put option?

When would you write a put option?

Target Date Funds: What Are They and How to Choose One

What Is a Target Date Fund?

How Do Target Date Funds Work?

Brief Overview of Retirement Funding

The Need for Target Date Funds

What a Target Date Fund Is and Is Not

Example of a Target Date Fund

How a Glide Path Might Work

Pros and Cons of Target Date Funds

Pros

Cons

What Are Target Date Funds Good For?

Good For…

Not Good For…

The Takeaway

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