Feb
12
2024
Pros & Cons of Working After Retirement
Many retirees continue working or take on a new job, but working after retirement can have downsides.
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Student Loan Consolidation and Refinancing
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Guide to 457 Retirement Plans
A 457 plan — technically a 457(b) plan — is similar to a 401(k) retirement account. It’s an employer-provided retirement savings plan that you fund with pre-tax contributions, and the money you save grows tax-deferred until it’s withdrawn in retirement.
But a 457 plan differs from a 401(k) in some significant ways. While any employer may offer a 401(k), 457 plans are designed specifically for state and local government employees, as well as employees of certain tax-exempt organizations. That said, a 457 has fewer limitations on withdrawals.
This guide will help you decide whether a 457 plan is right for you.
What Is a 457 Retirement Plan?
A 457 plan is a type of deferred compensation plan that’s used by certain employees when saving for retirement. The key thing to remember is that a 457 plan isn’t considered a “qualified retirement plan” based on the federal law known as ERISA (from the Employee Retirement Income Security Act of 1974).
These plans can be established by state and local governments or by certain tax-exempt organizations. The types of employees that can participate in 457 savings plans include:
• Firefighters
• Police officers
• Public safety officers
• City administration employees
• Public works employees
Note that a 457 plan is not used by federal employees; instead, the federal government offers a Thrift Savings Plan (TSP) to those workers. Nor is it exactly the same thing as a 401(k) plan or a 403(b), though there are some similarities between these types of plans.
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.
How a 457 Plan Works
A 457 plan works by allowing employees to defer part of their compensation into the plan through elective salary deferrals. These deferrals are made on a pre-tax basis, though some plans can also allow employees to choose a Roth option (similar to a Roth 401(k)).
The money that’s deferred is invested and grows tax-deferred until the employee is ready to withdraw it. The types of investments offered inside a 457 plan can vary by the plan but typically include a mix of mutual funds. Some 457 retirement accounts may also offer annuities as an investment option.
Unlike 401(k) plans, which require employees to wait until age 59 ½ before making qualified withdrawals, 457 plans allow withdrawals at whatever age the employee retires. The IRS doesn’t impose a 10% early withdrawal penalty on withdrawals made before age 59 ½ if you retire (or take a hardship distribution). Regular income tax still applies to the money you withdraw, except in the case of Roth 457 plans, which allow for tax-free qualified distributions.
So, for example, say you’re a municipal government employee. You’re offered a 457 plan as part of your employee benefits package. You opt to defer 15% of your compensation into the plan each year, starting at age 25. Once you turn 50, you make your regular contributions along with catch-up contributions. You decide to retire at age 55, at which point you’ll be able to withdraw your savings or roll it over to an IRA.
Who Is Eligible for a 457 Retirement Plan?
In order to take advantage of 457 plan benefits you need to work for an eligible employer. Again, this includes state and local governments as well as certain tax-exempt organizations.
There are no age or income restrictions on when you can contribute to a 457 plan, unless you’re still working at age 73. A 457 retirement account follows required minimum distribution rules, meaning you’re required to begin taking money out of the plan once you turn 73. At this point, you can no longer make new contributions.
A big plus with 457 plans: Your employer could offer a 401(k) plan and a 457 plan as retirement savings options. You don’t have to choose one over the other either. If you’re able to make contributions to both plans simultaneously, you could do so up to the maximum annual contribution limits.
Pros & Cons of 457 Plans
A 457 plan can be a valuable resource when planning for retirement expenses. Contributions grow tax-deferred and as mentioned, you could use both a 457 plan and a 401(k) to save for retirement. If you’re unsure whether a 457 savings plan is right for you, weighing the pros and cons can help you to decide.
Pros of 457 Plans
Here are some of the main advantages of using a 457 plan to save for retirement.
No Penalty for Early Withdrawals
Taking money from a 401(k) or Individual Retirement Account before age 59 ½ can result in a 10% early withdrawal tax penalty. That’s on top of income tax you might owe on the distribution. With a 457 retirement plan, this rule doesn’t apply so if you decide to retire early, you can tap into your savings penalty-free.
Special Catch-up Limit
A 457 plan has annual contribution limits and catch-up contribution limits but they also include a special provision for employees who are close to retirement age. This provision allows them to potentially double the amount of money they put into their plan in the final three years leading up to retirement.
Loans May Be Allowed
If you need money and you don’t qualify for a hardship distribution from a 457 plan you may still be able to take out a loan from your retirement account (although there are downsides to this option). The maximum loan amount is 50% of your vested balance or $50,000, whichever is less. Loans must be repaid within five years.
Cons of 457 Plans
Now that you’ve considered the positives, here are some of the drawbacks to consider with a 457 savings plan.
Not Everyone Is Eligible
If you don’t work for an eligible employer then you won’t have access to a 457 plan. You may, however, have other savings options such as a 401k or 403(b) plan instead which would allow you to set aside money for retirement on a tax-advantaged basis. And of course, you can always open an IRA.
Investment Options May Be Limited
The range of investment options offered in 457 plans aren’t necessarily the same across the board. Depending on which plan you’re enrolled in, you may find that your investment selections are limited or that the fees you’ll pay for those investments are on the higher side.
Matching Is Optional
While an employer may choose to offer a matching contribution to a 457 retirement account, that doesn’t mean they will. Matching contributions are valuable because they’re essentially free money. If you’re not getting a match, then it could take you longer to reach your retirement savings goals.
💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.
457 Plan Contribution Limits
The IRS establishes annual contribution limits for 457 plans. There are three contribution amounts:
• Basic annual contribution
• Catch-up contribution
• Special catch-up contribution
Annual contribution limits and catch-up contributions follow the same guidelines established for 401(k) plans.
The special catch-up contribution is an additional amount that’s designated for employees who are within three years of retirement. Not all 457 retirement plans allow for special catch-up contributions.
Here are the 457 savings plan maximum contribution limits for 2023 and 2024.
| 2023 | 2024 | |
|---|---|---|
| Annual Contribution | Up to 100% of an employees’ includable compensation or $22,500, whichever is less | Up to 100% of an employees’ includable compensation or $23,000, whichever is less |
| Catch-up Contribution | Employees 50 and over can contribute an additional $7,500 | Employees 50 and over can contribute an additional $7,500 |
| Special Catch-up Contribution | $22,500 or the basic annual limit plus the amount of the basic limit not used in prior years, whichever is less* | $23,000 or the basic annual limit plus the amount of the basic limit not used in prior years, whichever is less* |
*This option is not available if the employee is already making age-50-or-over catch-up contributions.
457 vs 403(b) Plans
The biggest difference between a 457 plan and a 403(b) plan is who they’re designed for. A 403(b) plan is a type of retirement plan that’s offered to public school employees, including those who work at state colleges and universities, and employees of certain tax-exempt organizations. Certain ministers may establish a 403(b) plan as well. This type of plan can also be referred to as a tax-sheltered annuity or TSA plan.
Like 457 plans, 403(b) plans are funded with pre-tax dollars and contributions grow tax-deferred over time. These contributions can be made through elective salary deferrals or nonelective employer contributions. Employees can opt to make after-tax contributions or designated Roth contributions to their plan. Employers are not required to make contributions.
The annual contribution limits to 403(b) plans, including catch-up contributions, are the same as those for 457 plans. A 403(b) plan can also offer special catch-up contributions, but they work a little differently and only apply to employees who have at least 15 years of service.
Employees can withdraw money once they reach age 59 ½ and they’ll pay tax on those distributions. A 403(b) plan may allow for loans and hardship distributions or early withdrawals because the employee becomes disabled or leaves their job.
Investing for Retirement With SoFi
When weighing retirement plan options, a 457 retirement account may be one possibility. That’s not the only way to save and invest, however. If you don’t have a retirement plan at work or you’re self-employed, you can still open a traditional or Roth IRA to grow wealth.
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).
FAQ
How does a 457 plan pay out?
If you have a 457 savings plan, you can take money out of your account before age 59 ½ without triggering an early withdrawal tax penalty in certain situations. Those distributions are taxable at your ordinary income tax rate, however. Like other tax-advantaged plans, 457 plans have required minimum distributions (RMDs), but they begin at age 73.
What are the rules for a 457 plan?
The IRS has specific rules for which types of employers can establish 457 plans; these include state and local governments and certain tax-exempt organizations. There are also rules on annual contributions, catch-up contributions and special catch-up contributions. In terms of taxation, 457 plans follow the same guidelines as 401(k) or 403(b) plans: Contributions are made pre-tax; the employee pays taxes on withdrawals.
When can you take money out of a 457 plan?
You can take money out of a 457 plan once you reach age 59 ½. Withdrawals are also allowed prior to age 59 ½ without a tax penalty if you’re experiencing a financial hardship or you leave your employer. Early withdrawals are still subject to ordinary income tax.
Photo credit: iStock/Nomad
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.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SoFi Invest®
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.
SOIN0224015
Feb
12
2024
Guide to Cash Balance Pension Plans
A cash balance pension plan is a defined benefit plan that offers employees a stated amount at retirement. The amount of money an employee receives can be determined by their years of service with the company and their salary. Employers may offer a cash balance retirement plan alongside a 401(k) or in place of one.
If you have a cash balance plan at work, it’s important to know how to make the most of it when preparing for retirement. Read on to learn more about what a cash balance pension plan is and the pros and cons.
What Are Cash Balance Pension Plans?
A cash balance pension plan is a defined benefit plan that incorporates certain features of defined contribution plans. Defined benefit plans offer employees a certain amount of money in retirement, based on the number of years they work for a particular employer and their highest earnings. Defined contribution plans, on the other hand, offer a benefit that’s based on employee contributions and employer matching contributions, if those are offered.
In a cash balance plan, the benefit amount is determined based on a formula that uses pay and interest credits. This is characteristic of many employer-sponsored pension plans. Once an employee retires, they can receive the benefit defined by the plan in a lump sum payment.
This lump sum can be rolled over into an individual retirement account (IRA) or another employer’s plan if the employee is changing jobs, rather than retiring. Alternatively, the plan may offer the option to receive payments as an annuity based on their account balance.
Get a 1% IRA match on rollovers and contributions.
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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.
How Cash Balance Pension Plans Work
Cash balance pension plans are qualified retirement plans, meaning they’re employer-sponsored and eligible for preferential tax treatment under the Internal Revenue Code. In a typical cash balance retirement plan arrangement, each employee has an account that’s funded by contributions from the employer. There are two types of contributions:
• Pay credit: This is a set percentage of the employee’s compensation that’s paid into the account each year.
• Interest credit: This is an interest payment that’s paid out based on an underlying index rate, which may be fixed or variable.
Fluctuations in the value of a cash pension plan’s investments don’t affect the amount of benefits paid out to employees. This means that only the employer bears the investment risk.
Here’s an example of how a cash balance pension works: Say you have a cash balance retirement plan at work. Your employer offers a 5% annual pay credit. If you make $120,000 a year, this credit would be worth $6,000 a year. The plan also earns an interest credit of 5% a year, which is a fixed rate.
Your account balance would increase year over year, based on the underlying pay credits and interest credits posted to the account. The formula for calculating your balance would look like this:
Annual Benefit = (Compensation x Pay Credit) + (Account Balance x Interest Credit)
Now, say your beginning account balance is $100,000. Here’s how much you’d have if you apply this formula:
($120,000 x 0.05) + ($100,000 x 1.05) = $111,000
Cash balance plans are designed to provide a guaranteed source of income in retirement, either as a lump sum or annuity payments. The balance that you’re eligible to receive from one of these plans is determined by the number of years you work, your wages, the pay credit, and the interest credit.
Cash Balance Plan vs 401(k)
Cash balance plans and 401(k) plans offer two different retirement plan options. It’s possible to have both of these plans through your employer or only one.
In terms of how they’re described, a cash balance pension is a defined benefit plan while a 401(k) plan is a defined contribution plan. Here’s an overview of how they compare:
| Cash Balance Plan | 401(k) | |
|---|---|---|
| Funded By | Employer contributions | Employee contributions (employer matching contributions are optional) |
| Investment Options | Employers choose plan investments and shoulder all of the risk | Employees can select their own investments, based on what’s offered by the plan, and shoulder all of the risk |
| Returns | Account balance at retirement is determined by years of service, earnings, pay credit, and interest credit | Account balance at retirement is determined by contribution amounts and investment returns on those contributions |
| Distributions | Cash balance plans must offer employees the option of receiving a lifetime annuity; can also be a lump sum distribution | Qualified withdrawals may begin at age 59 ½; plans may offer in-service loans and/or hardship withdrawals |
Pros & Cons of Cash Balance Pension Plans
A cash balance retirement plan can offer both advantages and disadvantages when planning your retirement strategy. If you have one of these plans available at work, you may be wondering whether it’s worth it in terms of the income you may be able to enjoy once you retire.
Here’s more on the pros and cons associated with cash balance pension plans to consider when you’re choosing a retirement plan.
Pros of Cash Balance Pension Plans
A cash balance plan can offer some advantages to retirement savers, starting with a guaranteed benefit. The amount of money you can get from a cash balance pension isn’t dependent on market returns, so there’s little risk to you in terms of incurring losses. As long as you’re still working for your employer and earning wages, you’ll continue getting pay credits and interest credits toward your balance.
From a tax perspective, employers may appreciate the tax-deductible nature of cash balance plan contributions. As the employee, you’ll pay taxes on distributions but tax is deferred until you withdraw money from the plan.
As for contribution limits, cash balance plans allow for higher limits compared to a 401(k) or a similar plan. For 2024, the maximum annual benefit allowed for one of these plans is $275,000. For 2023, the maximum annual benefit allowed is $265,000.
When you’re ready to retire, you can choose from a lump sum payment or a lifetime annuity. A lifetime annuity may be preferable if you’re looking to get guaranteed income for the entirety of your retirement. You also have some reassurance that you’ll get your money, as cash balance pension plans are guaranteed by the Pension Benefit Guaranty Corporation (PBGC). A 401(k) plan, on the other hand, is not.
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
Cons of Cash Balance Pension Plans
Cash balance pension plans do have a few drawbacks to keep in mind. For one, the rate of return may not be as high as what you could get by investing in a 401(k). Again, however, you’re not assuming any risk with a cash balance plan so there’s a certain trade-off you’re making.
It’s also important to consider accessibility, taxation, and fees when it comes to cash balance pension plans. If you need to borrow money in a pinch, for example, you may be able to take a loan from your 401(k) or qualify for a hardship withdrawal. Those options aren’t available with a cash balance plan. And again, any money you take from a cash balance plan would be considered part of your taxable income for retirement.
| Pros | Cons |
|---|---|
|
• Guaranteed benefits with no risk • Tax-deferred growth • Flexible distribution options • Higher contribution limits • Guaranteed by the PBGC |
• Investing in a 401(k) may generate higher returns • No option for loans or hardship withdrawals • Distributions are taxable |
Investing for Retirement With SoFi
A cash balance retirement plan is one way to invest for retirement. It can offer a stated amount at retirement that’s based on your earnings and years of service. You can opt to receive the funds as either a lump sum or an annuity. Your employer may offer these plans alongside a 401(k) or in place of one, and there are pros and cons to each option to weigh.
If you don’t have access to either one at work, you can still start saving for retirement with an IRA. You can set aside money on a tax-advantaged basis and begin to build wealth for the long-term.
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).
FAQ
Is a cash balance plan worth it?
A cash balance plan can be a nice addition to your retirement strategy if you’re looking for a source of guaranteed income. Cash balance plans can amplify your savings if you’re also contributing to a 401(k) at work or an IRA.
Is a cash balance plan the same as a pension?
A cash balance plan is a type of defined benefit plan or pension plan, in which your benefit amount is based on your earnings and years of service. This is different from a 401(k) plan, in which your benefit amount is determined by how much you (and possibly your employer) contribute and the returns on those contributions.
Can you withdraw from a cash balance plan?
You can withdraw money from a cash balance plan in a lump sum or a lifetime annuity once you retire. You also have the option to roll cash balance plan funds over to an IRA or to a new employer’s qualified plan if you change jobs.
Photo credit: iStock/sturti
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.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SoFi Invest®
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.
SOIN0124106
Feb
09
2024
How to Evaluate a Stock Before You Buy
The value of a stock is made up of several factors, including the company’s ability to continue making a profit, its customer base, its financial structure, the economy, political and cultural trends, and how the company fits within the industry. Understanding those basic factors will go a long way toward helping you select stocks for your portfolio.
If you’ve never bought or sold stocks in the past, the thought of trading for the first time might be daunting. But once you’ve done your homework and have developed the right habits, it may not be nearly as intimidating.
Getting Started with Stock Evaluations
Learning how to evaluate stocks starts with some basic homework. But even for those familiar with the stock market basics, it can be helpful to keep some overarching things in mind.
• When you buy a stock, you’re not simply buying a piece of paper. A stock is an ownership share in a company — you’re buying into that company and its potential performance. When a person invests, they gain an opportunity to join in on its success or failures over the long haul.
• The more you know about the company, its industry, and general stock market trends, the better. Professional advice is important, but so is trusting common sense.
• A consumer may be able to spot investing trends that eventually translate to a company’s strong performance down the line, asking questions like: Why am I investing in this company? Why now?
• It’s important to assess your individual tolerance for risk before investing, and check in on that periodically. Additionally, make time to review your stocks’ performance and watch the market on a regular basis.
• When considering how many stocks to buy, most investors may want to keep portfolio diversification in mind, with stocks across a range of sectors and risks. Being invested in only one stock means that if the company fails, you could lose your invested money.
Understand the Two Types of Stock Analysis
There are two general types of stock analysis: Fundamental, and technical.
Fundamental analysis as it relates to stocks involves analyzing the underlying company’s financial health and operations. It may include looking at financial statements, earnings reports, annual reports, and more, and the overall goal is to get a sense of the stock’s intrinsic value.
Technical analysis, on the other hand, incorporates the use of data and indicators from charts to try and identify patterns and trends. Its goal is to determine where a stock’s value might go next.
Review Stock Materials
With some general evaluation guidelines in mind, the next step is to dig deeper to calculate stock value. This involves reviewing a stock’s materials and documentation.
Balance Sheet and Other Financials
The Securities and Exchange Commission (SEC) requires all public companies to file regular financial documents that disclose their performance. These quarterly filings indicate profit and loss, material issues that can affect performance, expenses, and other key information that will help you gauge a company’s health, and get a better idea of a potential return on equity.
Recommended: FINRA vs. the SEC
Consumers can find these and other reports on SEC.gov:
Balance sheet: This records whether the company reduced or increased their debt. Some major items to look for here are the company’s tax paid and tax rate, along with expenses that aren’t related directly to profits, like administrative expenses.
Income statement: The revenue, major expenses, and bottom-line income may reveal trends in the company’s profitability.
Cash flow statement: Not all income is realized, so the cash flow statement shows you what the company actually got paid during the quarter — not what it’s expected to receive from sales 30, 60, or 90 days from now. The operating cash flow (which excludes a windfall or unusual influx of cash) provides a sense of the real, day-to-day (or quarter) activity of the business: how much cash comes in and how much goes out; how the company handles assets and investments; and the money it raises or distributes to lenders and shareholders. Some companies, most famously Amazon, can have meager profits relative to their sales but impressive cash flows.
In particular, as you read through these statements, pay attention to:
• Revenue: The company’s gross income
• Operating expenses and non-operating expenses: These are typical day-to-day expenses, and also ones that don’t relate to the core business (for example, a non-operating expense might be any interest paid on debt)
• Total net income: This is the company’s actual profit, after deducting all expenses from revenue
• Earnings before interest, taxes, depreciation, and amortization (also known as EBITDA): This figure excludes non-operating expenses
Financial performance ratios offer insight into a company’s financial health.
Form 10-Q
While publicly traded companies tend to release their own financial statements in the form of a presentation for investors, analysts, and the media every three months, they are also required to produce a more comprehensive quarterly report known as the 10-Q, which is filed with the Securities and Exchange Commission (SEC).
This document “includes unaudited financial statements and provides a continuing view of the company’s financial position during the year,” according to the SEC, and can be useful to investors as it provides a comprehensive overview of the company’s performance for the previous three months. The 10-Q also offers insight into other factors that might give an impression of a company’s overall health, including:
• Any risk factors to the business
• Information about legal matters
• Issues that might impact a company’s inventory
Form 10-K
Form 10-K is similar to form 10-Q but it comes out on an annual, as opposed to quarterly, basis. The form is meant to “provide a comprehensive overview of the company’s business and financial condition and includes audited financial statements,” according to the SEC. The annual 10-K can give investors a broader picture of the business through the ups and downs of a year, during which sales and expenses can often fluctuate.
These reports include both detailed financial information and actual writing from the company’s management about how their business is doing. They also outline how executives are paid, which is one more piece of information about the company’s management that can be useful to shareholders.
💡 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).
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How to Value Stocks with Financial Ratios
If learning how to evaluate a stock starts with analyzing financial statements, step two is understanding performance through financial ratios. Ratios offer insight into a company’s financial health, allowing for comparisons to other companies in the same industry or against the overall market.
These are important financial ratios to know.
Price-to-earnings Ratio (P/E)
This is a stock valuation formula that will help you determine how one company’s stock price compares to another. The price-to-earnings ratio is straightforward: It divides the market price of a company’s stock by the company’s earnings per share. The ratio can reveal how many years it will take for a company to generate enough value to buy back its stock.
Price-to-earnings (PE) ratios can also indicate how much the market expects the company’s profits to grow in the future. When investors buy stocks with a high PE ratio, it typically means they’re “buying” present earnings at a high price, with the expectation that earnings will accelerate going forward. On the other hand, a stock with a low PE ratio could give an investor a good value for their money — but it could also be a sign that investors aren’t confident in the company’s future performance.
Looking back historically, the market has tended to have a PE ratio of about 15, meaning investors pay $15 for every $1 of earnings. But different companies and even different sectors can have wildly different PE ratios.
For example, software companies, especially younger ones, tend to have high PE ratios as investors think there’s a chance they could get much, much larger in the future and turn fast-growing revenue into profits. In software, PE ratios can be in the 30s or even much higher when companies see their stock prices take off quickly, with a PE or around 90.
Earnings Per Share (EPS)
Earnings per share (EPS) tells investors how much earnings each shareholder would receive if the company was liquidated immediately. Investors like to see growing earnings, and rising EPS means the company potentially has more money to distribute to shareholders or to roll back into the business. This figure is calculated by taking net income, subtracting any preferred stock dividends, and dividing the result by the total number of outstanding common stock shares.
Return on Equity (ROE)
Return on equity is a key guide for investors to measure the growth in profit for a company. ROE is determined by dividing the company’s net income by the shareholders’ equity, then multiplying by 100. The ratio tells you the value you would receive as a shareholder should the company liquidate tomorrow. Some investors like to see ROE rising by 10 percent or more per year, which reflects the performance of the S&P 500.
Debt-to-equity Ratio (D/E)
The debt-to-equity ratio, determined by dividing total liabilities by total shareholder equity, gives investors an idea of how much the company is relying on debt to fund its operation.
A high debt-to-equity ratio indicates a company that borrows a lot. Whether it’s too high depends on a comparison with other companies in the industry. For example, companies in the tech industry tend to have a D/E ratio of around 2, whereas companies in the financial sector may have D/E ratios of 10.
Debt-to-asset Ratio (D/A)
A debt-to-asset ratio can be informative when comparing a company’s debt load against that of other companies in the industry. This allows potential investors to better gauge the riskiness of the investment. Too much debt can be a warning sign for investors.
How to Evaluate Stocks with Qualitative Research
It’s important to note that using financial ratios and stock materials to evaluate stocks is a form of quantitative research. Investors can also use qualitative research methods to evaluate stocks, too. That can include intangible value and outside influences.
Intangible Value
Some investors have argued that traditional metrics don’t capture the values of intangible assets a company might hold, like brand power and intellectual property. These have become increasingly important to a company’s worth in more recent years, particularly when it comes to tech stock investing.
For instance, a software company’s patents or intellectual property rights may be incredibly valuable. But on the other hand, it wouldn’t have assets like factories or equipment that are easier to appraise.
Investors should also look at a company’s growth trends, such as at what pace it’s growing its revenue or customer base. Paying attention to “company guidance” — the projections the corporation gives when it releases earnings — can also be helpful in trying to gauge growth.
Outside Influences
Investors can also learn a stock’s beta, or its sensitivity to volatility in the broader market. Some companies are more vulnerable to changes in the domestic or global economy, and others may see their fortunes swing depending on the political party in charge of a government.
Learning a stock’s beta or finding one’s portfolio beta are ways investors can better gauge how much volatility their holdings will experience when there’s turbulence in the broader market.
Pay Attention
Once a potential investor has evaluated a stock they’re hoping to buy by analyzing the company’s financial filings and employing a few stock valuation formulas, there is one last step that can help inform the decision: Paying attention.
There are hundreds, if not thousands, of helpful online news sites and tools to help you research companies, screen stocks, and model a stock’s potential in the future. Here are some viable options.
Financial News Sites: There are numerous financial news sites to read, and you can even try looking at stock market forums to stay on top of things.
Online Financial Tools: Stock screeners help you filter stocks according to the parameters you set, whether you’re looking for blue chip stocks or less-established companies in which to invest.
Company Details: Research more than just the financial facts and figures. Find out how it makes money, the core values of the business, CEO performance, and more. Much information can be gleaned by searching reputable news and business media sites for articles and features about the company and its leaders.
Value Traps
Another common term to be familiar with is value trap — a stock that appears deceptively cheap but is actually not a good pick. Investors who follow the value style of investing tend to be very wary of value traps.
Because while these might seem like bargains, they’re usually not good businesses and may be trading at cheap valuations due to a permanent downhill move or industry changes, rises in costs, or bad management.
Whether a stock is a value trap depends on how the stock performs. If it moves back up to its “intrinsic value” or its true worth, it was indeed a bargain. But if it continues downward or stagnates, the market value was basically a true reflection of its intrinsic value.
💡 Quick Tip: One advantage of using a robo investing advisor is that these services are intended to be cost effective. Still, it’s wise to learn what the underlying costs are for the investment choices these services provide, as fees offset returns over time.
The Takeaway
There are a number of key terms, indicators, tools and tips that can help potential investors learn to evaluate a stock and its company’s performance. Investors can review a company’s balance sheets, and forms 10-Q and 10-K to get relevant information about a company’s financial performance and outlook.
Investors looking to evaluate stocks should also be familiar with certain ratios, which can indicate earning potential, debt, and dividend performance, among other indicators that can signal the health of the company and the stock.
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).
FAQ
What is the difference between price-to-earnings ratio and price-to-sales ratio?
The difference between price-to-earnings ratio and price-to-sales ratio is that P/E ratios compare a company’s share price to its annual profits, and P/S ratios compare share price to annual revenue.
What are some online financial tools that can help me screen and compare stocks?
There are numerous online stock screeners, market simulators, and comparison tools that can be found online, and investors who are interested can try them out to see which they prefer.
How far back should you go when evaluating stocks?
Investors may want to go back a couple of decades when evaluating stocks, as too short of a time frame may not provide enough context, and too much may not prove helpful. But ultimately, it’ll be up to personal preference.
What are some factors that can affect the stock price of a company besides its financial performance?
Stock values can be influenced by any number of factors, including changes to the economy, political changes in a given country, and even things like bad weather.
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.
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Read moreFeb
08
2024
What Are the Different Types of Stocks?
There are numerous types of stocks, categorized by company characteristics, size, region, sector, and more. Equipped with an understanding of different stock types, an investor can start building a diversified portfolio. Though all stocks can experience volatility and potentially lose value, holding a mix of different types of shares can mitigate the risk of being too heavily invested in any one category.
An Overview Of Stocks
A stock represents a percentage of ownership in a publicly traded company. So essentially, investors can own small pieces or “shares” of companies.
Generating returns via the stock market can usually happen in one of two ways. First, the value of the stock can increase over time, something known as capital appreciation. The second is through dividend payments, where companies make cash payouts periodically to all owners of that company’s stock. Some people make investments based on a company’s ability to pay consistent dividends, or “income.” Utility and telephone companies often fit into this bucket.
When you own a stock, you hold equity (or ownership) in that company. That’s why stocks are sometimes referred to as equities. Each individual share represents an equal proportion of ownership. Owners of stocks are often referred to as stockholders or shareholders.
💡 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).
Categories of Stocks
There are several ways that different stocks are categorized, which is important to know if you’re brushing up on the stock market basics. Stocks are also sometimes classified by styles of investing. These categories often have to do with how that company makes money and how the stock is valued. You may often hear this associated when discussing value vs. growth stocks.
Value Stocks
Value stocks are stocks that are considered to be trading below their actual worth, and are a key component in value investing. Investors hope that by buying companies that are priced below their “true” value, they can profit as the gap narrows over time.
Growth Stocks
Growth stocks are companies that are growing at a fast pace or those that are expected to continue growing at a faster rate than other stocks or competitors. Investors can encounter higher valuations in growth investing.
Common Stock
Common stock represents shares of ownership in a corporation. When an investor receives common shares, they are typically also granted voting rights to the company and can participate in shareholder voting processes — usually one vote for each share. For investors, it can be helpful to understand the differences between common versus preferred stock.
Preferred Stocks
Preferred stocks make regular dividend payments, but holders of preferred shares often have zero or limited voting rights. If a company becomes financially insolvent however, preferred stockholders have a claim on assets before common shareholders do.
Exchange-traded Funds (ETFs)
Exchange-traded funds, or ETFs, group multiple securities into a single share. For instance, a stock ETF will hold numerous companies, while a bond ETF can hold many individual bonds, whether it’s a collection of Treasurys or high-yield debt. ETFs are popular because of the cheap, instant diversification they offer.
There are many types of ETFs, too, including low cost ETFs, and ETFs with their holdings concentrated in certain sectors.
Initial Public Offerings (IPOs)
An initial public offering (IPO) is the process of a private company listing and debuting on a public stock exchange. Investors can buy IPO shares on their first day of trading.
Special Purpose Acquisition Companies (SPACs)
SPACs are shell companies that go public on the stock exchange, and then try to find a private operating business to purchase.
Real Estate Investment Trusts (REITs)
REITs are companies that own and operate real estate, usually focusing on one type of property, such as warehouses, hotels or office buildings. There are pros & cons to investing in REITs. For example, one pro is that they tend to pay consistent dividends. Cons include sensitivity to interest rates, and taxed dividends.
Blue-Chip Stocks
Blue-chip stocks are stocks that large, well-established companies issue and usually have a long-standing history of growth. They’re generally considered to be financially sound, and may be considered lower-risk than other stocks.
Cyclical and Non-Cyclical Stocks
Cyclical investing concerns making stock selections surrounding economic changes, and cyclical stocks are those that may see their performance closely align with larger economic shifts. Non-cyclical stocks, on the other hand, do not see their performance tied to larger economic changes.
Defensive Stocks
Defensive stocks may be used as a part of a defensive investing strategy, and usually involves investing in stocks that may be seen as lower-risk. This can include blue-chip stocks, or stocks from sectories like utilities and consumer staples.
Penny Stocks
Penny stocks are low-priced stocks that generally trade for less than $5 per share, and many trade for less than $1. They’re usually risky, and highly-speculative stocks.
Income Stocks
Income stocks are a category of stocks that tend to offer regular, steady income to investors. That income generally comes in the form of dividends.
Environmental, Social, and Corporate Governance (ESG)
ESG stocks are those that may have certain non-financial criteria that appeal to certain investors. ESG stocks are shares of companies that are socially and environmentally responsible, though there is no universally-shared or accepted set of ESG criteria.
Different Market Caps
The sizes of stocks are classified by the market capitalization of the company’s publicly traded stock. Market cap is calculated by multiplying the stock price by the total number of outstanding shares.
Generally speaking, larger companies tend to be older, more established, and have greater international exposure — so a higher percentage of a large-cap company’s revenue comes from overseas. Meanwhile, smaller-cap stocks tend to be newer, less established and more domestically oriented. Smaller-cap companies can be riskier but also offer more growth potential.
Similarly, if you’re interested in buying mid-cap stocks, that means you’re investing in mid-sized companies — generally speaking.
While the market-caps that determine which companies are small or large can shift, here’s a breakdown that gives some rough parameters.
Micro-Cap: $50 million to $300 million
Small-Cap: $300 million to $2 billion
Mid-Cap: $2 billion to $10 billion
Large-Cap: $10 billion or higher
Mega-Cap: $200 billion or higher
Types of Stock Classes
There are also stock classes that investors should be aware of, and those generally involve Class A, Class B, and Class C shares, which all may be issued by the same company. The specifics of each category will vary from company to company, too.
For some rough guidelines, though, Class A shares tend to have more voting power and higher priority for dividends. Class B shares may have lesser voting power than Class A shares, but no preferential treatment for dividends. Class C shares are often given to employees as a part of a compensation package, and may have associated trading restrictions.
💡 Quick Tip: What makes a robo advisor effective? Typically these automated investing services offer automatic deposits, a diversified portfolio of low-cost ETFs, and automatic rebalancing — all of which are designed to help you reach a specific goal. They can be less flexible and cost more than some other options, however.
Stocks By Sector
Additionally, stocks are often grouped by the industry that that company works within. According to the Global Industry Classification Standard (GICS), there are 11 recognized sectors, with numerous industries within those sectors. They include (but are not limited to):
Energy: Energy equipment and services, oil, gas, and consumable fuels. If you want to invest in energy stocks, this is the category to look at.
Materials: Chemicals, construction materials, containers and packaging, metals and mining
Industrials: Aerospace and defense, building products, machinery, construction and engineering, electrical equipment, industrial conglomerates
Consumer Discretionary: Automobiles, automobile components, household durables, leisure products
Consumer Staples: Food products, beverage, tobacco, household products
Health Care: Health care equipment and services, pharmaceuticals, biotechnology, life sciences
Financials: Banks, insurance, consumer finance, capital markets, financial services
Information Technology: IT services, software, communications equipment
Communication Services: Diversified telecommunication services, media, entertainment
Utilities: Electric utilities, gas utilities, water utilities, independent power and renewable electricity producers
Real Estate: Real estate management and development, various REITs (retail, residential, office, etc.)
Again, these categories can be helpful to investors looking to diversify their portfolios. If you want to add some real estate stocks, or even invest in tech stocks, sector investing may be something to research further.
Note, too, that there may be other categories or sectors of stocks not listed above, such as retail stocks.
Stocks by Country
Different overseas stocks can be classified by the country or region in which they’re headquartered, even if the company’s operations are global. Individuals looking to invest in international stocks have found that they can do so easily with ETFs, which hold numerous foreign companies within a single share.
Regions that are commonly used in the world of stock investing are:
EAFE is an acronym which stands for Europe, Australasia, and the Far East. Investors may see this used when making investment choices, as the MSCI EAFE is a common index used for international stock funds. These countries are all “developed” nations, which means they have established financial markets, stable political climates, and mature economies.
Emerging-market stocks, which stocks with companies based out of countries whose economies are described as developing. Brazil, Russia, Mexico, China, and India are just a few emerging markets. Emerging markets may be riskier to invest in but may pose an opportunity for high rates of growth.
The Takeaway
There are numerous types of stocks on the market, and it can be important for investors to understand the differences between them. The stock market can be volatile and prone to dramatic declines, but in order to shield themselves from the risks, investors often create diversified portfolios by stocking their holdings through various different stock types.
Diversification is easier to do if an investor understands the different types of stocks that exist in the U.S. equity market. From mega-cap stocks to ETFs to emerging-market companies, there are a myriad of investing opportunities in the equity market.
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).
FAQ
What are the benefits of investing in different types of stocks?
Investing in different types of stocks can be beneficial to investors as it can diversify their portfolio, which may help reduce investing risk as the market fluctuates.
What is the riskiest type of stock?
Penny stocks are likely the riskiest type of stock, as they are shares of companies that are new, unproven, and highly volatile. While there’s a big potential upside to investing in penny stocks, the risks are significant.
What stocks are best for beginners?
While it’ll depend on the individual investor, beginner investors may want to look at investing in blue chip stocks, ETFs, or other stocks that have either built-in diversification, or a long track record of viability, which can be a sign of lower associated risks.
What are the risks and opportunities of investing in emerging markets?
Emerging markets can be volatile or unstable, and there may be political, monetary, and economic risks that investors are unaware of in those markets.
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.
SOIN0224002
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