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Feb

2024

IRA vs 401(k): What Is the Difference?

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

Table of Contents

How Are IRAs and 401(k)s Different?
Other Key Differences Between IRAs and 401(k)s
A Closer Look at IRAs
A Closer Look at a 401(k)
When Should You Use a 401(k)?
When Should You Use an IRA?
When Should You Use Both an IRA and 401(k)?

The biggest difference between an IRA vs. a 401(k) is the amount you can save. You can save over three times as much in a 401(k) vs. an IRA — $23,000 versus $7,000 for tax year 2024, and $22,500 versus $6,500 for tax year 2023. But not everyone has access to a 401(k), because these are sponsored by an employer, typically for full-time employees.

“A 401(k) is probably one of the most common retirement vehicles,” says Brian Walsh, a CFP® at SoFi. “A 401(k) will be available through work. Your employer is going to choose whether or not to make a 401(k) available to all the employees. Generally speaking, 401(k)s are the most popular retirement plan employers provide.”

Other than that, a traditional IRA and a 401(k) are similar in terms of their basic provisions and tax implications. Both accounts are considered tax deferred, which means you can deduct the amount you contribute each year — unless you have a Roth account, which has a different tax benefit.

Before you decide whether one or all three types of retirement accounts might make sense for you, it helps to know all the similarities and differences between a 401(k) and a traditional IRA and Roth IRA.

Key Points

• An IRA (Individual Retirement Account) and a 401(k) are both retirement savings accounts, but they have different features and eligibility requirements.

• IRAs are typically opened by individuals, while 401(k)s are offered by employers to their employees.

• IRAs offer more investment options and flexibility, while 401(k)s may have employer matching contributions and higher contribution limits.

• Both accounts offer tax advantages, but the timing of tax benefits differs: IRAs provide tax benefits during retirement, while 401(k)s offer tax benefits upfront.

• Choosing between an IRA and a 401(k) depends on factors like employment status, employer contributions, investment options, and personal financial goals.

How Are IRAs and 401(k)s Different?

The government wants you to prioritize saving for retirement. As a result, they provide tax incentives for IRAs vs. 401(k)s.

In that respect, a traditional IRA and a 401(k) are somewhat similar; both offer tax-deferred contributions, which may lower your taxable income, and tax-deferred investment growth. Also, you owe taxes on the money you withdraw from these accounts in retirement (or beforehand, if you take an early withdrawal).

There is a bigger difference between a Roth IRA and a 401(k). Roth accounts are funded with after-tax contributions — so they aren’t tax deductible. But they provide tax-free withdrawals in retirement.

And while you can’t withdraw the contributions you make to a traditional IRA until age 59 ½ (or incur a penalty), you can withdraw Roth contributions at any time (just not the earning or growth on your principal).

These days, you may be able to fund a Roth 401(k), if your company offers it.

¹Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

Other Key Differences Between IRAs and 401(k)s

As with anything that involves finance and the tax code, these accounts can be complicated. Because there can be stiff penalties when you don’t follow the rules, it’s wise to know what you’re doing.

Who Can Set Up a 401(k)?

As noted above, a key difference between an IRA and a 401(k) is that 401(k)s are qualified employer-sponsored retirement plans. You typically only have access to these plans through an employer who offers them as part of a full-time compensation package.

In addition, your employer may choose to provide matching 401(k) funds as part of your compensation, which is typically a percentage of the amount you contribute (e.g. an employer might match 3%, dollar for dollar).

Not everyone is a full-time employee. You may be self-employed or work part-time, leaving you without access to a traditional 401(k). Fortunately, there are other options available to you, including solo 401(k) plans and opening an IRA online (individual retirement accounts).

Who Can Set Up an IRA?

Anyone can set up an individual retirement account (IRA) as long as they’re earning income. (And if you’re a non-working spouse of someone with earned income, they can set up a spousal IRA on your behalf.)

If you already have a 401(k), you can still open an IRA and contribute to both accounts. But if you or your spouse (if you’re married) are covered by a retirement plan at work, you may not be able to deduct the full amount of your IRA contributions.

Understanding RMDs

Starting at age 72, you must take required minimum distributions (RMDs) from your tax-deferred accounts, including: traditional IRAs, SEP and SIMPLE IRAs, and 401(k)s. Be sure to determine your minimum distribution amount, and the proper timing, so that you’re not hit with a penalty for skipping it.

It’s worth noting, though, that RMD rules don’t apply to Roth IRAs. If you have a Roth IRA, or inherit one from your spouse, the money is yours to withdraw whenever you choose. The rules change if you inherit a Roth from someone who isn’t your spouse, so consult with a professional as needed.

However, RMD rules do apply when it comes to a Roth 401(k), similar to a traditional 401(k). The main difference here, of course, is that the Roth structure still applies and withdrawals are tax free.

A Closer Look at IRAs

An IRA is an individual retirement account that has a much lower contribution limit than a 401(k) (see chart below). Anyone with earned income can open an IRA, and there are two main types of IRAs to choose from: traditional and Roth accounts.

Self-employed people can also consider opening a SEP-IRA or a SIMPLE IRA, which are tax-deferred accounts that have higher contribution limits.

Traditional IRA

Like a 401(k), contributions to a traditional IRA are tax deductible and may help lower your tax bill. In 2024, IRA contribution limits are $7,000, or $8,000 for those aged 50 or older. In 2023, IRA contribution limits are $6,500, or $7,500 for those aged 50 or older.

With a traditional IRA, investments inside the account grow tax-deferred. And unlike 401(k)s where an employer might offer limited options, IRAs are more flexible because they are classified as self-directed and you typically set up an IRA through a brokerage firm of your choice.

Thus it’s possible to invest in a wider range of investments in your IRA, including stocks, bonds, mutual funds, exchange-traded funds, and even real estate.

When making withdrawals at age 59 ½, you will owe income tax. As with 401(k)s, any withdrawals before then may be subject to both income tax and the 10% early withdrawal penalty.

What Are Roth Accounts?

So far, we’ve discussed traditional 401(k) and IRA accounts. But each type of retirement account also comes in a different flavor — known as a Roth.

The main difference between traditional and Roth IRAs lies in when your contributions are taxed.

• Traditional accounts are funded with pre-tax dollars. The contributions are tax deductible and may provide an immediate tax benefit by lowering your taxable income and, as a result, your tax bill.

• Money inside these accounts grows tax-deferred, and you owe income tax when you make withdrawals, typically when you’ve reached the age of 59 ½.

Roth accounts, on the other hand, are funded with after-tax dollars, so your deposits aren’t tax deductible. However, investments inside Roth accounts also grow tax-free, and they are not subject to income tax when withdrawals are made at or after age 59 ½.

As noted above, Roths have an additional advantage in that you can withdraw your principal at any time (but you cannot withdraw principal + earnings until you’ve had the account for at least five years, and/or you’re 59 ½ or older — often called the five-year rule).

Roth accounts may be beneficial if you anticipate being in a higher tax bracket when you retire versus the one you’re in currently. Then tax-free withdrawals may be even more valuable.

It’s possible to hold both traditional and Roth IRAs at the same time, though combined contribution limits are the same as those for traditional accounts. And those limits can’t be exceeded.

Additionally, the ability to fund a Roth IRA is subject to certain income limits: above a certain limit you can’t contribute to a Roth. There are no income limits for a designated Roth 401(k), however.

A Closer Look at a 401(k)

Contributions to your 401(k) are made with pre-tax dollars. This makes them tax-deductible, meaning the amount you save each year can lower your taxable income in the year you contribute, possibly resulting in a smaller tax bill.

In 2024, you can contribute up to $23,000 to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $30,500. In 2023, you can contribute up to $22,500 each year to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $30,000.

401(k) catch-up contributions allow people nearing retirement to boost their savings. In addition to the contributions made, an employer can also match their employee’s contribution, up to a combined employer and employee limit of $69,000 in 2024 and $66,000 in 2023.

An employer may offer a handful of investment options to choose from, such as exchange-traded funds (ETFs), mutual funds, and target date mutual funds. Money invested in these options grows tax-deferred, which can help retirement investments grow faster.

When someone begins taking withdrawals from their 401(k) account at age 59 ½ (the earliest age at which you can start taking penalty-free withdrawals), those funds are subject to income tax. Any withdrawals made before 59 ½ may be subject to a 10% early withdrawal penalty, on top of the tax you owe.

When Should You Use a 401(k)?

If your employer offers a 401(k), it may be worth taking advantage of the opportunity to start contributing to your retirement savings. After all, 401(k)s have some of the highest contribution limits of any retirement plans, which means you might end up saving a lot. Here are some other instances when it may be a good idea:

1. If your employer matches your contributions

If your company matches any part of your contribution, you may want to consider at least contributing enough to get the maximum employer match. After all, this match is tantamount to free money, and it can add up over time.

2. You can afford to contribute more than you can to an IRA

For tax year 2024, you can only put $7,000 in an IRA, but up to $23,000 in a 401(k) — if you’re over 50, those amounts increase to $8,000 for an IRA and $30,500 for a 401(k).

For tax year 2023, you can only put $6,500 in an IRA, but up to $22,500 in a 401(k) — if you’re over 50, those amounts increase to $7,500 for an IRA and $30,000 for a 401(k). If you’re in a position to save more than the IRA limit, that’s a good reason to take advantage of the higher limits offered by a 401(k).

3. When your income is too high

Above certain income levels, you can’t contribute to a Roth IRA. How much income is that? That’s a complicated question that is best answered by our Roth IRA calculator.

And if you or your spouse are covered by a workplace retirement plan, you may not be able to deduct IRA contributions.

If you can no longer fund a Roth, and can’t get tax deductions from a traditional IRA, it might be worth throwing your full savings power behind your 401(k).

When Should You Use an IRA?

If you can swing it, it may not hurt to fund an IRA. This is especially true if you don’t have access to a 401(k). But even if you do, IRAs can be important tools. For example:

1. When you leave your company

When you leave a job, you can rollover an old 401(k) into an IRA — and it’s generally wise to do so. It’s easy to lose track of old plans, and companies can merge or even go out of business. Then it can become a real hassle to find your money and get it out.

You can also roll the funds into your new company’s retirement plan (or stick with an IRA rollover, which may give you more control over your investment choices).

Recommended: How to Roll Over Your 401(k)

2. If your 401(k) investment choices are limited

If you have a good mix of mutual funds in your 401(k), or even some target date funds and low-fee index funds, your plan is probably fine. But, some plans have very limited investment options, or are so confusing that people can’t make a decision and end up in the default investment — a low interest money market fund.

If this is the case, you might want to limit your contributions to the amount needed to get your full employer match and put the rest in an IRA.

3. When you’re between jobs

Not every company has a 401(k), and people are not always employed. There may be times in your life when your IRA is the only option. If you have self-employment income, you can make higher contributions to a SEP IRA or a Solo 401(k) you set up for yourself.

4. If you can “double dip.”

If you have a 401(k), are eligible for a Roth IRA, or can deduct contributions to a traditional IRA, and you can afford it — it may be worth investing in both. After all, saving more now means more money — and financial security — down the line. Once again, you can check our IRA calculator to see if you can double dip. Just remember that the IRA contribution limit is for the total contributed to both a Roth and traditional IRA.

The real question is not: IRA vs. 401(k), but rather — which of these is the best place to put each year’s contributions? Both are powerful tools to help you save, and many people will use different types of accounts over their working lives.

When Should You Use Both an IRA and 401(k)?

Using an IRA and a 401(k) at the same time may be a good way to save for your retirement goals. Funding a traditional or Roth IRA and 401(k) at once can allow you to save more than you would otherwise be able to in just one account.

Bear in mind that if you or your spouse participate in a workplace retirement plan, you may not be able to deduct all of your traditional IRA contributions, depending on how high your income is.

Having both types of accounts can also provide you some flexibility in terms of drawing income when you retire. For example, you might find a 401(k) as a source of pre-tax retirement income. At the same time you might fund a Roth IRA to provide a source of after-tax income when you retire.

That way, depending on your financial and tax situation each year, you may be able to strategically make withdrawals from each account to help minimize your tax liability.

The Takeaway

What is the difference between an IRA and a 401(k)? As you can see now, the answer is pretty complicated, depending on which type of IRA you’re talking about. Traditional IRAs are tax deferred, just like traditional 401(k)s — which means your contributions are tax deductible in the year you make them, but taxes are owed when you take money out.

Roth accounts — whether a Roth IRA or a Roth 401(k) — have a different tax treatment. You deposit after-tax funds in these types of accounts. And then you don’t pay any tax on your withdrawals in retirement.

The biggest difference is the amount you can save in each. For tax year 2023, it’s $23,000 in a 401(k) ($30,500 if you’re 50 and over) versus only $7,000 in an IRA ($8,000 if you’re 50+). For tax year 2023, it’s $22,500 in a 401(k) ($30,000 if you’re 50 and over) versus only $6,500 in an IRA ($7,500 if you’re 50+).

Another difference is that a 401(k) is generally sponsored by your employer, so you’re beholden to the investment choices of the firm managing the company’s plan, and the fees they charge. By contrast, you set up an IRA yourself, so the investment options are greater — and the fees can be lower.

Generally, you can have an IRA as well as a 401(k). The rules around contribution limits, and how much you can deduct may come into play, however.

If you’re ready to open an IRA, it’s easy when you set up an Active Invest account with SoFi Invest.

Not sure what the right strategy is for you? SoFi Invest® offers educational content as well as access to financial planners. The Active Investing platform lets investors choose from an array of stocks, ETFs or fractional shares. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is open and fund a SoFi Invest account.

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

FAQ

Is a 401(k) considered an IRA for tax purposes?

No. A 401(k) is a completely separate account than an IRA because it’s sponsored by your employer.

Is it better to have a 401(k) or an IRA?

You can save more in a 401(k), and your employer may also offer matching contributions. But an IRA often has a much wider range of investment options. It’s wise to weigh the differences, and decide which suits your situation best.

Can you roll a 401(k) Into an IRA penalty-free?

Yes. If you leave your job and want to roll over your 401(k) account into an IRA, you can do so penalty free within 60 days. If you transfer the funds and hold onto them for longer than 60 days, you will owe taxes and a penalty if you’re under 59 ½.

Can you lose money in an IRA?

Yes. You invest all the money you deposit in an IRA in different securities (i.e. stocks, bonds, mutual funds, ETFs). Ideally you’ll see some growth, but you could also see losses. There are no guarantees.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SoFi Invest®

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

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

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

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Feb

2024

How To Know When to Buy a Stock

By Ashley Kilroy | Growing Wealth, invest, Investing | No Comments

Table of Contents

The Best Time of Day to Buy Stocks
The Best Day of the Week to Buy Stocks
The Best Month to Buy Stocks
When Should You Buy Stocks
When Is the Worst Time to Buy Stocks?

Since investors don’t have (functional) crystal balls, figuring out how to know when to buy a stock, in an effort to time the market and generate the biggest return, is difficult. While you shouldn’t necessarily try to time the market, if you are trading and incorporating some knowledge and tactics around when to buy a stock as a part of your larger financial plan, you’ll want to do what you can to fine-tune your strategy.

Trading stocks, of course, is fairly risky, and investors will want to keep that in mind. But with some practice and knowledge, you may be able to figure out the best time to buy stocks, and other variables, to help you try to boost your portfolio.

Key Points

• Timing the stock market is difficult, but understanding when to trade stocks can help your portfolio.

• The best time of day to buy stocks is usually in the morning, shortly after the market opens.

• Mondays and Fridays tend to be good days to trade stocks, while the middle of the week is less volatile.

• Historically, April, October, and November have been the best months to buy stocks, while September has shown the worst performance.

• Knowing when to hold or sell stocks depends on personal strategies, research, and confidence in the stock’s potential for growth.

The Best Times to Buy Stocks

As noted, it’s generally not a good idea to try and time the market. But that’s not to say that there are larger market forces at work that result in certain trends. With that in mind, there can be good times of the day, days of the week, and even months to buy stocks that could generate bigger returns – though nothing is guaranteed.

The Best Time of Day to Buy Stocks

First and foremost, remember when the stock market is open and when trading is occurring. The New York Stock Exchange and Nasdaq, two of the largest and most active stock exchanges, are open 9:30 a.m. to 4:30 p.m. ET, Monday through Friday.

With that, the best time of the day, in terms of price action, is usually in the morning, in the hours immediately after the market opens up until around 11:30 a.m. ET, or so. That’s generally when most trading happens, leading to the biggest price fluctuations and chances for investors to take advantage.

The Best Day of the Week to Buy Stocks

If investors are aiming to trade during times of relative volatility, then they’ll want to utilize a trading strategy that aims to crowd their activity near the beginning and end of the week. Monday is probably the best day to trade stocks, since there is likely considerable volatility pent up over the weekend.

That said, Friday can also be a good day to trade, as investors make moves to prepare their portfolios for a couple of days off. The middle of the week tends to be the least volatile.

The Best Month to Buy Stocks

best month to buy stocks

When thinking about the best months to buy stocks, examining historic performance can be helpful. Data showing average monthly returns for the S&P 500 between 1950 and 2023 shows that broadly, November, July, April, and October tend to be the best months to buy. Conversely, September and February have tended to see weaker performances than the other months.

Again, these “best times to buy stocks” in terms of times, days, and months aren’t guarantees of anything, but are merely based on historical performance. That can be good to keep in mind.

When Should You Buy Stocks

factors to consider when buying stock

There’s a difference between “can” and “should” – and investors trying to discern when they should buy stocks should really consider their personal preferences, risk tolerance, and investment strategies. The right time to buy a stock is when an investor has done their research and feels confident that a stock price will rise in the short or long term, and that they’re willing to hold onto it until it does.

It helps to be informed when considering whether to buy stocks, and one way to do that is to learn about the company itself. Interested investors can find many company’s financial reports and earnings reports from government databases or private company research reports.

While ultimately it may be a good idea to buy stocks across different industries in order to diversify, it sometimes helps to start with a business or industry one is familiar with. Knowing about the company can help put the earnings reports into context.

Understanding the value of stocks is often, if not always tied to understanding the business those stocks represent a share in. Is the company a good investment? Does it have sound financials and growth potential? Here are helpful questions to consider when contemplating buying a stock:

What is the price range at which you’re willing to buy? If an investor has a company in mind, setting a price range at which they would want to buy stock in that company may help inform their decision. One can do this through analysts’ reports and consensus price targets, which average all analyst opinions.

Does the stock appear undervalued? There are different ways to determine value. The most common valuation metric is a price-earnings ratio (or P/E), which takes the price per share and divides it by earnings per share. The lower the number, the less the value. Generally for U.S. companies, a P/E below 15 is considered a good value and a P/E over 20 is considered a bad value. You can also compare the company’s P/E to others in the industry.

Another way to look at value is a discounted cash flow (DCF) analysis, which takes projected cash values and discounts them back to the present. This ultimately gives an investor a theoretical price target; if the actual price is below the target, then in theory, it’s undervalued and a good buy.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

When Is the Worst Time to Buy Stocks?

Just as there are the purported best times to buy stocks, there are also the worst times to buy stocks, too. Given that investors may be looking for relatively volatile times in the market to buy stocks, relatively calm periods during the trading day may be the worst times to buy. Those hours would be during the middle of the day, perhaps from 11:30 a.m. ET until 3 p.m. ET.

In terms of days of the week? Tuesdays, Wednesdays, and Thursdays may be worse than Mondays or Fridays, barring any market-moving news or other volatility-inducing events. Finally, September, February, and May tend to be the weakest-performing months for the stock market, dating back nearly a century.

How Do You Know When to Hold Stocks?

Knowing when to hold a stock often comes down to one’s investment strategy. With a passive investment approach, investors invest in various stocks with the intention of holding them for an indefinite amount of time. This is also known as a buy and hold investment strategy.

With this type of investing, investors attempt to match a market index such as the S&P 500 and the Dow Jones Industrial Average. So, they select stocks in that market index coinciding with the same percentages in that index.

One benefit of the buy and hold strategy is that the tax rate on long-term capital gains (from stocks that an investor has owned for more than one year) are much lower than that of short-term capital gains.

For many, if not most investors, if you’re going to buy a stock, it may be a good strategy to hold onto it for a while. When an investor buys an undervalued stock, it could take a few years for it to reach its “correct” valuation. And of course, there’s always a risk it will never reach what the investor has determined is the correct valuation.

Not everyone holds onto their stocks for a long time, but there are risks to day trading that may inspire some to become buy-and-holders.

How Do You Know When to Sell a Stock?

Just like how a decision to hold a stock largely depends on an individual investor’s specific strategy, so does the choice as to whether or not to sell.

Some investors rely on a rule of thumb that states that the stock market reaches a high point in May or June and then goes down over the summer until September or October. While that can sometimes be observed in overall market behavior — partially because traders (just like lots of people) go on vacation in the summer and partially because it’s a bit of a self-fulfilling prophecy — it doesn’t mean an individual stock will definitely go down over the summer.

Taking this advice, however, — and other, similar types of advice – should be taken with a grain of salt. Again, the choice of whether to sell a stock is up to you, and the research you’ve put into making the decision.

Recommended: When to Sell Stock

The Takeaway

Knowing when to buy, sell, and hold stocks can be less confusing when an investor does the research into company health, overall market conditions, and their own financial needs as relates to personal short-term and long-term goals.

One of the easiest ways to buy and sell stocks or manage any investment portfolio is to open an online taxable brokerage account. This is often appealing to investors who want to take more of an active investing approach and buy and sell stocks. Investors would typically pay fees based on the account and the number of trades they make.

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

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

FAQ

Is it best to buy stocks when they are down?

The best time to buy a stock is when an investor has done their research and due diligence, and decided that the investment fits their overall strategy. With that in mind, buying a stock when it is down may be a good idea – and better than buying a stock when it is high. But there are always risks to take into consideration.

Should I buy stocks at night?

Investors can engage in after-hours trading, but there are unique risks to doing so, and orders won’t execute until the market opens. Interested investors may want to try after-hours trading to get a feel for it before fully incorporating it into their strategy.

What are the worst months for the stock market?

Based on past performance, the worst months for the stock market tend to be in the early fall and summer. September is usually the worst, but October, June, and August can be bad as well.

You may also be interested in:

What You Need to Know When the Market Is Down

Is Stock Market Timing a Smart Investment Strategy?

5 Investment Strategies for Beginners

SoFi Invest®

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

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

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

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

SOIN1023007

Feb

2024

What Are High-Net Worth Individuals?

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

Table of Contents

What Defines a High Net Worth Individual?
Benefits Afforded to HNWIs
HNWI Examples & Statistics
How Is Net Worth Calculated?
What Is an Ultra High Net Worth Individual?
How to Get a Higher Net Worth
FAQ

A high net worth individual (HNWI) is generally considered to be someone who has $1 million or more in investable assets. That includes liquid assets such as cash or cash equivalents.

Someone who has a high net worth may rely on specialized financial services for money management. For example, they may work with a wealth manager or open accounts at a private bank. In terms of financial planning, the needs of high net worth individuals may include estate planning, investment guidance, and tax management.

Achieving a high net worth is something that can be done through strategic investing and careful portfolio building. It’s important to keep in mind that high net worth individuals may have access to certain investments that the everyday investor would not. Minimizing liabilities is another part of the wealth-building puzzle, as net worth takes debt into account alongside assets.

Key Points

• A high net worth individual (HNWI) is someone with $1 million or more in investable assets, including cash or cash equivalents.

• HNWIs may rely on specialized financial services like wealth managers or private banks for money management, estate planning, investment guidance, and tax management.

• Different metrics, such as income, investable assets, and net worth (assets minus liabilities), can be used to define high net worth individuals.

• The SEC requires registered advisors to disclose information about high net worth individuals on Form ADV, and accredited investors are also considered high net worth individuals.

• HNWIs may enjoy benefits like reduced fees, discounts on financial services, access to exclusive investments, and special perks and events.

What Defines a High Net Worth Individual?

When it comes to the high net worth definition, there are different metrics that can be used to calculate net worth and determine whether someone falls under the high net worth umbrella. Those can include a person’s:

• Income

• Investable assets

• Total net worth when liabilities are deducted from assets

The Securities and Exchange Commission (SEC) requires registered advisors to provide information about high net worth individuals on Form ADV. Specifically, the form asks advisors to list how many clients they serve who have $750,000 in investable assets or a $1.5 million net worth.

The SEC can also refer to high net worth individuals when discussing accredited investors. An accredited investor is defined as having:

• Earned income of $200,000 or more (or $300,000 for couples) in each of the two prior years, with a reasonable expectation of the same income in future years

• Net worth of over $1 million either alone or with a spouse, excluding the value of a primary residence

What is considered a high net worth individual to those who work with them? Private banks or wealth managers who serve high net worth individuals might choose to define them differently. For example, someone who wants to open an account with a private bank might need to have $5 million or $10 million in investable assets to qualify. Someone who has that much in assets may be relabeled as “very high net worth” instead. And at higher levels of assets, they enter the realm of ultra high net worth.

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Benefits Afforded to HNWIs

High net worth individuals may get a number of special benefits. For instance, they might qualify for reduced fees and discounts on financial services like investments and banking. They may also be granted access to special perks and events.

HNWI can also invest in things other investors or the general public can’t, such as hedge funds, venture capital funds, and private equity funds.

HNWI Examples & Statistics

The super rich, or HNWI, are tracked by Forbes on the Real-Time Billionaires List, which is updated daily. As of August 31, 2023, these were the HNWI at the top if the list:

• Elon Musk with a net worth of $248.8 billion

• Bernard Arnault and family with a net worth of $208 billion

• Jeff Bezos with a net worth of $160.9 billion

• Larry Ellison with a net worth of $152.3 billion

• Warren Buffet with a net worth of $121.1 billion

How Is Net Worth Calculated?

Wondering how to find net worth? It’s a relatively simple calculation. There are three steps for figuring out net worth:

1. Add up assets. These can include:

◦ Bank account balances, including checking, savings, and certificates of deposit

◦ Retirement accounts

◦ Taxable investment accounts

◦ Property, such as real estate or vehicles

◦ Collectibles or antiques

◦ Businesses someone owns

2. Add up liabilities. Liabilities are debts owed. For example, a home’s value can be considered an asset for net worth calculations. But if there’s a mortgage owing on it, that amount has to be entered into the liabilities column.

3. Subtract liabilities from assets. The remaining amount is an individual’s net worth.

Net worth can be a positive or negative number, depending on how much someone has in assets versus what they owe in liabilities.

Net Worth vs Liquid Net Worth

In simple terms, net worth is the difference between assets and liabilities. Liquid net worth, on the other hand, is the difference between liquid assets and liabilities. A liquid asset is one that can easily be sold or used to invest. So cash in a savings account is an example of a liquid asset while investments in a real estate investment trust (REIT) would be illiquid since they can’t be sold at short notice.

What Is an Ultra High Net Worth Individual?

Someone who fits the definition of an ultra high net worth individual (UHNWI) generally has personal financial holdings or assets of $30 million or more. People who are considered to be ultra high net worth individuals are among the top 1% wealthiest in the world.

So what is the net worth of the top 1%?

According to a report from Knight Frank, the typical net worth of the 1% falls far below the $30 million in assets required for ultra high net worth status. For example, in the U.S. someone would need $4 million in wealth to join the ranks of the top 1%. They’d need $7.9 million to belong to the top 1% in Monaco.

But what about the top 0.1%? Again, the level of wealth needed to qualify is still below the $30 million cutoff required for an UHNWI. In the U.S., you’d need $25.1 million to be considered part of the 0.1%. This is the highest amount of assets needed to qualify among the countries included in Knight Frank’s research.

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How to Get a Higher Net Worth

Reaching high net worth status can be a lofty goal but it’s one many HENRYs — high earner not rich yet — work toward. The typical HENRY makes most or all of their income from working. While they may earn an above-average income, they may not have sufficient disposable income to start building wealth to increase their net worth.

There are, however, some ways to change that. For example, someone who earns a higher income but doesn’t have the higher net worth to reflect it may consider things like:

• Paying off student loans or other debts

• Relocating to a less expensive area to reduce their cost of living

• Rethinking their tax strategy so they’re able to keep more of their income

• Finding ways to increase income

Coming up with a solid investment strategy is also important for boosting net worth. That includes diversifying to manage risk while investing in assets that are designed to produce income. For example, that might include such things as:

• Purchasing shares of dividend stocks

• Enrolling in a dividend reinvestment plan (DRIP)

• Buying dividend exchange-traded funds (ETFs)

• Investing in REITs or real estate mutual funds

Creating multiple streams of income with investments or starting a side hustle while also reducing liabilities can help with making progress toward a higher net worth. At the same time, it’s also important to take advantage of wealth-building assets you may already have on hand.

For example, if you have access to a 401(k) or similar plan at work, then making contributions can be an easy way to increase net worth. If your employer offers a company matching contribution you could use that free money to help build wealth.

The Takeaway

High net worth individuals are typically described as people who have $1 million or more in investable assets. Those with more than $5 to 10 million in investable assets may be labeled as “very high net worth”, and those with more than $30 million are generally considered ultra high net worth individuals.

Individuals with a higher net worth often consider time to be an asset in itself. The thinking goes, the sooner you begin investing, the better.

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FAQ

What are different types of high-net-worth individuals?

There are several types of high net worth individuals. Those who are high net worth have more than $1 million. Individuals with about $5 million are considered very high net worth. If a person has more than $30 million dollars they are considered ultra high net worth.

Where are most of the HNWIs located?

North America has the most high net worth individuals. There are 7.9 million HNWI in North America. The Asia-Pacific region has 7.2 million high net worth individuals, and there are 5.7 million HNWI in Europe.

Do high-net-worth individuals include 401(k)?

Yes. All of your different retirement accounts, including your 401(k), are included as assets when calculating high net worth.

Photo credit: iStock/Cecilie_Arcurs

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

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Feb

2024

Pros & Cons of Investing in REITs

By MP Dunleavey | Growing Wealth, invest, Investing | Comments Off

Table of Contents

What Are REITs?
Types of REITs
Pros of Investing in REITs
Cons of Investing in REITs
Are REITs a Risky Investment?
Investing in REITs

REIT is the abbreviation for Real Estate Investment Trust, a type of company that owns or operates properties that generate income. Investors can buy shares of REITs as a way of investing in different parts of the real estate market, and there are pluses and minuses to this option.

While developing and operating a real estate venture is out of the realm of possibility for some, REITs make it possible for people to become investors in large-scale construction or other real estate projects.

With a REIT, an investor buys into a piece of a real estate venture, not the whole thing. Thus there’s less responsibility and pressure on the shareholder, when compared to purchasing an investment property. But there is also less control, and most REITs come with specific risks.

Key Points

• REITs (Real Estate Investment Trusts) allow investors to buy shares of companies that own and operate income-generating properties.

• Investing in REITs provides diversification and the potential for dividends.

• REITs can be publicly traded or non-traded, with different risks and trading options.

• Benefits of investing in REITs include tax advantages, tangibility of assets, and relative liquidity compared to owning physical properties.

• Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.

What Are REITs?

When a person invests in a REIT, they’re investing in a real estate company that owns and operates properties that range from office complexes and warehouses to apartment buildings and more. REITs offer a way for someone to add real estate investments to their portfolio, without actually developing or managing any property.

Many, but not all, REITs are registered with the SEC (Securities and Exchange Commission) and can be found on the stock market where they’re publicly traded. Investors can also buy REITs that are registered with the SEC but are not publicly traded.

Non-traded REITs (aka, REITs that are not publicly traded) can’t be found on Nasdaq or the stock exchange. They’re traded on the secondary market between brokers which can make trading them a bit more challenging. To put it simply, this class of REITs has a whole different list of risks specific to its type of investing.

Non-traded REITs make for some pretty advanced investing, and for this reason, the rest of this article will discuss publicly traded REITs.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

Types of REITs

Real Estate Investment Trusts broadly fall into two categories:

• Mortgage REITs. These REITs can specialize in commercial or residential, or a mix of both. When an investor purchases Mortgage REITs, they’re investing in mortgage and mortgage-backed securities that in turn invest in commercial and residential projects. Think of it as taking a step back from directly investing in real estate.

• Equity REITs. These REITs often mean someone’s investing in a specific type of property. There are diversified equity REITs, but there are are specialized ones, including:

◦ Apartment and lodging

◦ Healthcare

◦ Hotels

◦ Offices

◦ Self-storage

◦ Retail

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Pros of Investing in REITs

Investing in REITs can have several benefits, such as:

• Diversification. A diverse portfolio can reduce an investor’s risk because money is spread across different assets and industries. Investing in a REIT can help diversify a person’s investment portfolio. REITs aren’t stocks, bonds, or money markets, but a class unto their own.

• Dividends. Legally, REITs are required by law to pay at least 90% of their income in dividends. The REIT’s management can decide to pay out more than 90%, but they can’t drop below that percentage. Earning consistent dividends can be a compelling reason for investors to get involved with REITs.

• Zero corporate tax. Hand in hand with the 90% payout rule, REITs get a significant tax advantage — they don’t have to pay a corporate tax. To put it in perspective, many dividend stocks pay taxes twice; once corporately, and again for the individual. Not having to pay a corporate tax can mean a higher payout for investors.

• Tangibility. Unlike other investments, REITs are investments in physical pieces of property. Those tangible assets can increase in value over time. Being able to “see” an investment can also put some people at ease — it’s not simply a piece of paper or a slice of a company.

• Liquidity. Compared to buying an investment property, investing in REITs is relatively liquid. It takes much less time to buy and sell a REIT than it does a rental property. Selling REITs takes the lick of a button, no FOR SALE sign required.

Compared to other real estate investment opportunities, REITs are relatively simple to invest in and don’t require some of the legwork an investment property would take.

Cons of Investing in REITs

No investment is risk-free, REITS included. Here’s what investors should keep in mind before diving into REITs:

• Taxes on dividends. REITs don’t have to pay a corporate tax, but the downside is that REIT dividends are typically taxed at a higher rate than other investments. Oftentimes, dividends are taxed at the same rate as long-term capital gains, which for many people, is generally lower than the rate at which their regular income is taxed.

However, dividends paid from REITs don’t usually qualify for the capital gains rate. It’s more common that dividends from REITs are taxed at the same rate as a person’s ordinary income.

• Sensitive to interest rates. Investments are influenced by a variety of factors, but REITs can be hypersensitive to changes in interest rates. Rising interest rates can spell trouble for the price of REIT stocks (also known as interest rate risk). Generally, the value of REITs is inversely tied to the Treasury yield — so when the Treasury yield rises, the value of REITs are likely to fall.

• Value can be influenced by trends. Unlike other investments, REITs can fall prey to risks associated specifically with the property. For example, if a person invests in a REIT that’s specifically a portfolio of frozen yogurt shops in strip malls, they could see their investment take a hit if frozen yogurt or strip malls fall out of favor.

While investments suffer from trends, REITs can be influenced by smaller trends, specific to the location or property type, that could be harder for an investor to notice.

• Plan for a long-term investment. Generally, REITs are better suited for long-term investments, which can typically be thought of as those longer than five years. REITs are influenced by micro-changes in interest rates and other trends that can make them riskier for a short-term financial goal.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

Are REITs a Risky Investment?

No investment is free of risk, and REITs come with risks and rewards specific to them. As mentioned above, they’re generally more sensitive to fluctuations in interest rates, which have an inverse influence on their value.

Additionally, some REITs are riskier than others, and some are better suited to withstand economic declines than others. For example, a REIT in the healthcare or hospital space could be more recession-proof than a REIT with properties in retail or luxury hotels. This is because people will continue using real estate associated with healthcare spaces regardless of an economic recession, while luxury real estate may not experience continued demands during times of economic hardship.

Risks aside, REITs do pay dividends, which can be appealing to investors. While REITS are not without risk, they can be a strong part of an investor’s portfolio.

Investing in REITs

Investing in publicly traded REITS is as simple as purchasing stock in the market — simply purchase shares through a broker. Investors can also purchase REITs in a mutual fund.

Investing in a non-traded REIT is a little different. Investors will have to work with a broker that is part of the non-traded REITs offering. Not any old broker can help an investor get involved in non-traded REITs. A potential drawback of purchasing non-traded REITs are the high up-front fees. Investors can expect to pay fees, which include commission and fees, between 9 and 10% of the entire investment.

The Takeaway

Investing in REITs can be a worthwhile sector to add to your portfolio’s allocation. They carry risks, but also benefits that might make them a great addition to your overall plan.

After all, REITs allow investors to partake of specific niches within the real estate market, which may provide certain opportunities. But owing to the types of properties REITs own, there are inevitably risks associated with these companies — and they aren’t always tied to familiar types of market risk.

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Feb

2024

What Is Leverage in Finance?

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Table of Contents

What Is Leverage?
How Leverage Works
Example of Leverage
Pros and Cons of Leverage
Leverage vs Margin
Types of Leverage
Leveraged Products
Volatility and Leverage Ratio
FAQ

Leverage in finance involves using a relatively small amount of capital to make larger trades or investments, increasing the potential of larger returns. In the world of finance, it’s critical to understand leverage if you plan to day trade or make other types of short-term investments, and the additional risks involved.

In general, leverage means doing a lot with a little. Think about how you may use an actual, physical lever to turn a switch, for instance. The switch itself may be small, and require a turn that’s a quarter of an inch to flip from off to on. But by using a lever — which is much bigger, physically, than the switch itself — the work becomes easier.

Key Points

• Leverage in finance involves using a small amount of capital to make larger trades or investments, potentially increasing returns.

• Leverage can be achieved through borrowing money or trading on margin, allowing investors to make increased dollar investments.

• While leverage can amplify gains, it also magnifies losses and comes with additional risks and costs.

• Different types of leverage exist, including financial leverage used by businesses to raise capital and operating leverage used to analyze fixed and variable costs.

• Leverage can be used in personal finance, such as taking out a mortgage, and is also utilized by professional traders to potentially increase profits.

What Is Leverage?

In finance, leverage refers to using a small amount of capital to do a relatively big amount of work — making big investments with a small amount of money. The rest of the money used to make the investment is borrowed, or investors are trading on margin.

In short: Leverage is about borrowing capital to make bigger bets in an effort to increase returns.

How Leverage Works

In leveraged investing, the leverage is debt that investors use as a part of their investing strategy. While it’s easy to think that all debt is bad, in fact it can actually be useful when folded into a specific investing tactic, although it also introduces additional risks and costs.

Leverage typically works like this: A person or company wants to make an outsized investment, but doesn’t have enough capital to do it. So, they use the capital they do have in conjunction with margin (borrowed money) to make a leveraged investment. If they’re successful, the return on their investment is far greater than it would’ve been had they only invested their own capital.

The risk, of course, is that those returns do not materialize, putting the investor in debt. Investors will also need to consider how their overall costs could increase, as they’ll likely pay interest on the money they borrow, too.

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Example of Leverage

Here is an example of how leverage could be used:

Let’s say that you found a startup. To get the company off the ground, you take in $10 million from investors, but you want to expand operations fast — hire employees, ramp up research and development efforts, and build out a distribution network.

You can do that with the $10 million, but if you were to borrow another $10 million, you would be able to double your efforts. That would allow you to hire more employees, improve your products faster, and distribute them further and wider, though you’d need to pay interest on the loan, too, factoring into overall costs.

That $10 million you borrowed is allowing you to do more with less. Of course, you run the risk that the company won’t be able to sustain a quick growth pace, in which case you may not be able to pay back the loan, or end up paying additional costs for interest and fees. But if things do work out, you’d be able to grow faster and accrue more value than if you hadn’t taken on any additional debt.

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Pros and Cons of Leverage

On the surface, leverage can sound like a powerful tool for investors — which it can be. But it’s a tool that can cut both ways: Leverage can add to buying power and potentially increase returns, but it can also magnify losses, and put an investor in the hole.

What’s important to remember is that there are both pros and cons to a tool like leverage.

Pros of Leverage	Cons of Leverage
Adds buying power	Increased risks and costs
Potential to earn greater returns	Leveraged losses are magnified
For investors, it’s generally easy to access	It can be more complex than meets the eye

Leverage vs Margin

Margin is a type of leverage that is specifically tied to use in the financial markets by investors. It is basically like a line of credit for a brokerage or investment account.

Here’s how margin works: An investor has a cash balance, which acts as collateral, and there are interest rates at play, like any other type of loan. With a margin account, investors can tradesome, but not all stocks or other assets on margin.

Using margin, an investor can effectively supercharge their potential gains or losses. It’s also important to note — and it’s worth repeating over and over — that using margin as an investor can increase overall costs and risks. Not every investor will be comfortable assuming those risks and costs (such as interest charges), so you’ll want to know what you’re doing before using margin.

Margin and leverage are related, and it’s easy to confuse the two. Even if you know what margin trading is and how margin accounts work, it’s important to make sure you know what the differences are. This chart should help.

Leverage vs Margin
Leverage	Margin
A loan from a bank for a specific purpose	A loan from a brokerage for investing in financial instruments
May involve a cash injection to be used for a specific purpose	No cash is exchanged; acts as a line of credit
Can be used by businesses or individuals; May take the form of a mortgage or to expand inventory	Can be used to create leverage and increase investment buying power

Types of Leverage

So far, we’ve mostly discussed leverage as it relates to the financial markets for investors. But there are other types of leverage, too.

Financial Leverage

Financial leverage is used by businesses and organizations as a way to raise money or access additional capital without having to issue additional shares or sell equity. For instance, if a company wants to expand operations, it can take on debt to finance that expansion.

The main ways that a company may do so is by either issuing bonds or by taking out loans. Much like in the leverage example above, this capital injection gives the company more spending power to do what it needs to do, with the expectation that the profits reaped will outweigh the costs of borrowing in the long run.

Operating Leverage

Operating leverage is an accounting measure used by businesses to get an idea of their fixed versus variable costs.

When discussing financial leverage, math needs to be done to figure out whether a company’s borrowing is profitable (called the debt-to-equity ratio). When calculating operating leverage, a company looks at its fixed costs as compared to variable costs to get a sense of how the costs of borrowing are affecting its profitability.

Leverage Investing

Leverage trading is the use of borrowed money to try and increase profits or returns. A company can use leverage investing by purchasing a new factory, allowing it to expand its ability to create products, and as such, increase profitability. An individual investor can borrow money to buy more stocks, increasing their potential returns.

It’s important to keep in mind, though, that leverage trading, or the use of borrowed money to invest, increases overall costs for investors, as they will need to pay interest on the money they borrow, and may be subject to other fees, too.

With that in mind, there are a few ways that leverage can be used in investing, either by individuals, or organizations.

Buying on Margin

Margin is a form of leverage, and trading on margin means that an investor is using money borrowed from their brokerage to execute a trade. In other words, an investor is borrowing money from their trading platform or brokerage — paying an applicable interest rate to do so, which can vary and should be considered as a part of overall trading costs — and making trades with it. It’s similar to using a credit card for investing, in some ways.

Given that margin concerns interest charges and additional costs, using it to trade or invest involves additional risks, particularly for inexperienced investors.

Leveraged ETFs

ETFs, or exchange-traded funds, can also have leverage baked into them. Leveraged ETFs are tradable funds that allow investors to potentially increase their returns by using borrowed money to invest in an underlying index, rather than a single company or stock. Leveraged ETFs utilize derivatives to increase potential returns for investors.

Using Borrowed Money to Invest

While many investors utilize margin, it’s also possible to borrow money from an outside source (not your broker or brokerage) to invest with. This may be appealing to some investors who don’t have high enough account balances to meet the thresholds some brokerages have in place to trade on margin. For example, a platform may require an investor to have a minimum balance of $25,000 in their account before they’ll offer the investor margin trading.

If an investor doesn’t have that much, looking for an outside loan — a personal loan, a home equity loan, etc.— to meet that threshold may be an appealing option.

But, as mentioned when discussing margin, borrowing money to invest can rope in additional risk, and investors will need to consider the additional costs associated with borrowing funds, such as applicable interest rates. So, before doing so, it may be a good idea to consult a financial professional.

Leverage in Personal Finance

The use of leverage also exists in personal finances — not merely in investing. People often leverage their money to make big purchases like cars or homes with auto loans and mortgages.

A mortgage is a fairly simple example of how an individual may use leverage. They’re using their own money for a down payment to buy a home, and then taking out a loan to pay for the rest. The assumption is that the home will accrue value over time, growing their investment.

Leverage in Professional Trading

Professional traders tend to be more aggressive in trying to boost returns, and as such, many consider leverage an incredibly important and potent tool. While the degree to which professional traders use leverage varies from market to market (the stock market versus the foreign exchange market, for example), in general most pro traders are well-versed in leveraging their trades.

This may allow them to significantly increase returns on a given trade. And professionals are given more leeway with margin than the average investor, so they can potentially borrow significantly more than the typical person to trade. Of course, they also have to stomach the risks of doing so, too — because while it may increase returns on a given trade, there is always the possibility that it will not.

Leveraged Products

There are numerous financial products and instruments that investors can use to gain greater exposure to the market, all without increasing their investments, like leveraged ETFs.

Volatility and Leverage Ratio

A leverage ratio measures a company’s debt situation, and gives a snapshot of how much debt a company currently has versus its cash flows. Companies can use leverage to increase their profitability by expanding operations, etc., but it’s a gamble because that profitability may not materialize as planned.

Knowing the leverage ratio helps company leaders understand just how much debt they’ve taken on, and can even help investors understand whether a company is a potentially risky investment given its debt obligations.

The leverage ratio formula is: total debt / total equity.

Volatility is another element in the mix, and it can be added into the equation to figure out just how volatile an investment may be. That’s important, given how leverage can significantly amplify risk.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

The Takeaway

Leverage can help investors, buyers, corporations and others do more with less cash on hand in their accounts at a given time. But there are some important considerations to keep in mind when it comes to leverage. In terms of leveraged investing, it has the potential to magnify gains — but also to magnify losses, and increase total costs.

Utilizing leverage and margin as a part of an investing or trading strategy has its pros and cons. But investors should give the risks some serious consideration before getting in over their heads. It may be a good idea to speak with a financial professional accordingly.

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FAQ

What is leverage in simple terms?

In simple terms, the concept of leverage means to do a lot with a little. As it relates to finance or investing, this can mean using a small amount of capital to make large or outsized trades or investments.

What is an example of leverage?

An example of leverage could be a mortgage, or home loan, in which a borrower makes a relatively small down payment and borrows money to purchase a home. They’re making a big financial move with a fraction of the funds necessary to facilitate the transaction, borrowing the remainder.

Why do people want leverage?

Leverage allows investors or traders to make bigger moves or take larger positions in the market with only a relatively small amount of capital. This could lead to larger returns — or larger losses.

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How Are IRAs and 401(k)s Different?

Get a 1% IRA match on rollovers and contributions.

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.1

Other Key Differences Between IRAs and 401(k)s

Who Can Set Up a 401(k)?

Who Can Set Up an IRA?

Understanding RMDs

A Closer Look at IRAs

Traditional IRA

What Are Roth Accounts?

A Closer Look at a 401(k)

When Should You Use a 401(k)?

1. If your employer matches your contributions

2. You can afford to contribute more than you can to an IRA

3. When your income is too high

When Should You Use an IRA?

1. When you leave your company

2. If your 401(k) investment choices are limited

3. When you’re between jobs

4. If you can “double dip.”

When Should You Use Both an IRA and 401(k)?

The Takeaway

FAQ

Is a 401(k) considered an IRA for tax purposes?

Is it better to have a 401(k) or an IRA?

Can you roll a 401(k) Into an IRA penalty-free?

Can you lose money in an IRA?

The Best Times to Buy Stocks

The Best Time of Day to Buy Stocks

The Best Day of the Week to Buy Stocks

The Best Month to Buy Stocks

When Should You Buy Stocks

Get up to $1,000 in stock when you fund a new Active Invest account.*

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When Is the Worst Time to Buy Stocks?

How Do You Know When to Hold Stocks?

How Do You Know When to Sell a Stock?

The Takeaway

FAQ

Is it best to buy stocks when they are down?

Should I buy stocks at night?

What are the worst months for the stock market?

You may also be interested in:

What Defines a High Net Worth Individual?

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Benefits Afforded to HNWIs

HNWI Examples & Statistics

How Is Net Worth Calculated?

Net Worth vs Liquid Net Worth

What Is an Ultra High Net Worth Individual?

How to Get a Higher Net Worth

The Takeaway

FAQ

What are different types of high-net-worth individuals?

Where are most of the HNWIs located?

Do high-net-worth individuals include 401(k)?

What Are REITs?

Types of REITs

Alternative investments, now for the rest of us.

Start trading funds that include commodities, private credit, real estate, venture capital, and more.

Pros of Investing in REITs

Cons of Investing in REITs

Are REITs a Risky Investment?

Investing in REITs

The Takeaway

What Is Leverage?

How Leverage Works

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 12%* and start margin trading.

Example of Leverage

Pros and Cons of Leverage

Leverage vs Margin

Leverage vs Margin

Types of Leverage

Financial Leverage

Operating Leverage

Leverage Investing

Buying on Margin

Leveraged ETFs

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