Mar
24
2025
What Is a Financial Instrument? Types & Asset Classes Explained

What Is a Financial Instrument? Types & Asset Classes Explained

By | Growing Wealth, invest, Investing | Comments Off on What Is a Financial Instrument? Types & Asset Classes Explained

A financial instrument is simply a contract between entities that represents the exchange of money for a certain asset. Financial instruments include most types of investments: cash, stocks, bonds, mutual funds, exchange-traded funds (ETFs), certificates of deposit (CDs), loans, derivatives, and more.

Financial instruments facilitate the movement of capital through the markets and the broader economic system. While this may take different forms, the flow of capital remains a central feature.

What Is a Financial Instrument?

Generally Accepted Accounting Principles (GAAP) defines a financial instrument as cash; evidence of an ownership interest in a company or other entity; or a contract. A financial instrument confers either a right or an obligation to the holder of the instrument, and is an asset that can be created, modified, traded, or settled.

Investors can trade financial instruments on a public exchange. The New York Stock Exchange (NYSE) is an example of a spot market in which investors can trade equity instruments for immediate delivery.


💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

Financial Instrument vs Security

A security is a type of financial instrument with a fluctuating monetary value that carries a certain amount of risk for the individual or entity that holds it. Investors can trade securities through a public exchange or over-the-counter market.

The federal government regulates securities and the securities industry under a series of laws, including the Securities Act of 1933, the Securities Exchange Act of 1934, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

All securities are financial instruments but not all financial instruments are securities.

Like financial instruments, securities fall into different groups or categories. The four types of securities include:

•   Equities. Equities represent an ownership interest in a company. Stocks and mutual funds are examples of equity securities.

•   Debt. Debt refers to money lent by investors to corporate or government entities. Corporate and municipal bonds are two examples of debt securities.

•   Derivatives. Derivatives are financial contracts whose value is tied to an underlying asset. Futures and stock options are derivative instruments.

•   Hybrid. Hybrid securities combine aspects of debt and equity. Convertible bonds are a type of hybrid instrument.

Recommended: Bonds vs. Stocks: Understanding the Difference

Types of Financial Instruments

Financial instruments are not all alike. There are different types of financial instruments in different asset classes. Certain financial instruments are more complex in nature than others, meaning they may require more knowledge or expertise to handle or trade.

1. Cash Instruments

Cash instruments are financial instruments whose value fluctuates based on changing market conditions. Cash instruments can be securities traded on an exchange, such as stocks, or other types of financial contracts.

For example, a certificate of deposit account (CD) is a type of cash instrument. Loans also fall under the cash instrument heading as they represent an agreement or contract between two parties where money is exchanged.

2. Derivative Instruments

Derivative instruments or derivatives draw their value from an underlying asset, and fluctuate based on the changing value of the underlying security or benchmark.

As mentioned, options are a type of derivative instrument, as are futures contracts, forwards, and swaps.

3. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments associated with international markets. For example, in forex trading investors trade currencies from different currencies through global exchanges.

Asset Classes of Financial Instruments

Financial instruments can also be broken down by asset class.

4. Debt-Based Financial Instruments

Companies use debt-based financial instruments as a means of raising capital. For example, say a municipal government wants to launch a road improvement project but lacks the funding to do so. They may issue one or more municipal bonds to raise the money they need.

Investors buy these bonds, contributing the capital needed for the road project. The municipal government then pays the investors back their principal at a later date, along with interest.

5. Equity-Based Financial Instruments

Equity-based financial instruments convey some form of ownership of an entity. If you buy 100 shares of stock in XYZ company, for example, you’re purchasing an equity-based instrument.

Equity-based instruments can help companies raise capital, but the company does not have to pay anything back to investors. Instead, investors may receive dividends from the stock shares they own, or realize profits if they’re able to sell those shares for a capital gain.

Are Commodities Financial Instruments?

Commodities such as oil or gas, precious metals, agricultural products and other raw materials are not considered financial instruments. A commodity itself, such as pork or copper, doesn’t direct the flow of capital.

That said, there are certain instruments whereby commodities are traded, including stocks, exchange-traded funds, and futures contracts.

A futures contract represents an agreement to buy or sell a certain commodity at a specific price at a future date. So, for example, an orange grower might sell a futures contract agreeing to sell a certain amount of their crop for a set price. An orange juice company could then buy a contract to purchase oranges at X price.

For the everyday investor, futures trading in commodities typically doesn’t mean you plan to take delivery of two tons of coffee beans or 4,000 bushels of corn. Instead, you buy a futures contract with the intention of selling it before it expires.


💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

Uses of Financial Instruments

Investors and businesses may use financial instrument for the following purposes:

1. As a Means of Payment

You already use financial instruments in your everyday life. When you write a check to pay a bill or use cash to buy groceries, you’re exchanging a financial instrument for goods and services.

Likewise, business entities may charge purchases to a business credit card. They’re borrowing money from the credit card company and paying it back at a later date, often with interest.

2. Risk Transfer

Investors use financial instruments to transfer risk when trading options and other derivative instruments, such as interest rate swaps. With options, for example, an investor has the option to buy or sell an underlying asset at a specified price on or before a predetermined date. A contract exists between the individual who writes the option and the individual who buys it. This type of financial instrument allows an investor to speculate about which way prices for a particular security may move in the future.

3. To Store Value

Businesses often use financial instruments in this way. For example, say you default on a credit card balance. Your credit card company can write off the amount as a bad debt and sell it to a debt collector. Meanwhile, businesses with outstanding invoices they’re awaiting payment on can use factoring or accounts receivables financing to borrow against their value.

4. To Raise Capital

Companies may issue stocks or bonds in order to get access to capital that they can invest in their business. In this case, the financial instruments could be a means of raising capital for one party and a store of value for the other.

Importance of Financial Instruments

Financial instruments are central to not only the stock market, but also the financial and economic system as a whole. They provide structures and legal obligations that facilitate the regulated exchange of capital via investing, lending and borrowing, speculation and growth.

In short, financial instruments keep the financial markets moving, and they also help businesses to keep their doors open and allow consumers to manage their finances, plan for the future, and invest with the hope of future gains.

For example, you may also have a savings account that you use to hold your emergency fund, an Individual Retirement Account (IRA) that you use to save for retirement and a taxable brokerage account for trading stocks. Your checking account is one of the basic tools you might use to pay bills or make purchases.

You might be paying down a mortgage or student loans while occasionally using credit cards to spend. All of these financial instruments allow you to direct the flow of money from one place to another.

The Takeaway

Financial instruments are integral to every aspect of the financial world, and they also play a significant part in business transactions and day-to-day financial management. If you trade stocks, invest in an IRA, or write checks to your landlord, then you’re contributing to the movement of capital with various financial instruments. Understanding the different types of financial instruments is the first step in becoming a steward of your own money.

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


Invest with as little as $5 with a SoFi Active Investing account.

Photo credit: iStock/Love portrait and love the world

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


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.

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.

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.

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Mar
24
2025
What Is a Financial Checkup?

What Is a Financial Checkup?

By | Budgeting & Goals, Financial Independence, money | Comments Off on What Is a Financial Checkup?

A financial checkup is a process in which you thoroughly review your finances and how you are tracking against your goals. It’s similar to an annual visit with your doctor to help ensure that you’re maintaining good physical health.

A financial checkup can be an important step in achieving financial wellness, which means meeting your money obligations today and also funding your future goals. Regular financial checkups can help you see how well you’re doing. What’s more, they give you the opportunity to pinpoint where you might be able to improve your money management strategy.

If you’ve never done a personal financial checkup before, fear not. Getting started is easier than you might think.

Key Points

•   A financial checkup involves a thorough review of personal finances, assessing budget, expenses, assets, and debt to gauge financial health.

•   The process can include examining credit reports and retirement savings to ensure progress towards financial goals.

•   Evaluating emergency savings and insurance needs can be a key step to securing financial stability.

•   Regular financial checkups help eliminate bad spending habits and clarify budgeting.

•   These checkups instill financial discipline and encourage consistent saving, essential for financial wellness.

What Is a Financial Checkup?

A financial checkup is a thorough review of your personal finances. It’s similar to getting a health checkup from a doctor, only instead of checking your blood pressure and other vitals, you’re measuring your financial stats. For example, some of the things you might review as part of a financial check include your:

•   Monthly budget and expenses

•   Assets, ranging from money in a savings account to equity in a home

•   Debt situation and repayment strategy

•   Credit reports and scores

•   Retirement savings

•   Emergency savings

•   College planning, if you have kids

•   Insurance needs and coverage

Those are all things that can go along with setting up a financial plan. What is a financial plan? It’s a strategy for managing your money in order to reach your personal money goals. You can complete a financial checkup and financial plan yourself or do so with the help of a professional financial advisor.

Recommended: Emergency Fund Calculator

Why Are Financial Checkups Important?

A financial health checkup can help you establish where you are with your money, where you’d like to be financially, and what steps you need to take to get there. Completing regular personal financial checkups can guide you to improve your financial health as you work toward your goals.

For instance, money checkups could help you to:

•   Get clarity around budgeting and expenses

•   Eliminate bad spending habits so you don’t overdraft your checking account

•   Define your short- and long-term financial goals

•   Instill a sense of financial discipline as you work toward those goals

•   Develop a habit of saving consistently

•   Create an actionable plan for paying off debt

•   Form a workable strategy for retirement savings

•   Fine-tune your investment goals

Taking those kinds of actions can get you on the path to living your personal definition of financial freedom. That might mean retiring early, for instance, or finding ways to create passive income so you can live a lifestyle that isn’t job-dependent.

Skipping regular financial checkups can make it more difficult to do those kinds of things and put your financial security in danger. The simple reason: You’re oblivious to how you’re managing your money.

Key Steps to Take for a Financial Checkup

Money checkups can help you move ahead with achieving financial security, but what do you actually include in one? How often do you need to perform a financial checkup? And do you need to get help from a professional financial advisor? Here’s a closer look.

•   Frequency: In terms of frequency, it may be a good idea to consider a personal financial check at least once a year. For example, you might schedule it for the beginning of January. That way, you can review the previous year and set goals for the upcoming year. Quarterly checkups may be a better option if you’d like to get smaller snapshots of your finances throughout the year.

•   Hiring a financial advisor: Whether you hire an advisor for a financial checkup is entirely up to you. An advisor can offer an extra set of eyes to review your finances but it’s important to know what you’ll pay for that help. The average financial advisor cost is around 1% of the assets they manage annually. However, some financial institutions provide access to professional advisors for free. It’s worth doing a bit of research to see what might be available.

Ready to start your financial health checkup? Here’s a simple checklist you can follow.

Take Your Financial Vital Signs

Getting some numbers down on paper can be a good way to start your financial checkup. Looking at certain metrics for the last 12 months can give you some perspective on where you are financially. Here are some of the most important measurements to take:

•   Your monthly income and expenses

•   How much you have saved for emergencies

•   What you’re carrying in total debt

•   Debt-to-income ratio (i.e., how much of your income goes to debt repayment)

•   Your credit scores

•   How much you’ve invested for retirement

•   What percentage of your income you’re saving monthly

Along with looking at specific numbers, it can also be helpful to ask some basic questions to gauge your financial health. For example, you might ask yourself:

•   How many months did I stick to my budget vs. going over budget?

•   Have I bounced any checks or overdrafted my bank account this year?

•   Was I late paying any bills in the past 12 months?

•   Did I reach any savings goals or fall short of any goals?

•   Did my overall debt load increase or decrease?

•   How well did my investments perform?

The purpose of looking at numbers first and asking these kinds of questions is to establish your financial baseline. You can then move on to the next steps to take a deeper dive into your money situation.

Review Your Budget

Making a budget is usually at the top of the list of personal finance basics for beginners. A budget is a plan for spending the income that you have each month. The basic elements of a budget include:

•   Fixed expenses, such as housing

•   Variable expenses, which need to be paid monthly but their amounts may change (such as food costs)

•   Discretionary expenses or the “wants” in your budget

•   Income

•   Debt repayment

•   Savings

You might also include taxes as its own budget category if you’re self-employed. In this situation, you will need to set aside money regularly to pay estimated tax bills.

If you’re doing a financial checkup for the last 12 months, it can be helpful to look at what’s changed in your variable and discretionary expenses. For example, are you paying more for utilities than you were 12 months ago? Has your grocery bill increased? Is a bigger chunk of your budget going to “fun” things like hobbies, entertainment, or recreation?

Analyzing individual budget categories can help you pinpoint money leaks or areas where you might be able to cut back on spending. It’s also a good opportunity to review what you’re paying for cell phone service, internet, or car insurance to see if it’s worth switching to a cheaper provider.

Get up to $300 when you bank with SoFi.

No account or overdraft fees. No minimum balance.

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Check Your Emergency Fund

An emergency fund is money that you save for unplanned or unexpected expenses. Emergency savings is meant to be separate from money you save for sinking funds or for various short- and long-term financial goals.

If you have an emergency fund, check the balance to see how much cash you have on hand for rainy days. How much should you have in an emergency fund? An often-cited rule of thumb dictates saving three to six months’ worth of expenses for emergencies. If your savings balance is below that amount, you might go back to your budget to see where you might be able to find extra money to set aside.

Also, consider where you’re keeping your emergency fund. Ideally, that money should be somewhere that’s easily accessible in case a true emergency comes along. But you might also be interested in earning a great interest rate in the meantime.

If you’re keeping your emergency fund in a traditional savings account at a regular bank, you might consider upgrading to a high-yield savings account instead in order to snag a higher rate. Online banks may be a good option for finding one with a competitive interest rate.

Recommended: Emergency Fund Calculator

Factor in Life Changes

Life changes can affect your financial plans in different ways. Losing a job, for instance, can shrink your income. Getting married might increase your household income if you’re both working. Having a child, changing jobs, moving, buying a home, and starting a business are other situations that can impact your financial outlook.

If you’ve been through any of these life changes in the past year, consider what that might mean for things like budgeting, saving, and expenses. It’s also important to review your tax situation.

Getting married, for instance, means a change to your tax filing status. Having a child can open the door for added tax breaks. And starting a new business can bring additional tax obligations, such as estimated quarterly tax payments. Those are all things that could increase your tax bill year to year. It’s therefore important to consider where they fit in during your financial checkup.

Recommended: Getting Back on Track After Going Over Budget

Review Your Investment and Retirement Goals

Investing can be key to building wealth over the long-term. You can invest inside of a tax-advantaged plan, such as a 401(k) or individual retirement account (IRA), or through a taxable brokerage account. As part of your financial health check, it’s helpful to know:

•   Where your money is invested (i.e., taxable vs. tax-advantaged accounts)

•   How your portfolio is diversified across different asset classes

•   How those assets have performed over the last year

•   What you’re paying in investment fees

•   How your risk tolerance or tax situation has changed over the past year

•   Whether you’re on track with retirement saving.

Reviewing those things can give you an idea of whether you’re on the right track with your investments. For example, if you’re 30 years old and want to retire at 50 with $1 million, but you only have $10,000 invested, that’s a clear sign that you’ve got a lot of work left to do.

Using online investment calculators and retirement calculators can help you to figure out how closely you’re keeping up with your goals. And if you don’t have an investment account yet, you may want to consider setting up an IRA online and a taxable brokerage account so you can start growing wealth.

The Takeaway

A financial checkup is a smart way to keep tabs on your money and your financial health. It will give you the opportunity to make course corrections and can aid you with overcoming personal financial challenges. If you’re struggling with credit card debt, for example, then a periodic financial checkup can help you to figure out a strategy for paying down your balances while streamlining your expenses so you’re less reliant on plastic. It can also help you highlight ways you are succeeding financially and inspire you to keep going and keep your money growing.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.80% APY on SoFi Checking and Savings.

FAQ

How often should you do a financial checkup?

Completing a financial checkup at least once a year can be a good way to see whether you’re on track with your goals and where you might be able to improve. If you’d like to check in with your money more often, you might schedule quarterly financial checkups instead.

How do you do a financial health checkup?

A financial health checkup starts with gathering information about your income, expenses, debt, and savings. From there, you can review your financial progress and goals to determine what steps to take next with your money.

What does financial wellness include?

Financial wellness means being able to manage your current money obligations with ease while also being able to look ahead to the future. Someone who has achieved financial wellness generally has stable income, a firm grip on their expenses, a dedicated savings habit, and little to no “bad” debt. Another component is looking forward and tracking well for future financial goals, like retirement.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/Bilgehan Tuzcu

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SoFi members with Eligible Direct Deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below).

Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning 3.80% APY, we encourage you to check your APY Details page the day after your Eligible Direct Deposit arrives. If your APY is not showing as 3.80%, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning 3.80% APY from the date you contact SoFi for the rest of the current 30-day Evaluation Period. You will also be eligible for 3.80% APY on future Eligible Direct Deposits, as long as SoFi Bank can validate them.

Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi members with Eligible Direct Deposit are eligible for other SoFi Plus benefits.

As an alternative to Direct Deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Eligible Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving an Eligible Direct Deposit or receipt of $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Eligible Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Eligible Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Eligible Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Eligible Direct Deposit or Qualifying Deposits until SoFi Bank recognizes Eligible Direct Deposit activity or receives $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Eligible Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Eligible Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

Members without either Eligible Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, or who do not enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days, will earn 1.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 1/24/25. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

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.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.


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.

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Mar
24
2025
Exit Strategy for Investors: Definition and Examples

Exit Strategy for Investors: Definition and Examples

By | Growing Wealth, invest, Investing | Comments Off on Exit Strategy for Investors: Definition and Examples

An exit strategy is a plan to leave an investment, ideally by selling it for more than the price at which it was purchased.

Individual investors, venture capitalists, stock traders, and business owners all use exit strategies that set specific criteria to dictate when they’ll get out of an investment. Every exit strategy plan is unique to its situation, in terms of timing and under which conditions an exit may occur.

What Is an Exit Strategy?

Broadly speaking, the exit strategy definition is a plan for leaving a specific situation. For instance, an employee who’s interested in changing jobs may form an exit strategy for leaving their current employer and moving on to their next one.

What is an exit strategy in a financial setting? In this case, the exit strategy definition is a plan crafted by business owners or investors that cover when they choose to liquidate their position in an investment. To liquidate means to convert securities or other assets to cash. Once this liquidation occurs, the individual or entity that executed the exit strategy no longer has a stake in the investment.

Creating an exit strategy prior to making an investment can be advantageous for managing and minimizing risk. It can also help with defining specific objectives for making an investment in the first place. In other words, formulating your exit strategy beforehand can give you clarity about what you hope to achieve.

Exit strategies often go overlooked, however, as investors, venture capitalists, and business owners may move ahead with an investment with no clear plan for leaving it.

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How Exit Strategies Work

Investors use exit strategies to realize their profit or to mitigate potential losses from an investment or business. When creating an exit strategy, investors will typically define the conditions under which they’ll make their exit.

For instance, an exit strategy plan for investors may be contingent on achieving a certain level of returns when starting to invest in stocks, or reaching a maximum threshold of allowable losses. Once the contingency point is reached, the investor may choose to sell off their shares as dictated by their exit strategy.

A venture capital exit strategy, on the other hand, may have a predetermined time element. Venture capitalists invest money in startups and early stage companies. The exit point for a venture capitalist may be a startup’s IPO or initial public offering.

Again, all exit strategies revolve around a plan. The mechanism by which an individual or entity makes their exit can vary, but the end result is the same: to leave an investment or business.

When Should an Exit Strategy Be Used?

There are different scenarios when an exit strategy may come into play. For example, exit strategies can be useful in these types of situations:

•   Creating a succession plan to transfer ownership of a profitable business to someone else.

•   Shutting down a business and liquidating its assets.

•   Withdrawing from a venture capital investment or angel investment.

•   Selling stocks or other securities to minimize losses.

•   Giving up control of a company or merging it with another company.

Generally speaking, an exit strategy makes sense for any situation where you need or want to have a plan for getting out.

Exit Strategy Examples

Here are some different exit strategy examples that explain how exit strategies can be useful to investors, business owners, and venture capitalists.

Exit Strategy for Investors

When creating an exit strategy for stocks and investing, including how to buy stocks, there are different metrics you can use to determine when to get out. For example, say you buy 100 shares of XYZ stock. You could plan your exit strategy based on:

•   Earning target return from the investment

•   Realizing a maximum loss on the investment

•   How long you want to stay invested

Say your goal is to earn a 10% return on the 100 shares you purchased. Once you reach that 10% threshold you may decide to exit while the market is up and sell your shares at a profit. Or, you may set your maximum loss threshold at 5%. If the stock dips and hits that 5% mark, you could sell to head off further losses.

You may also use time as your guide for making an exit strategy for stocks. For instance, if you’re 30 years old now and favor a buy-and-hold strategy, you may plan to make your exit years down the line. On the other hand, if you’re interested in short-term gains, you may have a much shorter window in which to complete your exit strategy.

Exit strategies can work for more than just stock investments. For instance, you may have invested in crowdfunding investments, such as real estate crowdfunding or peer-to-peer lending. Both types of investments typically have a set holding period that you can build into your exit plan.

Recommended: Bull Put Spread: How This Options Trading Strategy Works

Exit Strategy for Business Owners

An exit strategy for business owners can take different forms, depending on the nature of the business. For instance, if you run a family-owned business then your exit strategy plan might revolve around your eventual retirement. If you have a fixed retirement date in mind your exit plan could specify that you will transfer ownership of the business to your children or sell it to another person or company.

Another possibility for an exit strategy may involve selling off assets and closing the business altogether. This is something a business owner may consider if the business is not turning a profit, and it looks increasingly unlikely that it will. Liquidation can allow a business owner to repay their creditors and walk away from a failed business without having to file bankruptcy.

Exit Strategy for Startups

With startups and larger companies, exit strategies can be more complex. Examples of exit strategy plans may include:

•   Launching an IPO to allow one or more founders to make an exit

•   A merger or acquisition that allows for a transfer of ownership

•   Selling the company

•   Liquidating assets and shutting the company down

If a founder is ready to move on to their next project, they can use an IPO to leave the company intact while extricating themselves from it. And angel investors or venture capitalists who invested in the company early on also have an opportunity to sell their shares.

Startup exit strategies can also create possible opportunities for some investors. IPO investing allows investors to buy shares of companies when they go public.

The mechanics of using an IPO as an exit strategy can be complicated, however. There are IPO valuations and regulatory requirements to consider.

It’s important for startup founders to know how to value a business before taking it public to ensure that an IPO is successful. And early-stage investors may have to observe IPO lock-up period restrictions before they can sell their shares.

💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.

5 Types of Exit Strategies

There are different types of exit strategies depending on whether you’re an investor, a business owner, or a venture capitalist. Some common exit strategies include:

1. Selling Shares of Stock

Investors can use an exit strategy to set a specific goal with their investment (say, 12%), reach a certain level of profit, or determine a point at which they’ll minimize their loss if the investment loses value. Once they reach the target they’ve set, the investor can execute the exit strategy and sell their shares.

2. Mergers and Acquisitions

With this business exit strategy, another business, often a rival, buys out a business and the founder can exit and shareholders may profit. However, there are many regulatory factors to consider, such as antitrust laws.

3. Selling Assets and Closing a Business

If a business is failing, the owner may choose to liquidate all the assets, pay off debts as well as any shareholders, if possible, and then close down the business. A failing business might also declare bankruptcy, but that’s typically a last resort.

4. Transferring Ownership of a Business

This exit strategy may be used with a family-run business. The owner may formulate an exit plan that allows him to transfer the business to a relative or sell it at a particular time so that he or she can retire or do something else.

5. Launching an IPO

By going public with an IPO, the founder of a startup or other company can leave the company if they choose to, while leaving the business intact. As noted, using an IPO as an exit strategy can be quite complicated for business founders and investors because of regulatory requirements, IPO valuations, and lock-up period restrictions.

Why Exit Strategies Are Important

Exit strategies matter because they offer a measure of predictability in a business or investment setting. If you own a business, for example, having an exit strategy in place that allows you to retire on schedule means you’re not having to work longer than you planned or want to.

An exit strategy for investors can help with staying focused on an end goal, rather than following the crowd, succumbing to emotions, or attempting to time the market. For example, if you go into an investment knowing that your exit plan is designed to limit your losses to 5%, you’ll know ahead of time when you should sell.

Using an exit strategy can prevent doubling or tripling losses that could occur when staying in an investment in the hopes that it will eventually turn around. Exit strategies can also keep you from staying invested too long in an investment that’s doing well. The market moves in cycles and what goes up eventually comes down.

If you’re on a winning streak with a particular stock, you may be tempted to stay invested indefinitely. But having an exit strategy and a set end date for cashing out could help you avoid losses if volatility sends the stock’s price spiraling.

How To Develop an Exit Strategy Plan

Developing an exit strategy may look different, depending on whether it involves an investment or business situation. But the fundamentals are the same, in that it’s important to consider:

•   What form an exit will take (i.e. liquidation, IPO, selling shares, etc.)

•   Whether an exit is results-based or time-based (i.e. realizing a 10% return, reaching your target retirement date, etc.)

•   Key risk factors that may influence outcomes

•   Reasons and goals for pursuing an exit strategy

If you’re an individual investor, you may need to formulate an exit plan for each investment you own. For instance, how you exit from a stock investment may be different from how you sell off bonds. And if you’re taking on riskier investments, such as cryptocurrency, your exit strategy may need to account for the additional volatility involved.

For business owners and founders, exit strategy planning may be a group discussion that involves partners, members of the board, or other individuals who may have an interest in the sale, transfer, or IPO of a company. In either situation, developing an exit strategy is something that’s best done sooner, rather than later.

SoFi Investing

Investing can help you build wealth for the long-term and an exit strategy is an important part of the plan. It allows you to decide ahead of time how and when you’ll get out of an exit, and could help you lock in returns or minimize losses.

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FAQ

What are different exit strategies?

Examples of some different exit strategies include selling shares of a stock once an investor realizes a certain return or profit, transferring ownership of a family business so an owner can retire, or selling all the assets and closing down a failing business.

What are the most common exit strategies?

The most common exit strategies depend on whether you’re an investor, the owner of an established business, or the founder of a startup. For investors, the most common exit strategy is to sell shares of stock once they reach a certain target or profit level. For owners of an established business, the most common exit strategy is mergers and acquisitions, because doing so is often favorable to shareholders. For founders of startups, a common exit strategy is an initial public offering (IPO).

What is the simplest exit strategy?

For an investor, the simplest exit strategy is to sell shares of stock once they reach a certain profit or target level of return. At that point they can sell their shares for more money than they paid for them.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/Christian Guiton


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

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New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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Finding Your Old 401k: Here's What to Do

How to Find an Old 401(k)

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on How to Find an Old 401(k)

Tracking down an old 401(k) may take some time, and perhaps the quickest way to find old 401(k) money is to contact your former employer to see where the account is now. It’s possible that your lost 401(k) isn’t lost at all; instead, it’s right where you left it.

In some cases, however, employers may cash out an old 401(k) or roll it over to an IRA on behalf of a former employee. In that case, you might have to do a little more digging to find lost 401(k) funds. If you ever wished you could click on an app called “Find my 401(k),” the following strategies may be of use.

Key Points

•   Contacting previous employers is a primary method for locating old 401(k) accounts.

•   Old account statements can be useful for directly reaching out to 401(k) providers.

•   Government agencies keep records that can help track down old 401(k) plans.

•   National registries may list unclaimed retirement benefits, searchable by Social Security number.

•   Recovered 401(k) funds can be rolled over into another retirement account or cashed out.

4 Ways to Track Down Lost or Forgotten 401(k) Accounts

There’s no real secret to how to find old 401(k) accounts. But the process can be a little time consuming as it may require you to search online or make a phone call or two. But it can be well worth it if you’re able to locate your old 401(k).

There are several ways to find an old 401(k) account. Here are a handful that may prove fruitful.

1. Contact Former Employers

The first place to start when trying to find old 401(k) accounts is with your previous employer.

If you had more than $5,000 in your 401(k) at the time you left your job, it’s likely that your account may still be right where you left it. In that case, you have a few options for what to do with the money:

•   Leave it where it is

•   Transfer your 401(k) to your current employer’s qualified plan

•   Rollover the account into an Individual Retirement Account (IRA)

•   Cash it out

When your plan balance is less than $5,000 your employer might require you to do a 401(k) rollover or cash it out. If you’re comfortable with the investment options offered through the plan and the fees you’ll pay, you might decide to leave it alone until you get a little closer to retirement. On the other hand, if you’d like to consolidate all of your retirement money into a single account, you may want to roll it into your current plan or into an IRA.

Cashing out your 401(k) has some downsides. You would owe taxes on the money, and likely an early withdrawal penalty as well. So you may only want to consider this option if your account holds a smaller amount of money. If you had less than $5,000 in your old 401(k), it’s possible that your employer may have rolled the money over to an IRA for you or cashed it out and mailed a check to you.

Recommended: How Does a 401(k) Rollover Work?

2. Track Down Old Statements

If you have an old account statement, you can contact your 401(k) provider directly to find out what’s happened to your lost 401(k). This might be necessary if your former employer has gone out of business and your old 401(k) plan was terminated.

When a company terminates a 401(k), the IRS requires a rollover notice to be sent to plan participants. If you’ve moved since leaving the company, the plan administrator may have outdated address information for you on file. So you may not be aware that the money was rolled over.

Either way, your plan administrator should be able to tell you which custodian now holds your lost 401(k) funds. Once you have that information, you could reach out to the custodian to determine how much money is in the account. You can then decide if you want to leave it where it is, roll it over to another retirement account, or cash it out.

3. Check With Government Agencies

Different types of retirement plans, including 401(k) plans, are required to keep certain information on file with the IRS and the Department of Labor (DOL). One key piece of information is DOL Form 5500. This form is used to collect data for employee benefit plans that are subject to federal ERISA (Employee Retirement Income Security Act) guidelines.

How does that help you find your 401(k)? The Department of Labor offers a Form 5500 search tool online that you can use to locate lost 401(k) plans. You can search by plan name or plan sponsor. If you know either one, you can look up the plan’s Form 5500, which should include contact information. From there, you can reach out to the plan sponsor to track down your lost 401(k).

4. Search National Registries

Another place to try is the National Registry of Unclaimed Retirement Benefits. This is an online database you can use to search for an unclaimed 401(k) that you may have left with a previous employer. You’ll need to enter your Social Security number to search for lost retirement account benefits.

In order for your name to come up in the search results, your former employer must have entered your name and personal information in that database. If they haven’t done so, it’s possible you may not find your account this way.

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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.

What Should I Do With Recovered Funds?

If you do manage to recover an old 401(k) account and its assets, you’ll have some options as to what to do with it. In many cases, it might be a good idea to roll it over into another retirement account to try and stay on track with your retirement savings.

Another important point to consider: If you’ve changed jobs multiple times, it’s possible that you could have more than one “lost” 401(k) — and taken together, that money could make a surprising difference to your nest egg.

Last, if you were lucky to have an employer that offered a matching 401(k) contribution, your missing account (or accounts) may have more money in them than you think. For example, a common employer match is 50%, up to the first 6% of your salary. If you don’t make an effort to find old 401(k) accounts, you’re missing out on that “free money” as well.

But if you’re unsure of what to do, it may be worth speaking with a financial professional for guidance.

Further, if you’re not able to find lost 401(k) accounts you still have plenty of options for retirement savings. Contributing to your current employer’s 401(k) allows you to set aside money on a tax-deferred basis. And you might be able to grow your money faster with an employer matching contribution.

What if you’re self-employed? In that case, you could choose to open a solo or individual 401(k). This type of 401(k) plan is designed for business owners who have no employees or only employ their spouses. These plans follow the same contribution and withdrawal rules as traditional employer-sponsored 401(k) plans, though special contribution rules apply if you’re self-employed.

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The Takeaway

There are several ways to try and find an old 401(k) account, but for most people, the best place to start is by contacting your old employers to see if they can help you. From there, you can also try reaching out to government agencies, tracking down old statements, or even searching through databases to see what you can find.

Saving for retirement is important for most people who are trying to reach their financial goals – as such, if you have money or assets in a retirement account, it may be worthwhile to try and track it down. Again, it may be worth consulting with a financial professional if you need help.

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

Help grow your nest egg with a SoFi IRA.

FAQ

Is it possible to lose your 401(k)?

It’s possible to lose money from your 401(k) if you’re cashing it out and taking a big tax hit or your investments suffer losses. But simply changing jobs doesn’t mean your old 401(k) is gone for good. It does, however, mean that you may need to spend time locating it if it’s been a while since you changed jobs.

Do I need my social security number to find an old 401(k)?

Generally, yes, you’ll need your Social Security number to find a lost 401(k) account. This is because your Social Security number is used to verify your identity and ensure that the plan you’re inquiring about actually belongs to you.

What happens to an unclaimed 401(k)?

Unclaimed 401(k) accounts may be liquidated or converted to cash if enough time passes, and that cash could be transferred to a state government, where it will be held as unclaimed property.

Can a financial advisor find old 401(k) accounts?

A financial advisor may be able to help, but the simplest way to find old 401(k) accounts is contacting your former employer. It’s possible your money may still be in your old plan and if not, your previous employer or plan administrator may be able to tell you where it’s been moved to.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.

Photo credit: iStock/svetikd

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.

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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2025
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What Is an Equal-Weighted Index? How to Calculate It

By | Growing Wealth, invest, Investing | Comments Off on What Is an Equal-Weighted Index? How to Calculate It

An equal-weight index gives each constituent in a market index the same weight versus a market-cap-weighted or price-weighted index, where bigger companies (or those trading at higher prices) hold a larger share of the index.

Equal weighting strives to equalize the impact of each company’s performance on the overall index. Traditional market-cap weighting tends to give bigger companies more influence over outcomes. Equal-weight investing is a smart beta strategy that may appeal to certain types of investors more than others.

Key Points

•   An equal-weighted index assigns the same weight to each component, regardless of market capitalization.

•   Calculation involves dividing the total number of components into 100 to find the weight per component.

•   Rebalancing is necessary to maintain equal weighting, typically done quarterly or annually.

•   Performance can differ significantly from market-cap weighted indexes due to equal representation.

•   Potential benefits include increased diversification and reduced concentration risk in larger stocks.

What Is an Equal-Weighted Index?

A stock market index tracks the performance of a specific group of stocks or a particular sector of the market. For example, the S&P 500 Composite Stock Price Index tracks the movements of 500 companies that are recognized as leaders within their respective industries.

Stock market indexes are often price-weighted or capitalization-weighted.

•   In a price-weighted index, the stocks that have the highest share price carry the most weight. In a capitalization-weighted index, the stocks with the highest market capitalization carry the most weight.

•   Market capitalization represents the value of a company as measured by multiplying the current share price by the total number of outstanding shares.

While some investors may wish to invest in stocks, others may be interested in mutual funds or index funds, which are like a container holding many stocks.

How Equal Weighting Works

An equal-weighted index is a stock market index that gives equal value to all the stocks that are included in it. In other words, each stock in the index has the same importance when determining the index’s value, regardless of whether the company is large or small, or how much shares are trading for.

An equally weighted index essentially puts all of the stocks included in the index on a level playing field when determining the value of the index. With a price-weighted or capitalization-weighted index, on the other hand, higher-priced stocks and larger companies tend to dominate the index’s makeup — and thereby dictate or influence the overall performance of that index.

This in turn influences the performance of corresponding index funds, which track that particular index. Because index funds mirror a benchmark index, they are considered a form of passive investing.

Most exchange-traded funds (ETFs) are passive funds that also track an index. Now there are a growing number of actively managed ETFs. While equal-weight ETFs are considered a smart beta strategy, they aren’t fully passive or active in the traditional sense. These funds do track an index, but some active management is required to rebalance the fund and keep the constituents equally weighted.

Examples of Equal-Weight Funds

Equal-weight exchange-traded funds (ETFs) have grown more common as an increasing number of investors show interest in equal-weight funds. Equal weight falls under the umbrella of smart-beta strategies, which refers to any non-market-capitalization strategy.

The term “smart beta” doesn’t mean a particular strategy is better or more effective than others.

Equal-weight funds, for example, are designed to shift the weight of an index and its corresponding funds away from big-cap players, which can unduly influence the performance of the index/fund. And while an equal-weight strategy may have improved fund performance in some instances, the results are not consistent.

Here is a list of some of the top five equal-weight ETFs by assets under management (AUM):

1.    Invesco S&P 500 Equal Weight ETF (RSP )

2.    SPDR S&P Biotech (XBI )

3.    SPDR S&P Oil and Gas Exploration and Production (XOP )

4.    SPDR S&P Global Natural Resources ETF (GNR )

5.    First Trust Cloud Computing ETF (SKYY )

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How to Calculate Equal-Weighted Index

To calculate equal weighted index, you need to know two things:

•   The share price of each stock that’s included in the index

•   Total number of stocks included in the index

If you’re calculating an equally weighted index value for an index that has five stocks in it, each one would be weighted 20%, regardless of its stock price or market capitalization. To find an equal-weighted index value, you would simply add the share price of each stock together, then multiply it by the weight.

So for example, say an index has five stocks priced at $100, $50, $75, $90 and $85. Each one would be weighted at 20%.

Following the formula, you would add each stock’s price together for a total of $400. You’d then multiply that by the 20% weighting to arrive at an equal-weighted value of 80.

As fund turnover occurs and new assets are exchanged for old ones, or as share prices fluctuate, the equally weighted index value must be recalculated.

The equally weighted index formula can be used to determine the value of a particular index. You may want to do this when determining which index ETF to invest in or whether it makes sense to keep a particular index mutual fund in your portfolio.

Advantages of Using an Equally Weighted Index

An index investing strategy might be preferable if you lean toward more conservative investments or you simply want exposure to a broad market index without concentrating on a handful of stocks. That’s something you’re less likely to get with mutual funds or ETFs that follow a price-weighted or capitalization-weighted index.

Here are some of the reasons to consider an equal-weighted index approach:

•   An equal-weight strategy can increase diversification in your portfolio while potentially minimizing exposure to risk.

•   It’s relatively easy to construct an equally weighted portfolio using index mutual funds and ETFs.

•   It may appeal to value investors, since there’s less room for overpriced stocks to be overweighted and undervalued stocks to be underweighted.

•   Equal-weighted index funds may potentially generate better or more incremental returns over time compared to price-weighted or capitalization-weighted index funds, but there are no guarantees.

Disadvantages of Using Equally Weighted Index

While there are some pros to using an equal weighted approach, it may not always be the best choice depending on your investment goals. In terms of potential drawbacks, there are two big considerations to keep in mind:

•   Equal-weighted index funds or ETFs that have a higher turnover rate may carry higher expenses for investors.

   There is typically a constant buying and selling of assets that goes on behind the scenes to keep an equal-weighted mutual fund or ETF in balance.

   Higher turnover ratios, or, how often assets in the fund are swapped in and out, can lead to higher expense ratios if a fund requires more active management. The expense ratio is the price you pay to own a mutual fund or ETF annually, expressed as a percentage of the fund’s assets. The higher the expense ratio, the more of your returns you hand back each year to cover the cost of owning a particular fund.

•   Equal-weighted indexes can also be problematic in bear market environments, which are characterized by an overall 20% decline in stock prices. During a recession, cap-weighted funds may outperform equal-weighted funds if the fund is being carried by a few stable, larger companies.

◦   Conversely, an equal-weighted index or fund may miss out on some of the gains when markets are strong and bigger companies outperform.

Advantages

 Disadvantages
Can further diversify a portfolio Will typically have higher costs
Constructing an equal-weight portfolio is straightforward May see outsize declines in bear markets
Equal-weight strategies may appeal to value investors May not realize full market gains
Equal-weight strategies may perform better than traditional strategies, but there are no guarantees

The Takeaway

In an equal-weight index, each stock counts equally toward the index’s value, regardless of whether the company is large or small, or what shares are currently trading for. The same is true of any corresponding fund.

There are advantages to investing in an equal-weight index fund over a capitalization-weighted index or price-weighted index. For example, equal-weighted indexes may generate better or more consistent returns. Investing in an equal-weight index may be appealing to investors who prefer a value investing strategy or who want to diversify their portfolio to minimize risk.

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

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

FAQ

How do equal-weight ETFs work?

Like an equal-weight index, an equal-weight ETF holds the same proportion of each of its constituents, which in theory may equalize the impact of different companies’ performance.

When should you buy equal-weighted ETFs?

If you’d like to invest in a certain sector, but you don’t want to be riding the coattails of the biggest companies in that sector because you see the value in other players, you may want to consider an equal-weight ETF.

What is the equally weighted index return?

The return of an equally weighted index would be captured by the performance of an investment in a corresponding index fund or ETF. So if you invest $100 in Equal Weight Fund A, which tracks an equal weight index, and the fund goes up or down by 5%, you would see a 5% gain or loss.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.

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