Nov
27
2024
9 ESG Metrics Investors Should Know

9 ESG Metrics Investors Should Know

By | Growing Wealth, invest, Investing | Comments Off on 9 ESG Metrics Investors Should Know

A number of investors are choosing to invest in securities with an environmental, social, and governance (ESG) focus that may align with their values and investment goals. Many see ESG companies as being potentially more sustainable long-term. But determining whether a company’s ESG strategies are having the desired impact requires the use of ESG metrics to measure progress and enable accountability.

In addition, these days many investors also want to know how well companies are managing the risks associated with climate-related changes — which also requires metrics that can show whether a company is meeting key standards.

These concerns aren’t new, but they have driven a number of new ESG-focused regulatory efforts here and abroad. As yet, however, there isn’t a universal set of ESG metrics used by all investors or financial firms to evaluate a company’s progress toward ESG goals, or better manage ESG risks. What’s more, the regulatory landscape in this sector is evolving, which, for the near future, may make it challenging to track certain metrics over time. That said, there are a number of frameworks that companies and governments have embraced that can inform investors’ choices.

Key Points

•   With the growing appeal of ESG strategies, there is also a need for reliable ways to assess companies’ ESG performance and risk mitigation.

•   ESG metrics are necessary for accurate company disclosures, which also support transparency and accountability.

•   The use of ESG metrics and disclosures can also help investors compare companies within and across industries.

•   A number of organizations are establishing mandatory standards and/or compliance rules, although some are in flux or facing legal opposition.

•   At the moment, companies can choose from a range of ESG frameworks and standards.

What Is ESG Investing?

ESG stands for environmental, social, and governance standards that can help people assess whether companies are meeting certain criteria, as well as whether they are mitigating ESG-related risk factors that may impact performance.

•   Environmental factors capture how well a company safeguards the physical environment (e.g., reducing emissions, pollutants).

•   Social criteria refer to employee safety, fair labor practices, community investment, relationships with customers and vendors.

•   Governance factors include issues of leadership, fraud prevention, transparency in accounting and reporting, and more.

ESG investing began in the 1970s, broadly speaking, although impact investing in various forms has been around for centuries.

At first, investing with the aim of creating positive change for society and the planet seemed anchored in a kind of “do-goodism” and less focused on financial outcomes. In the last 20 or 30 years, though, investors have become interested in socially responsible investing (SRI), as many funds in this category have shown themselves to offer returns that are comparable to traditional strategies, according to a report published in 2023 by Morningstar, a fund rating and research firm.

ESG Metrics Are Key to ESG Reporting

Thus, with the growing appeal of ESG investments to some investors, there is a commensurate need for reliable ways to assess companies’ ESG performance when choosing to invest online or through a traditional brokerage.

ESG frameworks help companies, as well as investors, assess an organization’s stated aims in terms of meeting ESG standards. In theory, relying on a common set of metrics should help encourage more efficient and transparent ESG reporting.

•   ESG metrics establish a layer of transparency and accountability.

•   Reliable ESG reporting helps build trust and a positive image with investors, communities, and other stakeholders.

•   In addition, companies that adhere to ESG standards may be able to demonstrate better risk management.

Recommended: Beginner’s Guide to Sustainable Investing

What Are ESG Metrics?

Until now, ESG metrics and reporting standards have been largely proprietary or voluntary. But owing to widespread concerns about climate change and climate-related risk factors, thousands of companies around the world have adopted voluntary frameworks and metrics in recent years.

There are thousands of metrics in use, many are specific to certain industries. Common ESG metrics typically assess how well an organization is limiting pollutants and emissions, meeting renewable energy targets, upholding fair labor standards, adhering to transparency in accounting, corporate board selection, and more.

The Use of ESG Frameworks

Companies may be required to use certain metrics in their reporting and disclosures. Here too there is considerable variation.

For example, the Global Reporting Initiative (GRI), which has a voluntary governance structure, is a nonprofit organization that was established in 1999 to create a set of guidelines that help companies and governments disclose their efforts in light of climate change, human rights, and corruption.

More than three-quarters (78%) of the world’s largest corporations have adopted the GRI standards, making it the most common ESG framework at the moment.

In addition, there has been a rise in the number of organizations that are establishing mandatory standards and/or compliance rules that require standardized reporting and verifiable metrics regarding ESG performance.

For example, the Corporate Sustainability Reporting Directive (CSRD) began rolling out mandatory ESG reporting rules in January of 2024 in the European Union. The CSRD compliance rules impact non-E.U. companies, as well, about a third of which are based in the United States.

Similarly, some financial institutions have created screener tools that investors can use to evaluate certain securities, but these are typically proprietary and cannot be used to evaluate investments at a different institution.

SEC Climate-Disclosure Rules on Hold

Another widely watched set of reporting requirements was led by the Securities and Exchange Commission (SEC) over the last few years. The SEC adopted new rules in March of 2024, which established a higher bar for companies and required them to disclose ESG-related operational risks and expenses, as well as efforts to meet sustainability targets: e.g., emissions reduction.

But those rules were quickly challenged and remain on hold at the time of publication. Likewise, similar efforts in states like California and elsewhere have been stalled.

Recommended: The Growth of Socially Responsible Investing

The Importance of ESG Metrics

Although the landscape of ESG frameworks and reporting standards is still evolving, and is largely in flux, ESG metrics are important because they help investors to gauge a firm’s impact on environmental issues, societal issues, and issues of corporate responsibility against a set of comparable peers.

Since many investors who are interested in ESG strategies are also committed to making an impact with their money, being able to benchmark outcomes is important.

The Limitations of ESG Metrics

However, it can be difficult to measure ESG policies across different industries, as no official regulations for standardized ESG reporting currently exist. For example, a financial institution might require different standards for energy efficiency vs. an agricultural company or an actual energy producer.

Finally, some of the existing standards are qualitative and may be prone to subjectivity, which can make the ESG evaluation process difficult to quantify. These can all present challenges when you’re trying to apply ESG principles to your investing strategy.

Having an awareness of some of the limitations around these metrics can help investors use the currently available criteria wisely.

9 Common ESG Metrics

Commonly employed ESG metrics consist of both qualitative and quantitative metrics across all three categories of environmental, social, and governance factors.

3 Common Environmental Metrics

Environmental metrics measure the long-term ecological sustainability of a firm’s actions. These can be related to emissions, finite natural resources, and the environment, among other things.

Many of these metrics can be tracked on an aggregate basis or relative to other operating metrics (per capita, per unit produced, etc.).

•   Emissions: Quantifies how much a firm emits in greenhouse gasses, or whether it’s working to reduce carbon emissions through its operations.

•   Waste: Measures how much waste a company generates or recycles in their operations. Can also reflect a company’s impact on its surrounding ecology: e.g., air or water pollution.

•   Resource Usage: Tracks the efficiency and extent of a firm’s operations when it comes to using energy, water, or other key resources.

3 Common Social Metrics

Social metrics evaluate how a firm’s policies impact its workforce, the community, and society at large. Attempts to quantify these metrics have largely been implemented on a per-occurrence basis, or as a rate over time.

•   Human resources: Evaluates how a company treats its employees, gender pay gaps, diversity, frequency/magnitude of any workplace litigation, and employee turnover.

•   Labor safety: Tracks a firm’s commitment to safe labor practices via metrics like frequency of workplace accidents and lost productivity.

•   Product development and safety: Examines a firm’s product quality and sustainability through metrics like number of recalls, complaints, or even frequency of litigation. Can also be linked to environmental standards when it comes to how product inputs are sourced.

3 Common Governance Metrics

Governance metrics pertain to issues relating to business ethics, mitigation of agency risks, and transparency in reporting. These can be measured in terms of how executives are compensated, board policies, and accounting choices, among others.

•   Ownership structure: Reviews how faithful a firm is to its shareholders when it comes to metrics like the number of independent directors on the board, or how voting rights are distributed between management and shareholders.

•   Executive compensation: Measures executive compensation relative to industry standards or company profitability. Can also be tied to social concerns when measuring how compensation structures vary for different genders/minorities.

•   Financial reporting: Tracks a firm’s accounting policies and how comprehensive and accurate they are. Could involve reviewing a firm’s books for key disclosures or frequency of one-off exceptions.

How Do Firms Report ESG Metrics?

To some degree, how each firm reports its ESG metrics depends on its policies regarding disclosures. But now companies do have some standardization for reporting climate-related risk factors and mitigation efforts.

Keep in mind, the adoption of ESG frameworks can vary widely by firm and disclosure of these metrics is still largely voluntary. Additionally, certain metrics may be difficult to quantify and, in some cases, management, stakeholders, or shareholders may disagree on the impact of certain ESG factors.

As a result, professional money managers sometimes may solicit the assistance of third-party ESG consultants to obtain an independent assessment of how a company actually performs on ESG metrics.

How Can Investors Use ESG Metrics?

Investors want to be discerning when investing in specific firms or funds that offer an ESG approach.

Given the range of ESG frameworks and the inconsistency in how frameworks are applied, investors should be aware that some firms may cherry-pick which ESG metrics they use. Investment funds and ETFs that offer an ESG-based approach may use their own proprietary metrics when deciding how to allocate ESG investments; which may make them difficult to compare.

When using ESG metrics, you’ll want to examine a company’s ESG-related disclosures closely to ensure that there’s consistency in the data being reported. Depending on the metric you’re examining, you may wish to avoid making comparisons across disparate industries and focus on identifying “best-in-class” investments for a single industry.

The Takeaway

Broadly speaking, ESG metrics can offer investors a useful dimension for evaluating certain types of sustainable investment choices. Although a unified set of ESG standards and metrics is a work in progress, there has been a steady push among regulatory bodies to establish ESG reporting requirements, here and worldwide.

As with any investment strategy, investors will want to manage their expectations appropriately and employ ESG metrics as part of a larger toolbox for investment analysis.

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

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Nov
21
2024

Are You Asking Yourself: Are 401(k)s Worth It Anymore?

By | invest, Investing, Preparing for Retirement | Comments Off on Are You Asking Yourself: Are 401(k)s Worth It Anymore?

401(k) plans have been around for decades, and millions of Americans have successfully used them to help with saving for retirement. Named for the section of the tax code that enables them, a 401(k) is an employer-sponsored plan that allows you to withdraw funds directly from your paycheck to save for retirement. Having the money come out directly from your paycheck makes it quite easy to save for retirement.

There are several benefits that come from contributing to a 401(k) plan. You’ll get a tax break for contributing to your account, since contributions made to a traditional 401(k) are made with pre-tax dollars, reducing the gross income you’ll need to report to the IRS that year. Many employers also make matching contributions to their employees’ 401(k) accounts. Still, with so many other ways to save for retirement available now, you might be wondering if 401(k)s are worth it.

Key Points

•   A 401(k) is an employer-sponsored retirement plan allowing tax-advantaged contributions that can be invested and withdrawn in later years.

•   Traditional 401(k)s allow employees to make pre-tax contributions, meaning they reduce taxable income for that year, while Roth 401(k)s allow employees to make after-tax contributions.

•   Employer-matching in 401(k)s can provide additional funds, enhancing retirement savings.

•   401(k)s have higher contribution limits than IRAs but are limited by employer investment options.

•   In comparison with savings accounts, 401(k)s offer higher potential returns but come with penalties for early withdrawal.

How 401(k) Plans Work

A 401(k) is an employer-sponsored plan, which means that you have to be employed by a company that offers one. If your employer does not offer a 401(k) program, in most cases, you can not start one on your own. In that case, you may need to look for other options, and may want to think about opening an IRA.

If you do have a 401(k), you can specify a percentage of your total pay or an amount to be withheld from your paycheck each pay period. Contributions to a traditional 401(k) account are made with pre-tax dollars and are therefore not counted in the gross income you’ll need to report to the IRS (likely lowering your overall tax bill). Instead, you will pay income tax based on the amount of money you withdraw from your account when you reach retirement age. You can also choose how to invest your contributions, based on a list of investment options provided by your employer.

401(k) Matching Explained

Many employers offer 401(k) matching as an additional employee benefit, and employers can set up matching programs in a variety of different ways.

One example might be that a company might offer to match 50% of your contributions, up to a maximum of 6% of your pay. So if you contribute the full 6% of each paycheck to your 401(k) account, your employer will contribute an additional 3%.

Effectively, employer matching allows employees to benefit from “free money” coming from their employer directly into their retirement plans.

Pros and Cons of 401(k)s

401(k)s, like any other investment and savings vehicle, have advantages and disadvantages. Here are some pros and cons of 401(k) accounts.

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Pros:

•   401(k) plans are tax-advantaged, allowing for pre-tax (traditional) or post-tax (Roth) contributions

•   The contribution limits are higher than that of other retirement options (like IRAs)

•   Your employer may offer matching funds

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Cons:

•   Investment options are limited to what is offered by your employer

•   There is a limit to how much you can contribute each year

•   Some investment options may come with fees

401(k) vs Savings Account

If you’re considering where to put your money and deciding between 401(k) retirement savings versus stashing it in a regular savings account, there are a few things to keep in mind.

Money you put into a traditional 401(k) account is intended for retirement, so you may face penalties and an additional tax bill if you take it out before you reach retirement age. However, the investment options available in many 401(k) accounts may allow you to earn higher returns than those available in savings accounts. The money in a savings account would only accrue interest.

Here’s a hypothetical look at how returns may generate at various rates. All figures are for $50,000 invested in a diversified (401)k, assuming a 401(k) was invested entirely in an S&P 500 index fund, and at varying rates of return (compounding continuously, meaning that an investor earns returns on their initial investment, plus their returns, repeatedly) with no additional contributions.

Additionally, in the chart below, the percentage of corresponding rates of return is based on an inflation-adjusted return, and this percentage can be even lower based on time in the market. We’ve also included the rate of return for a hypothetical savings account, which might pay out 0.4% annual interest, for comparison:

Starting amount

 Rate of Return

 Ending amount after 20 years
$50,000 0.4% $54,156
$50,000 3% $90,306
$50,000 5% $132,665
$50,000 7% $193,484
$50,000 10% $336,375

As you can see, even a small increase in your overall rate of return may pay dividends in the long term. There can also be a place in your overall financial plan for both retirement savings and regular savings accounts, but generally, it’s probably a good idea to make sure that any money you are investing for the long term has the highest possible rate of return, given your risk tolerance. Typically, the higher the potential rate of return is for an investment, the higher the potential risk involved.

Compound Interest vs Simple Interest

Depending on how you are investing or saving your money, you may earn interest. And that interest may be calculated as simple interest, or compounded on a particular schedule.

Many investments in the stock market that you might use in a 401(k) account may compound continuously. Other investments like bonds, CDs, or savings accounts may use simple interest or compound interest on other schedules.

Here’s a look at how a $50,000 investment would grow at a 7% interest rate, using either simple interest or interest compounded at various other timeframes:

Starting amount

 APY

 Ending amount after 20 years
$50,000 7%, simple interest $120,000
$50,000 7%, compounded annually $193,484
$50,000 7%, compounded quarterly $200,320
$50,000 7%, compounded monthly $201,936.94
$50,000 7%, compounded continuously $202,760.00

401(k)s vs IRAs

401(k)s and Individual Retirement Accounts (IRAs) are both types of accounts that may give you tax advantages for saving for retirement. Again, a 401(k) is a retirement account sponsored by your employer, while an IRA is something you set up individually.

There are pros and cons with an IRA vs 401(k), so make sure you understand how they both work. That way you can make the best decision for your unique situation.

Perhaps the most stark difference between the two is the amount you can contribute in a year. For 2025, contribution limits are $23,500 in a 401(k) versus $7,000 in an IRA.

Is a 401(k) Right for You?

There are many different types of retirement accounts, and a 401(k) account can be an important part of your retirement plan. Check with your employer to see if they offer a 401(k) account, what investment options are available, and whether they offer any matching funds. Then consider how that fits in with your other retirement options to decide if a 401(k) is right for you.

The Takeaway

401(k) accounts are employer-sponsored retirement accounts that may be available as an employee benefit. When you contribute to a traditional 401(k) plan, the amount you contribute is not counted in the total gross income you’ll need to report that year. This may allow you to lower your overall tax liability. Additionally, many employers offer a 401(k) matching program, where they provide additional funds into your account as an employee benefit.

It can be a smart financial decision to use one of these accounts to make sure you have enough money put aside for your retirement.

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).

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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.

🛈 While SoFi does not offer 401(k) plans at this time, we do offer a range of Individual Retirement Accounts (IRAs).

FAQ

Is a 401(k) worth it anymore?

There are many different kinds of retirement plans, and each come with their own pros and cons. A 401(k) is a valuable tool that may be a good choice for many Americans. Compare the benefits of a 401(k) with the benefits that come with other types of retirement plans to make the best choice for your specific situation.

Is it better to have a 401(k), or just save money?

It can make sense to keep some of your money in safe investments like cash or money market accounts. Having a few months’ worth of expenses in cash or cash equivalents can serve as a useful emergency fund. However, you likely won’t want to keep too much of your money in these types of investments, since they generally offer lower returns than investments that might be available in a 401(k) account.

What are the main disadvantages of a 401(k)?

While a 401(k) account has a lot of benefits and advantages, there are a few disadvantages. First is that you can only open a 401(k) account if your employer offers one, and your employer controls what investments are available. You also are limited in how much money you can contribute to a 401(k) account each year.

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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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $50 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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Nov
21
2024

What Are Real Assets? Understanding Tangible Investments

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Are Real Assets? Understanding Tangible Investments

Real assets are tangible, physical assets that can be exchanged for cash, owing to their use in manufacturing and consumer goods, and other purposes. Real assets, as a category, may include precious metals, commodities, real estate, infrastructure, and more.

Typically, real assets are considered a type of alternative investment, owing to their low correlation with traditional asset classes such as stocks and bonds. As such, real assets may provide some portfolio diversification. But real assets are also susceptible to specific risks pertaining to each sector.

Key Points

•   Real assets take their name from the fact that they are tangible, physical assets, as opposed to financial assets (like stocks and bonds) or intangible assets (like a brand).

•   Real assets have a cash value, and can generally be traded for cash. They typically include real estate, land, commodities, infrastructure, precious metals, and more.

•   It’s possible to invest in real assets directly (by owning the physical goods, resources, or structures) or indirectly (via mutual or exchange-traded funds).

•   They are considered a type of alternative asset, because most real assets are not correlated with conventional asset classes, and thus may provide some portfolio diversification, and potential returns.

•   Real assets come with specific risk factors that pertain to each type of tangible asset, in addition to the risks that come with most alts: e.g., illiquidity, lack of transparency, less regulation.

Defining Real Assets

What is an asset? On the whole, assets can be considered tangible (e.g., land), intangible (e.g. a brand or trademark), or financial (e.g. shares of stock). While real assets have a cash value and can be exchanged for cash, they are not considered a type of financial asset because they are not securities.

Also, real assets are considered a type of alternative investment. Alts tend not to move in sync with, i.e., they’re not typically correlated with conventional assets like stocks and bonds. But like all types of alternative investments, real assets come with specific risks, including lack of liquidity, transparency, and less regulation in some cases.

Characteristics of Real Assets

The primary characteristic of real assets is that they are physical. They can be objects, goods, resources, or structures that have a specific cash value and can be traded for cash in certain markets.

However, real assets are considered non-securities, because they do not derive their value from a contractual ownership arrangement like stocks, bonds, exchange-traded funds (ETFs), options, and more.

Real Assets vs. Financial Assets

Financial assets fall into the category of securities; generally speaking there are debt securities (like bonds) and equity securities (stocks), as well as derivatives (options and futures). Real assets are non-securities.

•   Securities are financial instruments that can be traded on an exchange, with an expectation of making a profit. More important, securities are fungible, meaning the value of one unit is interchangeable with another of the same type of unit: e.g., a share of stock in Company A is the same as another share of that stock.

•   Real assets are physical goods, and in many cases they are not fungible: one type of property or infrastructure is not interchangeable with another. That said, commodities are a type of real asset, and are generally fungible: one barrel of crude oil is the same as the next.

💡 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.

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

Types of Real Assets

As noted, real assets consist of physical, tangible goods and resources. But while one stock generally behaves the same as another stock, each type of real asset has to be considered individually to understand its benefits and risks.

Real Estate

Real estate includes a wide range of property types and investment choices: e.g., commercial real estate, industrial real estate, healthcare facilities, rental properties, and more. While it’s possible to invest directly in real estate, it’s also possible to buy into a type of pooled investment like real estate investment trusts, or REITs.

Real estate may offer passive income (i.e., from rent), or gains from the sale of properties, but real estate investments come with potential risks: local laws and regulations can change; property can be damaged by extreme weather; interest rate risk can impact property values.

Commodities

Commodities include numerous raw materials, including agricultural products like corn and coffee; precious metals such as copper or nickel; energy sources (including renewables), and more. Commodity trading typically involves futures contracts, but it’s possible to invest in commodities via index funds and mutual funds, or ETFs.

These assets, owing to steady demand, may offer the potential for profits. They may help hedge against inflation. That said, the value of commodities can be impacted by weather, supply chain breakdowns, market fluctuations, and other factors, which makes them risky. Commodities can lose value for a number of reasons, and direct investments in commodities lack certain investor protections offered to other securities.

Infrastructure

Infrastructure assets are durable structures that provide public services, utilities, and the like to enable the smooth functioning of society. Infrastructure includes durable structures like bridges, roads, tunnels, and schools, as well as energy infrastructure like power plants. Infrastructure is typically stationary, has a long period of use, and generates predictable cash flow (via utility payments, tolls, and so on).

While it can be difficult for individual investors to invest directly in infrastructure, it’s possible to invest in municipal bonds, or funds that offer exposure to companies involved in infrastructure.

Investing in infrastructure comes with specific risks investors should consider, including interest-rate risk (which can affect access to loans, and interest on bonds), regulatory issues, climate and weather challenges, and more.

Precious Metals

Generally speaking, precious metals consist of a group of natural assets, including gold, silver, platinum, iridium, and others. Investing in precious metals may be appealing as many metals tend to retain value owing to their scarcity, their critical role in manufacturing and technology, and because some (like gold and silver) are themselves used as a store of value.

For many individual investors, it may not be obvious how to invest in gold, silver, or other metals. Though it’s possible to buy bullion or bars directly, it’s also possible to invest in ETFs that are invested in gold or precious metals, or in stocks of mining companies, and the like.

The risks of investing in precious metals include potential changes in demand, technological innovations that may require more or less of a given metal, supply chain issues, worker safety, and more.

Recommended: Why Invest in Alternative Investments?

Benefits and Risks of Investing in Real Assets

In addition to the advantages and disadvantages of different types of real assets noted above, there are a few other factors investors should consider.

Inflation Hedge

Inflation essentially decreases a dollar’s purchasing power, and a hedge against inflation can offer a potential upside.

In some cases real assets can provide a hedge against inflation. For example, assets that benefit from steady demand, like commodities, may help offset inflation’s bite. Also, land or real estate may rise in value even when the purchasing power of the dollar is declining, which may offer a potential inflation hedge.

That said, it’s impossible to predict for certain which asset classes will help to mitigate inflation, and there are no guarantees.

Portfolio Diversification

Another factor investors should consider is the potential benefit from diversification, which is the practice of investing in different asset classes to help mitigate risk. Diversifying your assets may help offset some investment risk.

Diversification is complex, however, and involves more than just including alternative investments along with equities and fixed income. Investors need to consider how certain investments, like tangible assets, might provide some sense of equilibrium in their portfolio if conventional strategies are down.

Potential for Steady Income

As discussed, some types of real assets, like infrastructure investments, can become a source of steady income. For example, roads and bridges and public transportation require a high initial investment, but then they may provide a predictable revenue stream from tolls and fares and so forth.

The same is true for some types of municipal power plants and other energy sources that supply utilities, and derive steady payments over time.

Liquidity Concerns

Taken as a whole, however, real assets are quite similar to other types of alternative investments in that they lack the liquidity and easy access to cash that most conventional investments provide.

Liquidity risk is something all investors must take into account when choosing investments, as the inability to enter and exit positions with ease, and as needed, can impact one’s goals.

Market Volatility

All markets fluctuate to some degree, but some markets are more volatile than others. When it comes to deciding whether to invest in real assets, investors must do their due diligence because the market for each type of tangible asset is vastly different from another.

Just as understanding volatility in the stock market is key to making smart choices about equities, it’s essential for investors to consider the real estate market for a property they might invest in, or the futures market for investing in commodities, and so forth.

Incorporating Real Assets into Your Investment Strategy

Would investing in real assets make sense in your portfolio? There are a few factors to consider.

Asset Allocation

Asset allocation is basically the mix of stocks, bonds, and other investments in your portfolio. While a standard allocation usually includes these conventional asset classes, some investors also include other choices such as commodities, real estate, private equity, and more.

Deciding on the right allocation for your portfolio means thinking about your goals, time horizon, and how much risk you’re willing to take on. Given that real assets are often higher-risk investments, but aren’t correlated with traditional assets, investors may want to consider the advantages and disadvantages before deciding on an asset allocation that makes sense.

Direct vs. Indirect Investment Methods

Owing to the physical nature of real assets, it’s possible to invest in many real assets directly (e.g., owning rental property or gold bullion) as well as investing indirectly in real assets.

For example, commodities are typically traded via futures contracts. A commodity futures contract is an agreement to either buy or sell a specified quantity of that commodity for a specific price at some point in the future. While it’s possible to end up with actual physical commodities this way (e.g., bushels of corn or barrels of oil), for the most part futures are an indirect way to gain access to the commodities markets.

REITs and ETFs

Real estate investment trusts (REITs) and ETFs are two other common instruments for investing indirectly in real assets.

•   A REIT is a trust that owns income-generating properties, so that investors are spared the hassle of direct ownership. A REIT may own warehouses, retail stores, storage units, hotels, and more. REITs can focus on a geographic area or specific market (like healthcare). A REIT is required to distribute 90% of its income to shareholders, so owning shares of a REIT may provide passive income, as well.

•   ETFs are another way to invest indirectly in certain types of real assets, because these funds invest in companies that either produce, process, or in some way support a given type of real assets.

For example, there are ETFs that invest in mining, equipment, or technology companies in the precious metals and commodities sectors. Likewise, there are ETFs that invest in companies that support infrastructure projects.

Investors who are interested in exploring real assets are not limited to direct investment strategies; there are other options to consider.

The Takeaway

Real assets are tangible assets like real estate, infrastructure, or commodities, and are considered a type of alternative investment. Alts are not typically correlated with traditional assets like stocks and bonds, and thus may provide portfolio diversification that can help mitigate some risk factors. But like all types of alts, real assets come with specific risks, including lack of liquidity and lack of transparency.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

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

FAQ

How do real assets perform during economic downturns?

Although some alternative investments may not be affected by a downturn, the markets for specific assets can react differently, depending on the economic conditions. For example, if stocks are down, real estate may not be impacted at all. When interest rates fluctuate, the cost of loans can impact real estate values and infrastructure projects, but not necessarily commodities. It’s incumbent on each investor to consider the pros and cons of any investment before putting money into it.

What percentage of a portfolio should be in real assets?

Deciding on the percentage any asset class should have in your portfolio is a personal calculation, taking into account your goals, time horizon, and stomach for risk. It’s especially important to consider that real assets are illiquid, a risk consideration that can impact whether you want to invest in real assets at all.

Are real assets suitable for all types of investors?

No. Real assets are better suited to experienced investors, who may have the skills to navigate the complexities of real asset markets, pricing, risks, and so forth.

Photo credit: iStock/Edwin Tan

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.


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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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.
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.


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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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21
2024
What Is Extrinsic Value?

What Is Extrinsic Value?

By | Growing Wealth, invest, Investing | Comments Off on What Is Extrinsic Value?

Editor's Note: Options are not suitable for all investors. 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. Please see the Characteristics and Risks of Standardized Options.

What Is Extrinsic Value?

Extrinsic value is the difference between an option’s market price, known as the premium, and its intrinsic value.

Extrinsic value reflects factors beyond the underlying asset’s price that can influence the overall worth of an option. This value fluctuates based on the time to expiration and the volatility of the underlying asset.

Key Points

•   Extrinsic value is the difference between an option’s market price and intrinsic value, influenced by time and volatility.

•   Longer contracts and higher implied volatility increase extrinsic value.

•   Interest rates and dividends affect extrinsic value differently for call and put options.

•   Extrinsic value cannot be negative; it represents the portion of an option’s price that exceeds its intrinsic value.

•   At-the-money options have the most extrinsic value due to sensitivity to time and volatility changes.

Understanding Intrinsic and Extrinsic Value

The intrinsic value of an option is the difference between an option’s strike price and the current price of the underlying asset, which can be calculated only when the underlying asset is in the money. An out-of-the-money option has no intrinsic value.

Remember, an option that is “in the money” would be profitable for the owner if exercised today, while an option that is “out of the money” would not.

An out-of-the-money option may present an investment opportunity for some, however, because of its potential to become in-the-money at expiration.

Extrinsic value equals the price of the option minus the intrinsic value. As an option’s expiration approaches, extrinsic value usually diminishes since there is less time for the price of the underlying asset to potentially move in a way that benefits the option holder (also known as time decay).

For example, an option that has two weeks before expiry typically has a higher extrinsic value than one that’s one week away. This does not imply it has more intrinsic value, however. It just means there is more time for it to move up or down in price.

Out-of-the-money option premiums consist entirely of extrinsic value, while in-the-money options have both intrinsic value and extrinsic value. Options that trade at-the-money might have a substantial proportion of extrinsic value if there is a long time until expiration and if volatility is high.


💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

How Extrinsic Value Works

Simply put, the more time until expiration and the more a share price can fluctuate, the greater an option’s extrinsic value. Extrinsic value demonstrates the time that remains for potential price movement, and the uncertainty in that movement. There are a few different factors that could influence extrinsic value, and understanding them is crucial for evaluating an option’s pricing.

Factors that Affect Extrinsic Value

Two key factors affect an option’s extrinsic value: contract length and implied volatility. In general, the longer the contract, the greater the extrinsic value of an option. That’s because the more time allowed until expiration, the more a stock price might move in favor of the option’s holder. It’s possible, however, that the price moves in the opposite direction; if the holder keeps the option in the hope that the price will rebound, they may lose some or all of their investment.

The second factor that determines extrinsic value is implied volatility. Implied volatility measures the expected magnitude of how much a stock might move over a specific period. Volatility impacts an option’s extrinsic value, and its sensitivity is represented by the Greek letter vega.

Recommended: Understanding the Greeks in Options Trading

1. Length of Contract

An option contract generally has less value the closer it is to expiration. The logic is that there is less time for the underlying security to move in the direction of the option holder’s benefit. As the time to expiration shortens, the extrinsic value decreases, all else equal.

To manage this risk, many investors use the options trading strategy of buying options with varying contract lengths. As opposed to standard option contracts, a trader might choose to buy or sell weekly options, which usually feature shorter contract lengths.

On the opposite side of the spectrum, Long-Term Equity Anticipation Securities (LEAPS) sometimes have contract lengths that measure in years. Extrinsic value could be a large piece of the premium of a LEAPS option.

Some traders will also use a bull call spread, in order to reduce the impact of time decay (and the loss of extrinsic value) on their options.

Recommended: A Beginner’s Guide to Options Trading

2. Implied Volatility

Implied volatility measures how much analysts expect an asset’s price to move during a set period. In general, higher implied volatility means more expensive options, due to higher extrinsic value. That’s because there is a greater chance a stock price could significantly move in the favor of the owner by expiration (or out of favor if the markets shift in the opposite direction). High volatility gives an out-of-the-money option holder more hope that their position will go in-the-money.

So, if implied volatility rises from 20% to 50%, for example, an option holder may benefit from higher extrinsic value (all other variables held constant). On the flip side, an out-of-the-money option on a stock with extremely low implied volatility may have a lower chance of ever turning in-the-money.

3. Others Factors

There is more than just the length of the contract and implied volatility that affect the premium of an option, however.

•   Time decay: The time decay, or the rate at which time decreases an option’s value, can greatly impact the premium of near-the-money options, this is known as theta. Time decay works to the benefit of the option seller, also known as the writer.

•   Interest rates: Even changes in interest rates, or rho, impact an option’s value. A higher risk-free interest rate pushes up call options’ extrinsic value higher, while put options have a negative correlation to interest rates.

•   Dividends: A stock’s dividend will decrease the extrinsic value of its call options while increasing the extrinsic value of its put options.

•   Delta: An option’s delta is the sensitivity between an option price and its underlying security. In general, the lower an option’s delta, the less likely it is to be in-the-money, meaning it likely has higher extrinsic value. Options with higher delta are in-the-money and may have more intrinsic value.



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

Extrinsic Value Example

Let’s say a trader bought a call option through their brokerage account on shares of XYZ stock. The premium paid is $10 and the underlying stock price is $100. The strike price is $110 with an expiration date in three months. Also assume there is a company earnings report due out in the next month.

Since the share price is below the call’s strike, the option is out-of-the-money. The option has no intrinsic value because it is out-of-the-money. Thus, the entire $10 option premium represents extrinsic value, or time value.

As expiration draws nearer, the time value declines, also known as time decay. A trader who takes the long position with a call option hopes the underlying asset appreciates by expiration.

An increase in volatility, perhaps due to the earnings report or another catalyst, might push the option’s price higher. Let’s assume the stock has risen to $120 per share following strong quarterly earnings results, and the call option trades at $11 immediately before expiration.

The call option’s intrinsic value is now $10, but the extrinsic value has declined to just $1, in this scenario, since there is little time to expiration and the earnings date volatility-driver has come and gone. In this case, the trader can sell the call for a small profit or they might choose to exercise the option.

Note that if the stock price had instead fallen below the strike price of $110, the call option would have expired worthless and the trader would have lost the premium they paid for the option.

Extrinsic vs Intrinsic Value

Extrinsic value reflects the length of the contract plus implied volatility, while intrinsic value is the difference between the price of the stock and the option’s strike when the option is in the money.

Extrinsic Value Factors (Call Option)

Intrinsic Value Factor (Call Option)

Length of Contract Stock Price Minus Strike Price
Implied Volatility

Extrinsic Value and Options: Calls vs Puts

Both call options and put options can have extrinsic value.

Calls

Extrinsic value for call options can be high. Consider that a stock price has no upper limit, so call options have infinite potential extrinsic value. The more time until expiration and the greater the implied volatility, the more extrinsic value a call option will have.

Puts

Put options have a lower potential value since a stock price can only drop to zero. Thus, there is a limit to how much a put option can be worth, which is the difference between the strike price and zero. Out-of-the-money puts, when the stock price is above the strike, feature a premium entirely of extrinsic value.

Recommended: Understanding the Greeks in Options Trading

The Takeaway

Understanding the fundamentals of intrinsic and extrinsic value is important for options traders. Although intrinsic value is a somewhat simple calculation, extrinsic value takes a few more factors into consideration — specifically time and volatility of the underlying asset. The more time until the contract expires, and the more a share price can fluctuate, the greater an option’s extrinsic value.

[product_push_invest_options]

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

Which options have the most extrinsic value?

At-the-money options typically have the most extrinsic value since their price is closest to the strike price, thus being most sensitive to changes in time and volatility.

Can an option’s extrinsic value be negative?

No. Extrinsic value represents the portion of an option’s price beyond its intrinsic value, so it can never be less than zero. If an option’s market price is lower than its intrinsic value, it can only be as low as zero.

Photo credit: iStock/alvarez

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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.
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.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Claw Promotion: Customer must fund their Active Invest account with at least $50 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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Nov
19
2024
woman on phone at desk

Alternative Investments: Definition, Examples, Strategies

By | Growing Wealth, invest, Investing | Comments Off on Alternative Investments: Definition, Examples, Strategies

While most investors are familiar with stocks, bonds, and cash, there is a world of investment opportunities beyond these assets.

Alternative investments are those outside of traditional assets. While they can be higher risk, alternatives can offer various potential upsides for investors, such as diversifying an existing investment portfolio, higher returns compared to stocks and bonds, and the opportunity to earn passive income.

Key Points

• Alternative investments include assets other than stocks, bonds, and cash, such as collectibles, commodities, derivatives, real estate, private equity, venture capital, hedge funds, and more.

• Alternative investments may provide portfolio diversification, as they often have a low correlation with traditional asset classes.

• Alternative investments have the potential to generate higher risk-adjusted returns compared with traditional assets, though this also comes with higher risk.

• Alternative investments tend to be illiquid, not as transparent as other financial assets, and may include the risk of total loss.

• You can invest in alternative investments through mutual funds, ETFs, interval funds, REITs, MLPs, or by working with an experienced asset manager.

What Are Alternative Investments?

Alternative investments — commonly known as alts — are those that are different from conventional investment categories such as stocks, bonds, and cash. Alts include a wide variety of securities as well as tangible assets such as commodities, foreign currencies, real estate, art and collectibles, venture capital, derivative contracts, and more.

Alts typically have a lower correlation with traditional asset classes, meaning they tend to move independently of them, and thus they may provide investment portfolio diversification. They also have the potential to generate higher returns when compared to stocks and bonds, and some are structured to provide passive income to investors. But alts typically include higher-risk assets and strategies, which can be illiquid and harder to track, owing to a lack of transparency.

Alts used to be accessible mainly to high net-worth and accredited investors, but now they’re available to a range of investors, thanks to the emergence of vehicles such as mutual funds and ETFs that include various alts and strategies.

The lack of liquidity for most alts means that determining the fair market value of these assets can be quite challenging. Often there is little by way of public data available regarding price changes or asset appreciation or depreciation, making it difficult to assess historical performance.

💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts 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.

Types of Alternative Investments

The following list encompasses some common types of alternative investments and alternative strategies available to investors today.

1. Real Estate

•   Summary: You can invest in real estate by owning rental property, investing in commercial real estate, industrial real estate, healthcare facilities, and more. Investors can also buy into Real Estate Investment Trusts, or REITs.

•   Pros and cons: Although real estate tends to hold its value over time, there are no guarantees. Different properties can be vulnerable to a host of factors including business trends, land values, interest rate risk, and more.

Recommended: How to Invest in Real Estate: 7 Ways for Beginners

2. Commodities

•   Summary: Commodities are raw materials that include agricultural products (e.g. grain, meat), precious metals such as gold, silver, copper, energy (including renewables), and more. Generally, investors participate in commodity trading using futures contracts, index funds, mutual funds, or ETFs.

•   Pros and cons: Some investors consider commodities a good hedge against inflation and they have the potential to deliver a profit. However, commodities can suffer from any number of unexpected risk factors, from weather conditions to supply chain breakdowns and more.

Recommended: How to Invest in Commodities

3. Private Equity

•   Summary: Private equity firms invest capital in companies that aren’t publicly traded, often with the aim of taking over the company. Because PE is a high-stakes endeavor, these opportunities are generally available to high net-worth and accredited investors. Now, however, retail investors can gain exposure to private funds through vehicles such as interval funds.

•   Pros and cons: Private equity is considered a high-risk investment, but if a private company goes public or gets acquired, these investments may perform well. The risk with private equity investments is that these are often focused on distressed companies, with a complex track record, and sometimes startups (see Venture Capital below).

Recommended: How to Invest in Private Equity

4. Venture Capital

•   Summary: VC investing is a way of putting money into startups with the hope of later gains, though there is no guarantee of a return. Investors can buy a slice of startup or private companies, through equity crowdfunding platforms (which differ from traditional crowdfunding in that investors own equity in the company) and interval funds.

•   Pros and cons: Venture capital investing is considered a subset of Private Equity, as noted above. It can be risky because if the startup fails, investors may lose all of their money. On the other hand, if a startup does well, investors may see a significant profit.

Learn more: What Is Venture Capital and How Does It Work?

5. Private Credit

•   Summary: Private credit involves direct loans made to companies from non-bank entities. Private credit can be a more expensive way to borrow, but it can be faster for the companies needing capital, and for investors it offers the potential for steady interest payments.

•   Pros and cons: Private credit funds tend to see greater inflows when the stock market is underperforming, and they usually pay higher rates than conventional fixed income instruments. The risk here is that most PC funds offer only quarterly redemptions — so they’re quite illiquid — and they can be vulnerable to defaults.

Learn more: Private Credit: Types and Investing Benefits

6. Art & Collectibles

•   Summary: Works or art and other types of collectibles (e.g., wine, jewelry, antiques, cars, rare books) can personally appeal to investors, and may grow in value over time. It’s also possible to invest in fractional shares of art, or in shares of an art-focused fund.

•   Pros and cons: Investing in art or collectibles may provide a hedge against inflation or other market factors. That said, the price of upkeep, insurance, and maintenance can be considerable. And while some pieces may gain value over time, art and collectibles can also be subject to changing trends and tastes. Fraud is another risk to consider.

7. Hedge Funds

•   Summary: Hedge funds offer investors access to alternative investing strategies, like arbitrage, leveraged trades, short-selling, and more. Hedge funds aren’t as heavily regulated as other types of funds, so they’re able to make riskier investments and lean into aggressive strategies, with the goal of delivering outsized returns.

•   Pros and cons: While hedge fund managers sometimes deliver a significant profit, they charge high fees and investment minimums that often put them beyond the reach of mainstreet investors. Today, investors may be able to access mutual funds, ETFs, funds of funds, or other vehicles that employ similar alternative strategies.

8. Farmland/Timberland

•   Summary: Like many types of real estate, farmland and timberland tend to hold their value over time, as long as they remain productive. This type of property can be similar to commodities in that there is potential profit in the products that come from the land (e.g. produce and timber).

•   Pros and cons: Owners of farmland can lease out the land to earn income, which can be profitable for investors. The potential downside of investing in farmland and timberland are the environmental and weather-related risks that can impact both the value of the land and its productivity.

9. Infrastructure

•   Summary: Infrastructure refers to the physical structures that economies depend on: roads and highways, bridges and tunnels, energy pipelines, and more. Municipal bonds are one way to invest in infrastructure, as are some types of REITs (real estate investment trusts).

•   Pros and cons: As a non-cyclical type of asset, infrastructure investments may offer the benefit of less exposure to market risk factors, steady cash flows, and low variable costs. The risks of infrastructure investments include political and environmental factors that can impact or delay the execution of a project.

10. Foreign Currencies

•   Summary: Foreign currencies are an example of an alternative investment that can be highly liquid, and thus easier to trade.

•   Pros and cons: Currency trading is known for its volatility, and currency traders often make leveraged trades, assuming a high degree of risk. Retail investors may find it potentially less risky to invest via mutual funds, ETFs, foreign bond funds, and even certain types of CDs (certificates of deposit), although the underlying volatility of most currencies will influence the performance of these investments as well.



💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.

Advantages and Disadvantages of Alternative Investments

In sum, alternative investments are certainly worth considering given their potential advantages, but it’s important to keep in mind the possible disadvantages to make the best choices in light of your own goals and risk tolerance.

Advantages

•   May offer the potential for higher risk-adjusted returns.

•   Are typically not correlated with traditional stock and bond markets, so they may help diversify a portfolio and mitigate risk.

•   May have the potential to deliver passive income.

•   Some alts may hedge against inflation or interest rate fluctuations.

•   May appeal to an individual’s personal interests: e.g., art, wine, memorabilia.

Disadvantages

•   Are often higher risk, or can be subject to greater volatility.

•   Can be less liquid than traditional investments due to limited availability of buyers and lack of a convenient market.

•   Often limited to high net-worth and accredited investors.

•   May have higher minimum investment requirements and higher upfront fees.

•   May have less available public data and transparency about performance, making it difficult to determine a financial asset’s value.

Recommended: Why Invest in Alternative Investments?

How to Invest in Alternative Investments

As mentioned above, alternative investments used to be limited to institutional investors and high net-worth investors, but they’re now available to average investors through mutual funds, ETFs, and sometimes even through companies’ IRAs.

If you’re thinking about adding alternative investments to your portfolio, finding the right brokerage and/or asset manager can help you incorporate alts into your portfolio in the way that makes sense for your long-term plan. SoFi, for example, is working with knowledgeable asset fund managers in the alts space to provide access to mutual funds across a variety of categories.

Once you’ve identified the types of alternative investments that would suit your goals, your risk tolerance, and your plan (e.g., you might prefer commodities to owning art), you can look for the funds that would help you buy into these alternative asset classes.

Here are some of the more traditional methods to invest in alternatives:





ETFs

An exchange-traded fund, or ETF, is an investment vehicle that enables investors to buy a group of stocks, bonds, commodities, or other securities in one bundle, thus promoting investment diversification and efficiency. They’re widely available, usually through major investment fund companies.

Interval Funds

These closed-end funds are not traded on the secondary market and have limitations on redemptions (among other risks and restrictions). But because the funds are highly illiquid and have infrequent redemptions, fund managers may use alternative investments to pursue higher yields.

MLPs

A master limited partnership, or MLP, is a business partnership that’s publicly traded on an exchange. While an MLP may sound like a company, these partnerships have a different type of structure and are restricted to natural resources and energy-related products and sometimes real estate.

MLPs can provide the liquidity of stocks, but the tax treatment can be complex — and they are higher risk than regular equities.

Mutual Funds

A mutual fund is an investment vehicle that pools money from many investors in order to invest in different securities. Mutual funds may hold any combination of stocks, bonds, money market instruments, or cash and cash equivalents.

They may also include alternative investments, such as real estate, commodities, or investments in precious metals.

REITs

A real estate investment trust, or REIT, is a way of investing in shares of different types of real estate within a single fund. REITs invest in companies that own, operate, or finance a wide variety of real estate types.

Things to Consider When Investing in Alts

Alternative investments are complex, and while the risk may be worth the potential reward for some investors, there are some additional caveats to bear in mind about these assets.

How Are Alternative Investments Taxed?

Unlike conventional asset classes, which are typically subject to capital gains tax or ordinary income tax, different alts can receive very different tax treatments, even when investing in these assets via a mutual fund or ETF. When investing in alts, it’s wise to involve a professional to help address the tax-planning side of the equation.

What Role Should Alts Play in Your Portfolio?

Remember, because alts don’t generally move in sync with traditional asset classes, they may offset certain risk factors. And while alts come with risks of their own, including volatility and lack of transparency, within the context of your portfolio as a whole, alts, and funds that invest in alts, may enhance returns. Some alts can provide passive income as well as gains.

It’s important to know, however, that alternative investments are higher risk, tend to be more illiquid, and less transparent. As such, alts should typically only be one part of your portfolio to complement other assets. Some advisors, for example, recommend up to a 10% allocation for alternative investments, though this number can vary.

The Takeaway

Alternative investments have the potential for high returns and may offer portfolio diversification. The scope and variety of these investments means investors can look for one (or more) that suits their investing style and financial goals. Unlike more conventional investments, alts tend to be higher risk, more expensive, and subject to complex tax treatment.

It’s important to research and do due diligence on any alternative investment option in order to make the best purchasing decisions and reduce risk. While some alternative investments are less accessible, others can be purchased through vehicles such as mutual funds and ETFs.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

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

FAQ

Are ETFs considered alternative investments?

Generally no. For the most part, exchange-traded funds (ETFs) are passive investments — meaning they track an index — and typically that index is for a conventional asset class like stocks or bonds. That said, some ETFs track niche parts of the market, including certain types of alternative strategies, including options, long-short strategies, managed futures, real estate investment trusts (REITs), and more.

Are alternative investments worth it?

For some investors, choosing to add alts to their portfolio might be worth it because alternative assets can add diversification (which can help manage risk), and alts may enhance returns over time. But alts also come with their own set of risk factors, including the fact that some alternative assets are illiquid, and are not regulated like other financial products.

How do alternative investment funds work?

Alternative investment funds work in a range of ways. A mutual fund focused on alternative strategies, like derivatives, is likely to be actively managed and employ techniques like leverage or short selling. Before investing in an alternative fund, it’s wise to make sure you understand the underlying strategy, assets, and fees.

What are the key characteristics of alternative investments?

Alternative investments may offer portfolio diversification with low correlation to traditional assets, potentially higher returns, and may provide protection against inflation or interest rate fluctuations. However, they can be illiquid, may have redemption restrictions, and determining their real-world value can be challenging due to limited transparency and public data.


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.

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.
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For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.


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.


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

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

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