Central Counterparty Clearing Houses (CCPs): What They Are and How They Work

Central Counterparty Clearing Houses (CCPs): What They Are and How They Work

A central counterparty clearing house (CCP), or Central Counterparty, is a financial institution that facilitates trading activities in European equity and derivative markets. Regional banks typically operate CCPs which are an important part of the international financial system.

CCPs maintain stability and efficiency across financial markets and reduce risks including counterparty, default, and market risks. In the United States, CCPs are called Derivatives Clearing Organizations (DCO) and are regulated by the Commodity Futures Trading Commission (CFTC).

Defining Central Counterparty Clearing Houses

The Bank for International Settlements (BIS) defines a CCP as “a clearing house that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the future performance of open contracts.” The Eurex is a well known CCP.

Central Counterparty Clearing Houses act as intermediaries between buyers and sellers in financial transactions. They handle clearing and settlements in various types of securities and derivatives transactions to reduce credit risk in the markets. Clearinghouses have existed for more than a century, and act as a way to reduce the risk of OTC derivative transactions.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

How Central Counterparty Clearing Houses Work

Central Counterparty Clearing Houses guarantee trade terms for buyers and sellers. They help reduce risk for investors by taking on credit risk involved in transactions, so even if a buyer or seller defaults on a transaction the other party doesn’t have as much loss as they might have without the CCP.

When buyers and sellers enter into transactions, they each deposit money with the CCP to cover the amount of the transaction. All CCP users must have a margin account.

In a process called “novation,” the CCP enters into two different contracts, one with the buyer and one with the seller. This provides a guarantee to the other party that if one side doesn’t follow through with the agreement the other side will still receive payment. CCPs typically use margin calls to settle trades if one party does not have the funds in their account.

If the trade falls through, the CCP completes the trade at the current market price. CCPs are for-profit businesses that generate revenue from their members and their transactions. They also work with parent exchanges that require them to remain profitable. Just like other types of businesses, CCPs each operate differently and have different business strategies to attract customers and earn revenue.

For instance, there are different types of derivative products that a CCP might choose to offer. One common business model for CCPs is to cross-margin products in a single netting pool. Parent exchanges place obligations on CCPs, so they need to earn enough revenue to meet those.

The specific financial products offered by a CCP, as well as its risk level, fee structure, and other features lead to different types of members, organizational structure, regulations, and rules for margin balances.

CCPs continue to evolve, offer new products, and become more sophisticated over time. Regulations are also evolving for CCPs which may change how they operate in the future.

Uses of a Central Counterparty Clearing House

CCPs maintain the anonymity of investors’ identities to protect their privacy. They also maintain the privacy of trading firms from buyers and sellers by using electronic order books and protect brokerage firms from the risk of buyers and sellers defaulting on their end of options such as calls or puts.

Another use of CCPs is to lower the number of transactions settled in order to move funds efficiently between investors.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

CCP Members

Financial institutions that want to clear trades through a central counterparty can become members of a particular CCP. Membership allows them to reduce credit risk for their customers and themselves. There are CCPs for different types of financial transactions, so financial institutions can choose the appropriate CCP to apply to for their needs.

CCPs want members that have a significant transaction volume, are creditworthy, and have a trading operation that works efficiently with the system run by the CCP. CCPs also want members to contribute funds to their default fund and secure collateral for their transactions. Each CCP has somewhat different criteria and requirements for membership, and membership information is not always publicly available.

Pros and Cons of CCPs

There are benefits and drawbacks to CCPs. Here are a few important ones to understand:

Pros

CCPs benefit investors in the following ways:

•   Reduce counterparty risk

•   Maintain stability in financial markets

•   Increase efficiency of transactions

•   Maintains privacy of customers

Cons

There are also some drawbacks to CCPs for investors, including the following:

•   Participation fees

•   May not be able to process non-standard transactions

•   Some CCPs may not have adequate scale

CCPs and Blockchain

CCPs are now being used with blockchain technology, made popular in cryptocurrency markets, to further reduce risk and costs. An international group of clearing houses launched the Post Trade Distributed Ledger Group launched in 2015. The group studies ways to use blockchain technology for transactions.

Since its formation, the group has expanded to include about 40 global financial institutions collaborating to bring CCPs together with blockchain. The goal of using blockchain technology with CCPs is to reduce margin requirements and risk, reduce operational costs, improve regulatory oversight, and increase the efficiency of trade settlements. Ideally blockchain can help support better settlements, clearing processes, and reporting.

Decentralized exchanges already operate similarly to CCPs as a third party that handles transactions.

The Takeaway

Central counterparty clearing houses help reduce the risk of trading derivatives and securities. They became more popular after the financial crisis as a way for investors to minimize counterparty risk.

While CCPs may help maintain stability in financial markets and increase efficiency, they may also involve participation fees, or may not be able to process non-standard transactions. Understanding the ins and outs of CCPs can be helpful to investors as they learn to navigate the markets.

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

What is the difference between a clearing house and a central counterparty?

While a CCP acts as a clearing house for transactions, it has an additional step involved before doing so. The two parties involved in a transaction agree upon transaction terms, then the CCP must agree to the terms before they clear the transaction.

What is the CCP margin?

CCPs require customers to make collateral deposits, known as margin deposits, before entering into transactions. This provides them with funds they can use to guarantee trades in the event that one party defaults on an agreement. The initial margin required depends on the customer, the type of financial product, and the particular trade agreement.

Does central clearing reduce counterparty risk?

Central clearing reduces counterparty risk by guaranteeing trades for buyers and sellers. They take on the credit risk involved in transactions by becoming the buyer to every seller and the seller to every buyer.


Photo credit: iStock/vm

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.

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.
*Borrow at 11%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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.

SOIN0124099

Read more
Free Margin Defined & Explained

Free Margin, Defined & Explained

Free margin is equity in a trader’s account not reserved for margin or open positions, and which is available to be used to open new trades. Free margin is also the amount your existing holdings can move against you before you face a margin call.

Changes in market values can impact this important margin balance when trading foreign exchange (“forex” or FX) and other derivative instruments. For investors, this can be an important concept to understand.

What Is Free Margin?

Free margin is the equity in a forex trading account that is not invested in open positions. It is also known as “usable margin” since you can open new positions with your free margin balance.

Margin works differently in forex versus with trading stocks. Margin in stock trading means you trade with borrowed funds and owe interest on the loan. Margin in forex is simply a deposit set aside to cover the potential for very large losses when you trade large amounts of currency.

Free margin in forex tells you how much wiggle room you have on your current holdings before you get hit with a margin call. A margin call can occur when your account’s margin level dips below 100%. You can also face a stop out call when your margin percentage declines below 50%.

Free margin also indicates how much you can withdraw from your account if you have no hedged positions.

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 11%* and start margin trading.

*For full margin details, see terms.


How Does Free Margin Work?

In general, margin can be categorized as “used” or “free.”

Used margin is the total amount of all the required margin from all your open positions. Free margin is the difference between equity and used margin — the available margin not taken up by current positions. You can use free margin to open new positions in the forex market.

Within the forex market, free margin is a constantly changing balance. The prices of currency pairs move throughout the day, so the free margin on your account will also fluctuate. Traders must constantly monitor their margin levels during the trading day. The forex market trades 24 hours a day for five and half days a week, so changes can also happen in the overnight hours.

Calculating Free Margin

This is the formula for calculating free margin:

Free margin = equity – used margin

Calculating Equity

This is the formula for calculating equity:

Equity = account balance + unrealized profits – unrealized losses

Free Margin Example

Let’s say you have a forex trading account with 100:1 leverage. Your margin deposit is $100. That means you can trade an amount up to $10,000. Now say you take a $20 position at 100:1 leverage. Your position size controls $2,000 of currency value. That $20 position is locked by your broker. The remaining $80 is your free margin. You can use up to that amount to trade more currency pairs in the FX market.

If the market moves to your benefit, your portfolio’s equity increases. You will have more free margin available as your holdings move in your favor. Free margin declines when the market moves against you, though.

Free Margin vs Used Margin

There are some key differences to know between free margin and used margin:

Free Margin

Used Margin

The amount of margin available to open new positions The amount held in reserve for existing positions
Also known as usable margin An aggregate of all the required margin from open positions
The difference between equity and used margin Equity minus free margin

Margin vs Free Margin

Similarly, there are some differences to understand between margin and free margin:

Margin

Free Margin

A good faith deposit with a broker when trading forex The amount existing positions can move against the trader before the broker issues a margin call
Collateral to protect the broker from excessive losses by the trader Total margin minus used margin
The amount of money reserved when you open a new position When free margin is zero or negative, new positions cannot be opened

Free Margin in Forex

Free margin is important to understand in forex trading. Volatility in your balances can be high due to the amount of leverage employed. Some traders have leverage ratios up to 500:1, while risk-averse traders can simply trade with only their margin. Trading with only your margin means you are not using leverage.

Free margin in forex tells a trader how much more money they can use to open new positions. It is also a risk management indicator, in that it can be seen as a kind of buffer amount before a margin call or forced liquidation is issued.

💡 Quick Tip: One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.

The Takeaway

Free margin in forex is the equity in a trader’s account that is not reserved in margin for open positions. It is considered the margin available to use for new trades and the amount your current positions can move against you before you get a margin call or automated stop out.

Free margin is an important term to know when trading in the forex market. Forex, with its often high degree of leverage and wide trading hours, can be more complicated than trading stocks and exchange-traded funds (ETFs).

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).

Get one of the most competitive margin loan rates with SoFi, 11%*

FAQ

Can you withdraw free margin?

Yes. Free margin in forex is the amount available to withdraw from your trading account if you have no hedged positions. If you have hedged positions, the amount you can withdraw is your equity minus margin hedges.

Is margin money free?

Margin in forex is your good faith deposit. It is considered collateral you post to trade on leverage. It does not cost you anything since you do not pay interest on that amount or on the amount of assets you control when trading with leverage. Margin is broken down into “used” or “free.” If you have open positions, then not all your margin is free.


Photo credit: iStock/kupicoo

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.

*Borrow at 11%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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.

SOIN0124102

Read more
Cup-and-Handle Stock Pattern: What It Is and How to Trade It

Cup and Handle Pattern Explained

A cup and handle pattern is something identified by stock traders or investors analyzing data related to certain securities. Traders analyzing stock charts can identify a cup and handle pattern, which comprises a period of falling values followed by a “breakout,” and use it to help inform their trading decisions.

The cup and handle pattern is one of many that investors may identify and use to help make investing decisions.

What Is a Cup and Handle Pattern?

The cup and handle security trading pattern is a bullish continuation pattern used in technical analysis. When the pattern appears on a stock chart, it shows a period of price consolidation followed by a price breakout. The pattern is called cup and handle because it has two distinct parts: the cup and the handle.

The cup pattern forms after an advance and looks like a bowl with a round bottom. It forms after a price advance. After that pattern forms, a “handle” forms to the right of the cup within a trading range. Finally, there is a breakout above the range of the handle, showing a bullish continuation of the prior advance.

Stock broker William O’Neil identified the cup and handle stock pattern and introduced it in his 1988 book, How to Make Money in Stocks.

💡 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.

How the Cup and Handle Works

The cup-and-handle candlestick pattern starts with the formation of the “cup,” which looks like a bowl. The two sides of the cup are not always the same height but in a perfect scenario they would be. Once the cup forms, the stock price pulls back, forming a “handle” out to the right of the cup. The handle shows price consolidation happening before a price breakout occurs.

The handle is smaller than the cup and generally doesn’t retrace more than ⅓ of the cup’s advance, staying in the upper part of the cup range. It can also form a triangle shape. If the handle forms at the bottom price range of the cup, the pattern may indicate that this is not a good time to trade. It may take six months or longer for the cup pattern to form, but the handle forms much faster, ideally within four weeks.

The entire pattern can also form within minutes or days. Technical analysts watching the cup-and-handle pattern try to buy when the price breaks out from the handle. This is marked by when the price moves above the old resistance level, which is the top of the right side of the cup. The more volume in the breakout the stronger the buy signal.

To estimate the price target the stock might hit after the breakout, a trader would measure the distance from the bottom of the cup to the top of the right side of the cup and then add that number to the buy signal point. If the left and right sides of the cup are different heights, the smaller side would give a more conservative price target, and the taller would be a more aggressive target.

What Does a Cup and Handle Pattern Tell Traders?

The cup-and-handle is a candlestick pattern that indicates a cup-shaped price consolidation. This involves a downward price movement, a stabilization period, then a price increase of about the same amount as the downward movement.

This is followed by a sideways pullback between the high and low of the cup shape, forming the handle. Then, a price breakout indicates increasing trade volume. However, as with any trading pattern, a cup-and-handle pattern does not guarantee the stock price will continue on a bullish trajectory, it’s just a trading indicator.

The cup and handle is a bullish pattern that can show a continuation or a reversal from a bearish trend into a bullish trend. Either way it indicates that the stock price will likely rise following the pattern.

Example of a Cup and Handle Pattern

An example of a cup and handle pattern would be if a cup shape forms between $48 and $50. A handle should then form between $49 and $50, ideally closer to $50. Then the price should break out above the price range of the handle.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Does the Cup and Handle Pattern Work?

The cup-and-handle pattern is one strategy that traders can use to get a sense of the market and inform their investing decisions. However, it is not a perfect tool.

Like any trading pattern, the cup and handle should be used in conjunction with other trend indicators and signals to make informed trading decisions. Although the cup and handle pattern can be a useful and easy to understand pattern to find entry and exit points, it does have some drawbacks.

The cup-and-handle pattern may form over the course of a day, weeks, months, or even a year. This makes it challenging to figure out exactly when to place a purchase order. Generally it forms over a month to a year, but identifying the exact breakout point is not easy.

Also, the depth of the cup can be a confusing part of the pattern. A shallow or a deep cup might be a false signal. The cup also doesn’t always form a handle at all, and the liquidity of the stock also affects the strength of the trading signal.

How to Trade a Cup and Handle Pattern

Traders wait for the handle pattern to form, which may either be in the shape of a sideways handle or a triangle. When the stock price breaks out above the top of the handle, that indicates completion of the cup-and-handle pattern, and creates a signal that stock price could continue to rise.

Although the cup-and-handle pattern can be a strong buy indicator, it does not guarantee that prices will go up. The stock price may rise, fall again, then continue to rise. Or it might rise and then simply fall.

One way to avoid significant losses when this happens is to set a stop-loss on trades with your broker. Day traders may want to close out the trade before the market closes.

Cup-and-Handle Patterns in Crypto

While the cup-and-handle pattern has traditionally been used for stock trading, it can also be used in crypto trading. Cup and handle patterns have formed in Bitcoin and Ethereum charts in recent years. Bitcoin formed a cup and handle pattern in 2019, and Ethereum formed one in 2021. The basic guidelines and indicators are the same for crypto as for stocks.

Recommended: Crypto Technical Analysis: What It Is & How to Do One

The Takeaway

Stock patterns are signals that form a certain recognizable shape when charted graphically, making them easy to spot and trade. They can help traders find entry or exit points, estimate price targets and potential risk. The cup-and-handle pattern is a useful and easy to follow trading pattern to help traders spot entry points for bullish trades.

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 cup and handle pattern bullish?

Yes, the cup and handle pattern is considered a bullish market signal, and investors may take it as a sign that they should go “long” on an investment or specific market position.

How reliable is cup and handle pattern?

The cup and handle pattern is merely an indicator, and not a promise or sure sign that something is going to happen. As such, investors should be careful not to take it as a sure thing. That said, investors may do well to use it in conjunction with other trading strategies and methods, and along with other trend markers.

What are the rules for the cup and handle pattern?

The cup and handle pattern doesn’t have “rules” per se, but instead, is a pattern that forms on a stock chart. That form shows a stock price decreasing in price over a short period of time, then stabilizing, forming a “cup,” which is then followed by a rise in value, creating the “handle.”

What is the weekly timeframe for the cup and handle pattern?

Cup and handle patterns can emerge on a stock chart over several months, but many times, over a handful of weeks.


Photo credit: iStock/jacoblund

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.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

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.

SOIN0124096

Read more
closeup of student writing in notebook

Top 5 401(k) Alternatives: Saving for Retirement Without a 401(k)

A 401(k) is a popular way to save for retirement. But not everyone has access to these employer-sponsored 401(k) savings plans. For instance, many small companies don’t offer them. And self-employed individuals don’t have access to regular 401(k)s.

For those who don’t have access to a 401(k) at work or want to consider other retirement savings options, there are a number of 401(k) alternatives. Read on to learn about how to save for retirement without a 401(k), some 401(k) alternatives, and what you need to know about each of them to choose a plan that aligns with your retirement savings goals.

5 Alternatives to a 401(k)

These are some popular retirement savings plans available beyond a regular 401(k).

Traditional IRA

A traditional IRA (Individual Retirement Account) is similar to a 401(k) in that contributions aren’t included in an individual’s taxable annual income. Instead, they are deferred and taxed later when the money is withdrawn at age 59 ½ or later.

Early withdrawals from an IRA may be subject to an added 10% penalty (plus income tax on the distribution). However the main difference between an IRA vs. 401(k) is that IRAs tend to give individuals more control than company-sponsored plans—an individual can decide for themselves where to open an IRA account and can exert more control in determining their investment strategy.

Learning how to open an IRA is relatively simple—such accounts are available with a variety of financial services providers, including online banks and brokerages. This flexibility allows individuals to comparison shop, evaluating providers based on criteria such as account fees and other costs.

Once an individual opens an account, they may make contributions up to an annual limit at any time prior to the tax filing deadline. For tax year 2024, the limit is $7,000 ($8,000 for individuals 50 and older). For tax year 2023, the limit is $6,500 ($7,500 for individuals 50 and older).

💡 Quick Tip: How much does it cost to set up an IRA? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

Roth IRA

There are a few key differences when it comes to a traditional IRA vs. a Roth IRA. To begin with, not everyone qualifies to contribute to a Roth IRA. The upper earnings limit to contribute even a reduced amount for tax year 2024 is $161,000 for singles, and $240,000 for married joint filers. The upper earnings limit for even a partial contribution for tax year 2023 is $153,000 for singles, and $228,000 for married joint filers.

Another thing that distinguishes Roth IRAs is that they’re funded with after-tax dollars—meaning that while contributions are not income tax deductible, qualified distributions (typically after retirement) are tax-free. Additionally, while an IRA has required minimum distributions (RMD) rules that state investors must start taking distributions upon turning 73, there are no minimum withdrawals required on Roth IRAs.

Like a traditional IRA, Roth IRAs carry an annual contribution limit of $7,000 for 2024 and $6,500 for 2023. Individuals aged 50 and up can make an additional $1,000 in 2023 and in 2024 in catch-up contributions. Roth IRAs also offer similar flexibility to traditional IRAs in that individuals can open online IRA accounts with a provider that best suits their needs—whether that means an account that offers more hands-on investing support or one with cheaper fees.

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


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.

Self-Directed IRA (SDIRA)

Another 401(k) alternative is a self-directed IRA. A SDIRA can be either a traditional or Roth IRA.

But whereas IRA accounts typically allow for investment in approved stocks, bonds, mutual funds, and CDs, self-directed IRAs allow for a much broader set of holdings, including things like REITs, promissory notes, tax lien certificates, and private placement securities. Some self-directed IRAs also permit investment in digital assets such as crypto trading and initial coin offerings.

While having the freedom to make alternative investments may be appealing to some individuals, the Security and Exchange Commission cautions that such ventures may be more vulnerable to fraud than traditional investing products.

The SEC cautions that individuals considering a self-directed IRA should do their homework before investing, taking steps to confirm both the investments and the person or firm selling them are registered. They also advise investors to be cautious of unsolicited offers and any promises of guaranteed returns.

Simplified Employee Pension (SEP) IRA

A SEP (Simplified Employee Pension) IRA follows the same rules as traditional IRAs with one key difference: They are employer-sponsored and allow companies to make contributions on workers’ behalf, up to 25% of the employee’s salary.

Though the proceeds of SEP IRAs are 100% vested with the employee, only the employer contributes to this type of retirement account. To be eligible, the employee must have worked for the company for three out of the last five years.

Because people who are self-employed or own their own companies are eligible to set up SEP IRAs—and can contribute up to a quarter of their salary—this type of account can be an attractive option for those individuals who would like to put away more each year than traditional or Roth IRAs allow.

Solo 401(k)

Self-employed individuals and business owners may want to consider a solo 401(k). This type of 401(k) is designed for those who have no employees other than their spouse, and the way it works is similar to a traditional 401(k). Contributions are made using pre-tax dollars and taxed when withdrawn in retirement. (However, there are also Roth solo 401(k)s using after-tax dollars.) The biggest difference between a regular 401(k) and a solo 401(k) is that there is no matching contribution from an employer with a solo 401(k).

The total contribution limits for a solo 401(k) are $66,000 for tax year 2023, and $69,000 for 2024. Catch-up contributions for those 50 and older are an additional $7,500 for each year.

One thing to consider: There are extra IRS rules and reporting requirements for a solo 401(k), which may make these plans more complicated.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

How a 401(k) Differs From Alternatives

As mentioned, a 401(k) is an employer-sponsored retirement fund. 401(k) contributions are determined by an employee and then drawn directly from their paycheck and deposited into a dedicated fund.

Income tax on 401(k) contributions is deferred until the time the money is withdrawn—usually after retirement—at which point it is taxed as income.

During the time that an employee contributes pre-tax dollars to their 401(k) plan, the contributions are deducted from their taxable income for the year, potentially lowering the amount of income tax they might own. For example, if a person earned a $60,000 annual salary and contributed $6,000 to their 401(k) in a calendar year, they would only pay income tax on $54,000 in earnings.

There are annual limits on 401(k) contributions, and the ceilings on contributions change annually. In 2024, the limit for traditional 401(k)s is $23,000—a $500 increase over the 2023 limit (individuals 50 and older can contribute an additional $7,500 in catch-up contributions). If a person participates in multiple 401(k) plans from several employers, they still need to abide by this limit, so it’s a good idea to add up all contributions across plans.

A 401(k) can be a helpful savings tool for a variety of reasons. Because withdrawals are set up in advance, and automatically deducted from an individual’s paycheck, it essentially puts retirement savings on “auto-pilot.” In addition, employers often contribute to these plans, whether through matching contributions or non-elective contributions.

But there are also some drawbacks to the plan, including penalties for early withdrawals. There are also mandatory fees, which may include plan administration and service fees, as well as investment fees such as sales and management charges. It’s helpful to brush up on all the costs associated with an employer’s 401(k) and look into other 401(k) alternatives if it makes sense.

The Takeaway

With a number of 401 (k) alternatives to choose from, it’s clear there’s no one right way to save for retirement. There are a variety of factors for an investor to consider, including current income, investment interests, and whether it makes sense to invest pre- or after-tax dollars.

Ultimately, the important thing is to identify a good retirement savings account for one’s individual needs, and then contribute to it regularly.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

What is a better option than a 401(k)?

There isn’t necessarily a better option than a 401(k), but if you’re looking for another type of retirement savings plan, you may want to consider a traditional IRA or Roth IRA. These retirement savings plans allow you to invest your contributions in different types of investments, and you will generally have a wider array of offerings than you might get with a 401(k). Plus, you can have an IRA in addition to a 401(k), which could help you save even more for retirement.

How to save for retirement if my employer doesn’t offer 401(k)?

If your employer doesn’t offer a 401(k), you could save for retirement with a traditional or Roth IRA. Both plans allow you to contribute a certain amount each year ($6,500 for tax year 2023, and $7,000 for 2024), plus an additional $1,000 in catch-up contributions if you are 50 or older. With traditional IRAs, you contribute pre-tax dollars, and you pay tax on the money when you withdraw it in retirement. With a Roth IRA, you contribute after-tax dollars and then withdraw the money tax-free in retirement.

What 401(k) alternatives are there for the self-employed?

Some 401(k) alternatives for the self-employed include SEP (Simplified Employee Pension) IRAs and solo 401(k)s. With a SEP IRA, individuals who are self-employed or own their own companies can contribute up to a quarter of their salary. Solo 401(k)s are designed for self-employed individuals who have no employees other than a spouse, and allow for contributions of up to $66,000 in 2023, and $69,000 in 2024.


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.


Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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.

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


An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

SOIN0124012

Read more

Private Equity vs Venture Capital

Venture capital and private equity funds are two different ways that companies, funds or individuals invest in other companies. While the two types of funds share some similarities, there are also key differences that you’ll want to be aware of. While many private equity and venture capital funds are privately held, some are open to individual investors.

A private equity fund might use its managerial, technological or other expertise to invest in one specific company, hoping to turn it around and improve its profitability. That would allow the fund to sell their investment for a healthy return. Venture capital firms often invest in early-stage companies or startups. They provide capital funds to these companies in exchange for a portion of the company’s equity.

Key Points

•   Private equity and venture capital are two ways that people, funds or companies invest in other companies.

•   Private equity funds often invest in a small number or even just one company at a time, usually a mature company.

•   Venture capital funds generally invest in many different companies that are early in their journey to profitability.

•   While many private equity and venture capital funds are privately held, there are some that are publicly traded and open to individual investors.

What Is Private Equity?

Private equity refers to investing in companies that are not publicly traded. Unlike investing in public equities (such as by purchasing index funds or shares of stock of companies listed on a public stock exchange), private equity investors put their money into privately-held companies.

While you might not think of private companies as having shares of stock in the same way that publicly-traded companies do, most incorporated companies do have shares of stock. A small company might only have a hundred or even less shares, all owned by the initial founders of the company.

A private company that is more established, on the other hand, might have hundreds of thousands or even millions of shares owned by a wide variety of people. The stock of private companies might be owned by the founders, employees or other private equity investors.

💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alternative funds through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.

Alternative investments,
now for the rest of us.

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


What Is Venture Capital?

Venture capital refers to investors and money that is invested into early-stage companies in the hope that they will generate an above-average return on investment. Venture capital investing usually refers to funds or individuals that give money to early-stage companies, but the investment can also be via managerial or technical expertise.

Venture capital money is often invested over a series of “rounds.” Initially there might be an “angel” round or “seed” round, and then Series A, B, C and so on. In each round, companies receive funding from venture capital investors in exchange for a percentage of the company’s stock, at an agreed-upon valuation.

Generally, the earlier the round of venture capital investment, the lower the valuation. This allows the earliest investors to potentially have the highest return on investment, since they also carry the largest amount of risk.

Venture capital and private equity may serve as examples of alternative investments for certain investors.

Key Differences Between Private Equity and Venture Capital

While private equity and venture capital both refer to companies or funds that invest in companies, there are a few key differences that you’ll want to be aware of:

Private Equity Venture Capital
Generally invests in already established companies Often invests in early-stage companies and/or startups
Often purchase entire companies and work to improve their profitability Purchase a portion of the companies they invest in
Generally invest more money and focus on fewer companies Firms tend to spread their money around — investing relatively fewer amounts of money in more investments

Advantages and Disadvantages

When you compare private equity vs. venture capital investing, there are a few similarities as well as advantages or disadvantages to investing in both.

In most cases, comparing the advantages and disadvantages of venture capital vs. private equity depends on your own specific situation or goal. What might be an advantage for one investor could be a disadvantage for an investor with a different risk tolerance or financial profile.

One potential advantage of investing in private equity is that private equity firms often concentrate their money in a small number of firms. This might allow the private equity investors to concentrate their expertise into improving the profitability of those companies. However, some might consider this a disadvantage, since you might lose some or most of your investment if the company is not able to turn things around.

Similarly, venture capital investors typically invest in a number of startups and early-stage companies. One advantage of investing in this manner is that you may see outsized returns if the company succeeds. However, a related disadvantage is that many companies in these early stages do not succeed, potentially wiping out your entire investment.

In that sense, it’s a high-risk, high-potentialy-reward area of investment.

Common Misconceptions

One common misconception about private equity vs. venture capital is that only investors with significant net worth can invest in these fields. While it is true that most actual private equity and venture capital investors are those with access to significant amounts of capital, there are also many private equity or venture capital funds that sell shares of the funds themselves to retail investors.

This may allow even regular individual investors to take part in investing in venture capital or private equity.

💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

The Takeaway

Private equity and venture capital funds are two different ways that companies invest in other companies. While they share a lot of similarities, there are also some key differences. One big difference is that generally, private equity funds invest more money in fewer companies while venture capital funds often invest (relatively) smaller sums of money in many companies.

While most private equity and venture capital funds are privately held, there are some that are publicly traded and open to individual investors.

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).

Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

Is private equity better than venture capital?

Private equity (PE) and venture capital (VC) are two forms of investing in other companies, and when comparing the difference between VC and PE, it isn’t really the case that one is better than the other. Instead, it will depend on your own specific financial situation and/or risk tolerance. You can also consider alternative investments to both private equity and venture capital.

Which is the riskier option?

Both private equity and venture capital carry some level of risk. In one manner of speaking, venture capital is riskier, since many of the early-stage companies that they invest in will not succeed. However, most venture capital funds mitigate that risk by investing in many different companies. One successful investment may pay off the losses of tens or even hundreds of unsuccessful venture capital investments.

Are there private equity or venture capital funds available to buy?

Many private equity and venture capital firms are targeted towards investors with significant assets and/or a high net worth. However, there are some funds that are publicly traded and thus available to individual investors. Make sure that you do your own research before investing in any one particular private equity or venture capital fund.


Photo credit: iStock/franckreporter
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.


An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

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.

SOIN0224028

Read more
TLS 1.2 Encrypted
Equal Housing Lender