InvestGen Archives

Oct

2025

Implied Volatility: What It Is & What It’s Used for

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

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.

Table of Contents

What Is Volatility?
What Is Implied Volatility?
How Implied Volatility Affects Options
Implied Volatility and Other Financial Products
How Is Implied Volatility Calculated?
What Affects Implied Volatility?
Implied Volatility Pros and Cons
FAQ

Implied volatility (IV) is a metric that describes the market’s expectation of future movement in the price of a security. Implied volatility, also known by the symbol σ (sigma), employs a set of predictive factors to forecast how volatile a security’s price may be.

Some investors may use implied volatility as a way to understand the level of market risk they may face. Implied volatility is often calculated using either the Black-Scholes model or the Binomial model.

Key Points

• Implied volatility measures expected future price movement, reflecting market sentiment.

• High implied volatility suggests larger price swings, which can significantly impact options premiums.

• Implied volatility may be calculated using the Black-Scholes and Binomial models, each with specific applications.

• Elevated market risk can be signaled through implied volatility, though it doesn’t indicate which direction prices may move.

• Limitations include the inability to predict future direction, account for unexpected events, and reflect fundamental value.

What Is Volatility?

Volatility, as it relates to investments, is the pace and extent that the market price of a security may move up or down during a given period. During times of high volatility, prices experience frequent, large swings, while periods of low volatility see fewer and smaller price changes.

What Is Implied Volatility?

Implied volatility is, in essence, a metric used in options trading that reflects the market’s anticipation of a security’s future price movements, rather than its historical performance. While it informs the price of an option, it does not guarantee that the price activity of the underlying security will be as volatile, or as stable, as the expectation embedded in its implied volatility. While implied volatility isn’t a window onto the future, it can often correlate with the broader opinion that the market holds regarding a given security.

To express implied volatility, investors typically use a percentage that shows the rate of standard deviation over a particular time period. As a measure of market risk, investors typically see the highest implied volatility during downward-trending or bearish markets, when they may expect equity prices to go down.

During bull markets on the other hand, implied volatility tends to go down as more investors may believe equity prices will rise. That said, as a metric, implied volatility doesn’t predict the direction of the price swings, only that the prices are likely to swing.

How Implied Volatility Affects Options

So how does implied volatility affect options? When determining the value of an options contract, implied volatility is a major factor. Implied volatility can help options traders evaluate an option’s price and also evaluate whether the option may be a good fit for their strategy.

An investor buying options contracts has the right, but not the obligation, to buy or sell a particular asset at an agreed-upon price during a specified time period. Because IV helps estimate the extent of the price change investors may expect a security to experience in a specific time span, it directly affects the price an investor pays for an option. It would not help them determine whether they want a call or a put option.

It may also be used by some traders to help them determine whether they want to charge or pay an options premium for a security. Options on underlying securities that have high implied volatility tend to come with higher premiums, while options on securities with lower implied volatility typically command lower premiums.

Implied Volatility and Other Financial Products

Implied volatility can also impact the prices of financial instruments other than options. One such instrument is the interest rate cap, a product aimed at limiting the increases in interest charged by variable-rate credit products.

For example, homeowners might purchase an interest rate cap to limit the risks associated with their variable-rate mortgages and adjustable-rate mortgage (ARM) loans. Implied volatility may be a consideration in the prices that borrowers may pay for those interest rate caps.

How Is Implied Volatility Calculated?

There are two implied volatility formulas that some investors typically use to estimate fair option pricing based on market conditions.

Black-Scholes Model

One of the most widely used methods of calculating implied volatility is the Black-Scholes Model. Sometimes known as the Black-Scholes-Merton model, the Black-Scholes model is named for three economists who published the model in a journal in 1973.

It can be a complex mathematical equation investors use to project potential price changes over time for financial instruments, including stocks, futures contracts, and options contracts. Investors use the Black-Scholes Model to estimate the value of different securities and financial derivatives. When used to price options, it uses the following factors:

• Current stock price

• Options contract strike price

• Amount of time remaining until the option expires

• Risk-free interest rates

The Black-Scholes formula takes those known factors and effectively back-solves for the value of implied volatility.

The Black-Scholes Model offers a quick way to calculate European-style options, which can only be exercised at their expiration date, but the formula is less useful for accurately pricing American options, since it only considers the price at an option’s expiration date. With American options, the owner may exercise at any time up to and including the expiration date.

Binomial Model

Many investors consider the binomial option pricing model more intuitive than the Black-Scholes model. It also represents a more effective way of calculating the implied volatility of U.S. options, which may be exercised at any point before (and on) their expiration date.

Invented in 1979, the binomial model uses the assumption that at any moment, the price of a security will either go up or down.

As a method for calculating the implied volatility of an options contract, the binomial pricing model uses the same basic data inputs as Black-Scholes, along with the ability to update the equation as market conditions change or new information becomes available. In comparison with other models, the binomial option pricing model is very simple at first. It can become extremely complex, however, as it accounts for many time periods and supports early exercise for pricing American-style options.

By using the binomial model with multiple periods of time, a trader can use an implied volatility chart to visualize potential changes in implied volatility of the underlying asset over time, and evaluate the option at each point in time. It also allows the trader to update those multi-period equations based on each day’s price movements and emerging market news.

The calculations involved in the binomial model can take a long time to complete, which may make it difficult for short-term traders to use.

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What Affects Implied Volatility?

The markets fluctuate, and so does the implied volatility of any security. As the price of a security rises, that can change its implied volatility, which can influence changes in the premium it costs to buy an option.

Another factor that changes the implied volatility priced into an option is the time left until the option expires. An option with a relatively near expiration date tends to have lower implied volatility than one with a longer duration. As an options contract grows closer to its expiration, the implied volatility of that option tends to fall.

Implied Volatility Pros and Cons

There are both benefits and drawbacks to be aware of when using implied volatility to evaluate a security.

Pros

• Implied volatility can help an investor quantify the market sentiment around a given security.

• Implied volatility can help investors estimate the size of the price movement that a particular asset may experience.

• During periods of high volatility, implied volatility can help investors identify potentially lower-risk sectors or products.

Cons

• Implied volatility cannot predict the future.

• Implied volatility does not indicate the direction of the price movement a security is likely to experience.

• Implied volatility does not factor in or reflect the fundamentals of the underlying security, but is based primarily on the security’s price.

• Implied volatility does not account for unexpected adverse events that could affect the price of the security and its implied volatility in the future.

The Takeaway

Some investors use implied volatility to assess expected price movement and evaluate option value. It can be a useful indicator, but it has limitations. Investors may want to use it in connection with other types of analysis to better contextualize risk and potential price behavior.

That said, having a basic understanding of implied volatility can be a helpful foundation for nearly all investors.

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FAQ

What is implied volatility?

Implied volatility measures the extent and frequency that the market expects a security’s price to move. Options traders may use it to evaluate whether premiums are relatively expensive or inexpensive, and to help them gauge strategy timing.

Is high IV good for options?

High implied volatility can work in favor of option sellers, since they may collect a higher premium for those options. Option buyers typically pay more upfront for an option with high implied volatility, but the potential for bigger price swings may increase the likelihood that the option will move into the money, though this comes with higher risk, as well.

How can I try to profit from implied volatility?

Traders may try to profit by buying options ahead of events that are likely to trigger sharp price moves, hoping the option’s value rises. Others may sell options when IV is high to collect larger premiums, expecting volatility may drop. Both strategies hinge on timing and carry risk.

What is the function of implied volatility?

Implied volatility reflects how much price movement the market anticipates for a given security. It helps determine options pricing and offers a snapshot of perceived risk, but it doesn’t predict the direction that the security’s price may move.

Photo credit: iStock/nortonrsx

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

SOIN-Q325-019

Oct

2025

What Are Pink Sheet Stocks?

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

Table of Contents

What Is a Pink Sheet OTC?
Pros and Cons of Pink Sheet Stocks
Pink Sheet Stock Investment Risks
Where to Find Pink Sheet Stocks
Investing in Pink Sheet Stocks
FAQ

Pink sheet stocks are stocks that trade through the over-the-counter (OTC) market rather than through a major stock exchange. The term “pink sheets” comes from the paper that stock quotes used to be printed on, though today, stock quotes and stock trading takes place electronically.

The over-the-counter market may appeal to smaller companies and companies that don’t meet the listing requirements of the major stock exchanges. A pink sheet stock does not face the same level of regulation as stocks from publicly traded companies that are traded on the New York Stock Exchange or NASDAQ and many pink sheet stocks tend to be volatile and high risk.

Key Points

• Pink sheet stocks trade over-the-counter (OTC), not on major stock exchanges.

• Pink sheet stocks are listed on the OTC market along with the stock’s country of origin, price, and trading volume.

• Companies may use pink sheets/OTC for such reasons as to save money on the IPO process, because they’re in financial distress, and/or because they can’t meet SEC listing requirements.

• Risks of pink sheet stocks include potential fraud, lack of regulation, and limited transparency.

• Pink sheet stocks also tend to have low liquidity and be highly volatile.

What Is a Pink Sheet OTC?

Pink sheet stocks are those that trade over the counter (OTC), rather than via stock exchanges. OTC Markets Group provides quotes for pink sheet stocks, and broker-dealers execute trades directly with each other.

Pink sheet OTC stock trading happens on an open market that does not have the same level of financial reporting rules as mandated by trading on the NYSE, NASDAQ or another stock exchange. It’s not illegal, though the Securities and Exchange Commission (SEC) warns investors to stay vigilant for potential scams or fraudulent trading involving the pink sheets market and microcap or penny stocks.

A company may choose to sell shares on the over-the-counter market if it can not meet the listing requirements established by the SEC, or does not want the expense of going through the IPO process. Many pink sheet stocks are penny stocks.

Pink sheet stocks can be highly volatile and risky so it’s important for investors to understand both the risks and potential rewards.

Listing Requirements

In order for a company to get listed on OTC pink sheets, they must file Form 211 with the Financial Industry Regulatory Authority (FINRA). Companies typically do this through a sponsoring market maker, or registered broker dealer firm. The sponsoring market maker accepts the risk of holding a certain number of shares in a pink sheet company to facilitate trading of those shares.

The Form 211 asks for financial information about the listed company. The broker dealer can then use this information to generate a stock price quote. Pink sheet over-the-counter stocks do not need to adhere to the same financial reporting requirements as stocks that trade on major exchanges.

Are Pink Sheets and OTC the Same?

The terms pink sheet stocks, and OTC or over the counter, are not the same thing, though they both refer to trades that take place outside of the traditional stock exchanges. The company OTC Markets provides quotes for companies listed on the pink sheets, as well as the OTCQX and the OTCQB trading marketplaces.

The OTCQX allows for trading of companies that are not listed on traditional exchanges but still subject to SEC rules. The OTCQB includes emerging companies with a stock price of at least a penny that are not in bankruptcy, have a minimum of 50 beneficial shareholders who each own 100 shares, and annually confirm that information is up to date.

Pink sheet stocks listed on the OTC marketplace have fewer financial reporting requirements than the OTCQX and OTCQB. In mid-2025, the OTC Markets Group took the step of splitting its Pink Current Market into two, more specific groups, called the OTCID Basic Market and the Pink Limited Market.

Companies listed on the OTCID Market provide certain baseline information, such as financial disclosures, management certification, and a company profile. Companies listed on Pink Limited, however, have limited information available and do not certify compliance with established reporting standards. OTC Markets lists these companies with a yield sign to alert investors to proceed with caution.

Are Pink Sheets and Stocks the Same?

Pink sheet stocks are stocks, meaning each one represents an ownership share in a company. A primary difference between pink sheet stocks and other types of stocks, such as blue chip stocks, is how investors trade them. Investors trade pink sheet stocks over the counter, and other types of stocks on an exchange.

Pink sheet stocks may have much lower valuations than small-cap, mid-cap or large-cap stocks, or they may be newer companies that have yet to establish themselves in the market.

Companies that Use Pink Sheets

There are quite a few companies that use pink sheet stocks, and that includes some big-name, well-known companies that most people would recognize. That said, most companies that use pink sheets likely wouldn’t be recognizable immediately to the average investor.

Pros and Cons of Pink Sheet Stocks

Pink sheet stocks have benefits and disadvantages, both for the companies that list over the counter and for investors. Here are some of the most important pros and cons.

Benefits of Pink Sheet Stocks

From a business perspective, being listed on the pink sheets can save companies resources. Rather than going through the IPO process to become a publicly-traded company, pink sheet stocks circumvent the major stock exchanges and their listing requirements.

Foreign companies may choose the pink sheets to avoid SEC financial reporting rules. Additionally, companies delisted from a stock exchange may seek to trade on the pink sheets OTC market.

For some investors, the possible appeal of pink sheet stock trading may be the potential to pick up stocks at very low prices. Because there are fewer reporting requirements, it may be possible to find a much broader range of stocks to invest in when trading on the OTC pink sheets. However, there are significant risks involved — see the information below.

Disadvantages of Pink Sheet Stocks

Trading on the pink sheets OTC can call a company’s reputation or credibility into question. Investors may wonder why a company is not seeking an IPO to get listed on a stock exchange or why a company has been delisted. That can make it difficult for a company to cement its footing in the marketplace and attract attention from new investors.

Investing in pink sheet stocks involves substantially more risk than trading stocks on a major exchange, since there is less transparency around them and may be limited financial information. That means investors are generally taking on more risk when investing in pink sheets because they may not know what they’re buying. In addition, pink sheet stocks can be highly volatile, and tend to have lower liquidity, meaning it can be more difficult to buy or sell shares.

Pink Sheet Stock Investment Risks

Part of investing means paying careful attention to risk management. Pink sheet stocks can present a much greater risk in a portfolio for several reasons. A major issue with pink sheet stocks is that they can be susceptible to price manipulation or fraud.

Individuals might use shell companies, for example, to trade on the pink sheets for the purpose of laundering money or otherwise defrauding investors. Because there’s so little regulation and transparency surrounding these stocks, it can be difficult to tell if a company is legitimate.

Also, there’s less liquidity surrounding these stocks due to lower trading volume. That could make it harder to sell shares of a penny stock or pink sheet stock.

The pink sheets market and over-the-counter trading in general can be more susceptible to stock volatility. Rapid price fluctuations could generate higher-than- anticipated losses if the price of a pink sheet stock nosedives unexpectedly.

And share dilution can also reduce the value of penny stocks or other pink sheet stocks. Dilution occurs when a company issues more shares of stock, watering down the value of the existing shares on the market.

Where to Find Pink Sheet Stocks

Pink sheet stocks may be offered through certain brokerages and can also be found through the OTC Markets Group. The platform has a stock screener to filter for Pink Limited stocks, as well as OTCID stocks. The filter provides the stock’s ticker symbol, its country of origin, price, and trading volume, among other information.

Investing in Pink Sheet Stocks

Those interested in investing in pink sheet stocks need a brokerage account and, specifically, a broker that offers pink sheet trading. Not all brokers offer this service so you may need to look into different options for where to trade pink sheet stocks online.

Given the high degree of risk involved, it’s important to thoroughly research the background, executives, and financials of a company you’re considering investing in. It’s equally crucial to consider how much you could realistically afford to lose if a pink sheet stock or penny stock gamble doesn’t pay off.

Keep in mind that commissions may apply, and brokerages may charge higher trading fees for pink sheet stocks versus stocks that trade on a major exchange, so it’s important to factor cost in when estimating your risk/reward potential.

The Takeaway

Pink sheet stocks, or OTC stocks, are stocks that do not trade on traditional large exchanges, and instead, trade “over the counter.” Companies that trade stocks on the over-the-counter market may include smaller companies, some foreign companies, and companies that don’t meet the listing requirements of the major exchanges.

Pink sheet stocks are risky and highly volatile since there is less regulation and oversight of them, a lack of transparency and financial information, and the potential for fraud and price manipulation. For investors, it’s very important to be aware of the risks involved.

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FAQ

Why do companies use pink sheets?

Companies may choose to use pink sheets or list their stocks on the over-the-counter (OTC) market for a number of reasons, including if they can’t meet listing requirements set forth by the SEC, or if they don’t want to go through the IPO process. Pink sheet stocks have less regulation and transparency, and they can be very risky and highly volatile.

Why is it called pink sheets?

“Pink sheets” refers to the paper that stock quotes were once printed on, which was pink in color. The term is still in use today even though stock quotes are now done electronically.

What are the risks of pink sheet investing?

Pink sheet investing can be very risky. Risks include potential fraudulent activity, less regulatory oversight, lack of transparency, low liquidity, and high volatility.

Photo credit: iStock/PeopleImages

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

SOIN-Q325-108

Oct

2025

The Ultimate List of Financial Ratios

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

Table of Contents

What Are Financial Ratios?
21 Key Financial Ratios
Liquidity Ratios
Solvency Ratios
Profitability Ratios
Efficiency Ratios
Coverage Ratios
Market-Prospect Ratios
Ratio Analysis: What Do Financial Ratios Tell You?
FAQ

Financial ratios compare specific data points from a company’s balance sheet to capture aspects of that company’s performance. For example, the price-to-earnings (P/E) ratio compares the price per share to the company’s earnings per share as a way of assessing whether the company is overvalued or undervalued.

Other ratios may be used to evaluate other aspects of a company’s financial health: its debt, efficiency, profitability, liquidity, and more.

The use of financial ratios is often used in quantitative or fundamental analysis, though they can also be used for technical analysis. For example, a value investor may use certain types of financial ratios to indicate whether the market has undervalued a company or how much potential its stock has for long-term price appreciation.

Meanwhile, a trend trader may check key financial ratios to determine if a current pricing trend is likely to hold.

With either strategy, informed investors must understand the different kinds of commonly used financial ratios, and how to interpret them.

Key Points

• Financial ratios serve as tools for evaluating aspects of a company’s financial health, assisting both business owners and investors in decision-making.

• Key financial ratios include earnings per share (EPS), price-to-earnings (P/E), and debt to equity (D/E), each providing insights into profitability, valuation, and leverage.

• Liquidity ratios, such as the current ratio and quick ratio, help assess a company’s ability to meet short-term obligations, crucial for evaluating newer firms.

• Profitability ratios, including gross margin and return on assets, gauge how effectively a company generates income from its operations and assets.

• Coverage ratios, like the debt-service coverage ratio and interest coverage ratio, measure a company’s capacity to manage its debt obligations, providing insights into financial stability.

What Are Financial Ratios?

A financial ratio is a means of expressing the relationship between two pieces of numerical data, which then provides a measurable insight. When discussing ratios in a business or investment setting, you’re typically talking about information that’s included in a company’s financial statements.

Financial ratios can provide insight into a company, in terms of things like valuation, revenues, and profitability. Various ratios can also aid in comparing two companies.

For example, say you’re considering investing in the tech sector, and you are evaluating two potential companies. One has a share price of $10 while the other has a share price of $55. Basing your decision solely on price alone could be a mistake if you don’t understand what’s driving share prices or how the market values each company.

That’s where financial ratios become useful for understanding the bigger picture of a company’s health and performance. In this example, knowing the P/E ratio of each company — again, which compares the price-per-share to the company’s earnings-per-share (EPS) — can give an investor a sense of each company’s market value versus its current profitability.

Recommended: How to Read Financial Statements

21 Key Financial Ratios

Investors tend to use some financial ratios more often or place more significance on certain ratios when evaluating business or companies, whether investing online or through a brokerage.

Bear in mind that most financial ratios are hard to interpret alone; most have to be taken in context — either in light of other financial data, other companies’ performance, or industry benchmarks.

Here are some of the most important financial ratios to know when buying stocks.

1. Earnings Per Share (EPS)

Earnings per share or EPS measures earnings and profitability. This metric can tell you how likely a company is to generate profits for its investors. A higher EPS typically indicates better profitability, though this rule works best when making apples-to-apples comparisons for companies within the same industry.

EPS Formula:

EPS = Net profit / Number of common shares

To find net profit, you’d subtract total expenses from total revenue. (Investors might also refer to net profit as net income.)

EPS Example:

So, assume a company has a net profit of $2 million, with 12,000,000 shares outstanding. Following the EPS formula, the earnings per share works out to $0.166.

2. Price-to-Earnings (P/E)

Price-to-earnings ratio or P/E, as noted above, helps investors determine whether a company’s stock price is low or high compared to other companies, or to its own past performance. More specifically, the price-to-earnings ratio can give you a sense of how expensive a stock is relative to its competitors, or how the stock’s price is trending over time.

P/E Formula:

P/E = Current stock price / Current earnings per share

P/E Example:

Here’s how it works: A company’s stock is trading at $50 per share. Its EPS for the past 12 months averaged $5. The price-to-earnings ratio works out to 10 — which means investors are willing to pay $10 for every one dollar of earnings. In order to know whether the company’s P/E is high (potentially overvalued) or low (potentially undervalued), the investors typically compare the current P/E ratio to previous ratios, as well as to other companies in the industry.

3. Debt to Equity (D/E)

Debt to equity or D/E is a leverage ratio. This ratio tells investors how much debt a company has in relation to how much equity it holds.

D/E Formula:

D/E = Total liabilities / Shareholders equity

In this formula, liabilities represent money the company owes. Equity represents assets minus liabilities or the company’s book value.

D/E Example:

Say a company has $5 million in debt and $10 million in shareholder equity. Its debt-to-equity ratio would be 0.5. As a general rule, a lower debt to equity ratio is better as it means the company has fewer debt obligations.

4. Return on Equity (ROE)

Return on equity or ROE is another financial ratio that’s used to measure profitability. In simple terms, it’s used to illustrate the return on shareholder equity based on how a company spends its money.

ROE Formula:

ROE = Net income – Preferred dividends / Value of average common equity

ROE Example:

Assume a company has net income of $2 million and pays out preferred dividends of $200,000. The total value of common equity is $10 million. Using the formula, return on equity would equal 0.18 or 18%. A higher ROE means the company generates more profits.

Liquidity Ratios

Liquidity ratios can give you an idea of how easily a company can pay its debts and other liabilities. In other words, liquidity ratios indicate cash flow strength. That can be especially important when considering newer companies, which may face more significant cash flow challenges compared to established companies.

5. Current Ratio

Also known as the working-capital ratio, the current ratio tells you how likely a company is able to meet its financial obligations for the next 12 months. You might check this ratio if you’re interested in whether a company has enough assets to pay off short-term liabilities.

Formula:

Current Ratio = Current Assets / Current Liabilities

Example:

Say a company has $1 million in current assets and $500,000 in current liabilities. It has a current ratio of 2, meaning for every $1 a company has in current liabilities it has $2 in current assets. Generally speaking, a ratio between 1.5 and 2 indicates the company can manage its debts; above 2 a company has strong positive cashflow.

6. Quick Ratio

The quick ratio, also called the acid-test ratio, measures liquidity based on assets and liabilities. But it deducts the value of inventory from these calculations.

Formula:

Quick Ratio = Current Assets – Inventory / Current Liabilities

Example:

Quick ratio is also useful for determining how easily a company can pay its debts. For example, say a company has current assets of $5 million, inventory of $1 million and current liabilities of $500,000. Its quick ratio would be 8, so for every $1 in liabilities the company has $8 in assets.

7. Cash Ratio

A cash ratio tells you how much cash a company has on hand, relative to its total liabilities, and it’s considered a more conservative measure of liquidity than, say, the current or quick ratios. Essentially, it tells you the portion of liabilities the company could pay immediately with cash alone.

Formula:

Cash Ratio = (Cash + Cash Equivalents) / Total Current Liabilities

Example:

A company that has $100,000 in cash and $500,000 in current liabilities would have a cash ratio of 0.2. That means it has enough cash on hand to pay 20% of its current liabilities.

8. Operating Cash Flow Ratio

Operating cash flow can tell you how much cash flow a business generates in a given time frame. This financial ratio is useful for determining how much cash a business has on hand at any given time that it can use to pay off its liabilities.

To calculate the operating cash flow ratio you’ll first need to determine its operating cash flow:

Operating Cash Flow = Net Income + Changes in Assets & Liabilities + Non-cash Expenses – Increase in Working Capital

Then, you calculate the cash flow ratio using this formula:

Formula:

Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities

Example:

For example, if a company has an operating cash flow of $1 million and current liabilities of $250,000, you could calculate that it has an operating cash flow ratio of 4, which means it has $4 in operating cash flow for every $1 of liabilities, in that time frame.

Solvency Ratios

Solvency ratios are financial ratios used to measure a company’s ability to pay its debts over the long term. As an investor, you might be interested in solvency ratios if you think a company may have too much debt or be a potential candidate for a bankruptcy filing. Solvency ratios can also be referred to as leverage ratios.

Debt to equity (D/E), noted above, is a key financial ratio used to measure solvency, though there are other leverage ratios that are helpful as well.

9. Debt Ratio

A company’s debt ratio measures the relationship between its debts and its assets. For instance, you might use a debt ratio to gauge whether a company could pay off its debts with the assets it has currently.

Formula:

Debt Ratio = Total Liabilities / Total Assets

Example:

The lower this number is the better, in terms of risk. A lower debt ratio means a company has less relative debt. So a company that has $25,000 in debt and $100,000 in assets, for example, would have a debt ratio of 0.25. Investors typically consider anything below 0.5 a lower risk.

10. Equity Ratio

Equity ratio is a measure of solvency based on assets and total equity. This ratio can tell you how much of the company is owned by investors and how much of it is leveraged by debt. An equity ratio above 50% can indicate that a company relies primarily on its own capital, and isn’t overleveraged.

Formula:

Equity Ratio = Total Equity / Total Assets

Example:

Investors typically favor a higher equity ratio, as it means the company’s shareholders are more heavily invested and the business isn’t bogged down by debt. So, for example, a company with $800,000 in total equity and $1.1 million in total assets has an equity ratio of 0.70 or 70%. This tells you shareholders own 70% of the company.

Profitability Ratios

Profitability ratios gauge a company’s ability to generate income from sales, balance sheet assets, operations and shareholder’s equity. In other words, how likely is the company to be able to turn a profit?

Return on equity (ROE), noted above, is one profitability ratio investors can use. You can also try these financial ratios for estimating profitability.

11. Gross Margin Ratio

Gross margin ratio compares a company’s gross margin to its net sales. This tells you how much profit a company makes from selling its goods and services after the cost of goods sold is factored in — an important consideration for investors.

Formula:

Gross Margin Ratio = Gross Margin / Net Sales

Example

A company that has a gross margin of $250,000 and $1 million in net sales has a gross margin ratio of 25%. Meanwhile, a company with a $250,000 gross margin and $2 million in net sales has a gross margin ratio of 12.5% and realizes a smaller profit percentage per sale.

12. Operating-Margin Ratio

Operating-margin ratio, sometimes called return on sales (ROS), measures how much total revenue is composed of operating income, or how much revenue a company has after its operating costs. It’s a measure of how efficiently a company generates its revenue and how much of that it turns into profit.

Formula:

Operating Margin Ratio = Operating Income / Net Sales

Example:

A higher operating-margin ratio suggests a more financially stable company with enough operating income to cover its operating costs. For example, if operating income is $250,000 and net sales are $500,000, that means 50 cents per dollar of sales goes toward variable costs.

13. Return on Assets Ratio

Return on assets, or ROA, measures net income produced by a company’s total assets. This lets you see how efficiently a company is using its assets to generate income.

Formula:

Return on Assets = Net Income / Average Total Assets

Example:

Investors typically favor a higher ratio as it shows that the company may be better at using its assets to generate income. For example, a company that has $10 million in net income and $2 million in average total assets generates $5 in income per $1 of assets.

Efficiency Ratios

Efficiency ratios or financial activity ratios give you a sense of how thoroughly a company is using the assets and resources it has on hand. In other words, they can tell you if a company is using its assets efficiently or not.

14. Asset Turnover Ratio

Asset turnover ratio measures how efficient a company’s operations are, as it is a way to see how much sales a company can generate from its assets.

Formula:

Asset Turnover Ratio = Net Sales / Average Total Assets

A higher asset turnover ratio is typically better, as it indicates greater efficiency in terms of how assets are being used to produce sales.

Example:

Say a company has $500,000 in net sales and $50,000 in average total assets. Their asset turnover ratio is 10, meaning every dollar in assets generates $10 in sales.

15. Inventory Turnover Ratio

Inventory turnover ratio illustrates how often a company turns over its inventory. Specifically, how many times a company sells and replaces its inventory in a given time frame.

Formula:

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

Example:

Investors use average inventory since a company’s inventory can increase or decrease throughout the year as demand ebbs and flows. As an example, if a company has a cost of goods sold equal to $1 million and average inventory of $500,000, its inventory turnover ratio is 2. That means it turns over inventory twice a year.

16. Receivables Turnover Ratio

Receivables turnover ratio measures how well companies manage their accounts receivable, and collect money from customers. Specifically, it considers how long it takes companies to collect on outstanding receivables, and convert credit into cash.

Formula:

Receivables Turnover Ratio = Net Annual Credit Sales / Average Accounts Receivable

Example:

If a company has $100,000 in net annual credit sales, for example, and $15,000 in average accounts receivable its receivables turnover ratio is 6.67. This means that the company collects and converts its credit sales to cash about 6.67 times per year. The higher the number is, the better, since it indicates the business is more efficient at getting customers to pay up.

Coverage Ratios

Coverage ratios are financial ratios that measure how well a company manages its obligations to suppliers, creditors, and anyone else to whom it owes money. Lenders may use coverage ratios to determine a business’s ability to pay back the money it borrows.

17. Debt-Service Coverage Ratio

Debt-service coverage reflects whether a company can pay all of its debts, including interest and principal, at any given time. This ratio can offer creditors insight into a company’s cash flow and debt situation.

Formula:

Debt-Service Coverage Ratio = Operating Income / Total Debt Service Costs

Example:

A ratio above 1 means the company has more than enough money to meet its debt servicing needs. A ratio equal to 1 means its operating income and debt service costs are the same. A ratio below 1 indicates that the company doesn’t have enough operating income to meet its debt service costs.

18. Interest-Coverage Ratio

Interest-coverage ratio is a financial ratio that can tell you whether a company is able to pay interest on its debt obligations on time. This is sometimes called the times interest earned (TIE) ratio. Its chief use is to help determine whether the company is creditworthy.

Formula:

Interest Coverage Ratio = EBIT ( Earnings Before Interest and Taxes) / Annual Interest Expense

Example:

Let’s say a company has an EBIT of $100,000. Meanwhile, annual interest expense is $25,000. That results in an interest coverage ratio of 4, which means the company has four times more earnings than interest payments.

19. Asset-Coverage Ratio

Asset-coverage ratio measures risk by determining how much of a company’s assets would need to be sold to cover its debts. This can give you an idea of a company’s financial stability overall.

Formula:

Asset Coverage Ratio = (Total Assets – Intangible Assets) – (Current Liabilities – Short-term Debt) / Total Debt

You can find all of this information on a company’s balance sheet. The rules for interpreting asset coverage ratio are similar to the ones for debt service coverage ratio.

So a ratio of 1 or higher would suggest the company has sufficient assets to cover its debts. A ratio of 1 would suggest that assets and liabilities are equal. A ratio below 1 means the company doesn’t have enough assets to cover its debts.

Recommended: What Is a Fixed Charge Coverage Ratio?

Market-Prospect Ratios

Market-prospect ratios make it easier to compare the stock price of a publicly traded company with other financial ratios. These ratios can help analyze trends in stock price movements over time. Earnings per share and price-to-earnings are two examples of market prospect ratios, discussed above. Investors can also look to dividend payout ratios and dividend yield to judge market prospects.

20. Dividend Payout Ratio

Dividend payout ratio can tell you how much of a company’s net income it pays out to investors as dividends during a specific time period. It’s the balance between the profits passed on to shareholders as dividends and the profits the company keeps.

Formula:

Dividend Payout Ratio = Total Dividends / Net Income

Example:

A company that pays out $1 million in total dividends and has a net income of $5 million has a dividend payout ratio of 0.2. That means 20% of net income goes to shareholders.

21. Dividend Yield

Dividend yield is a financial ratio that tracks how much cash dividends are paid out to common stock shareholders, relative to the market value per share. Investors use this metric to determine how much an investment generates in dividends.

Formula:

Dividend Yield = Cash Dividends Per Share / Market Value Per Share

Example:

For example, a company that pays out $5 in cash dividends per share for shares valued at $50 each are offering investors a dividend yield of 10%. This can be compared to the dividend yield of another company when choosing between investments.

Ratio Analysis: What Do Financial Ratios Tell You?

Financial statement ratios can be helpful when analyzing stocks. The various formulas included on this financial ratios list offer insight into a company’s profitability, cash flow, debts and assets, all of which can help you form a more complete picture of its overall health. That’s important if you tend to lean toward a fundamental analysis approach for choosing stocks.

Using financial ratios can also give you an idea of how much risk you might be taking on with a particular company, based on how well it manages its financial obligations. You can use these ratios to select companies that align with your risk tolerance and desired return profile.

Test your understanding of what you just read.

The Takeaway

Learning the basics of key financial ratios can be helpful when constructing a stock portfolio. Rather than focusing only on a stock’s price, you can use financial ratios to take a closer look under the hood of a company, to gauge its operating efficiency, level of debt, and profitability.

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

FAQ

Which ratios should you check before investing?

Many investors start with basics like the price-to-earnings (P/E) ratio, the debt-to-equity (D/E) ratio, and the working capital ratio. But different ratios can provide specific insights that may be more relevant to a certain company or industry, e.g., knowing the operating-margin ratio or the inventory-turnover ratio may be more useful in some cases versus others.

What is the best ratio when buying a stock?

There is no “best” ratio to use when buying a stock, because each financial ratio can reveal an important aspect of a company’s performance. Investors may want to consider using a combination of financial ratios in order to make favorable investment decisions.

What is a good P/E ratio?

In general, a lower P/E ratio may be more desirable than a higher P/E ratio, simply because a higher P/E may indicate that investors are paying more for every dollar of earnings — and the stock may be overvalued.

Photo credit: iStock/MStudioImages

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

SOIN-Q325-093

Oct

2025

Wash Trading: What Is It and How Does It Work?

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

Table of Contents

What Is Wash Trading?
How Does Wash Trading Work?
Example of a Wash Trade
Is Wash Trading Illegal?
Difference Between Wash Trading & Market Making
How to Detect & Avoid Wash Trading
FAQ

Wash trading is an illegal practice in which an investor buys and sells the same or a nearly identical stock or security within a certain period of time. Wash trading is a prohibited activity under the Commodity Exchange Act (CEA) of 1936 and the Securities Exchange Act of 1934.

Wash trading is basically an attempt at market manipulation and a way to portray false market activity. Read on to learn about the implications of wash trading and how it works.

Key Points

• Wash trading is a prohibited practice in which investors engage in buying and selling the same or similar securities to create the illusion of trading activity.

• This practice can be a form of market manipulation and a way to portray false market activity.

• The goal of wash trading is often to influence pricing or trading activity.

• Wash trading is illegal and may result in penalties from regulatory agencies.

• A wash sale is different from wash trading. The wash sale rule prohibits an investor from taking a tax deduction on a loss when they purchase the same or substantially identical security within 30 days before or after the sale.

What Is Wash Trading?

Wash trading occurs when an investor buys and sells the same or a similar security investment around the same time. This is also called round-trip trading, since an investor is essentially ending where they began — with shares of the same security in their portfolio.

Wash trades can be used as a form of market manipulation. Investors may buy and sell the same securities in an attempt to influence pricing or trading activity. The goal may be to spur buying activity to send prices up or encourage selling to drive prices down.

Some investors and brokers might work together to influence trading volume, usually for the financial benefit of both sides. The broker, for example, might benefit from collecting commissions from other investors who want to purchase a stock being targeted for wash trading. The investor, on the other hand, may realize gains from the sale of securities through price manipulation.

Wash trading is different from insider trading, which requires the parties involved to have some special knowledge about a security that the general public doesn’t. However, if an investor or broker possesses insider knowledge they could potentially use it to complete wash trades.

How Does Wash Trading Work?

Essentially, a wash trade means an investor is buying and selling shares of the same security at around the same time. But the definition of wash trades goes further and takes the investor’s intent (and that of any broker they may be working with) into account. There are generally two conditions that must be met for a wash trade to exist:

• Intent. The intent of the parties involved in a wash trade (i.e., the broker or the investor) must be that at least one individual involved in the transaction must have entered into it specifically for that purpose.

• Result. The result of the transaction must be a wash trade, meaning the same asset was bought and sold at the same time or within a relatively short time span for accounts with the same or common beneficial ownership.

Beneficial ownership means accounts that are owned by the same individual or entity. Trades made between accounts with common beneficial ownership may draw the eye of financial regulators, as they can suggest wash trading activity is at work.

Wash trades don’t necessarily have to involve actual trades, however. They can also happen if investors and traders appear to make a trade on paper without any assets changing hands.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Example of a Wash Trade

Here’s a wash trade example:

Say an investor owns 100 shares of a stock and sells those shares at a $5,000 loss on September 1. On September 5, they purchase 100 shares of the same stock, then resell them for a $10,000 gain. This could be considered a wash trade if the investor engaged in the trading activity with the intent to manipulate the market.

Is Wash Trading Illegal?

Yes, wash trading is illegal. The Commodity Exchange Act prohibits wash trading. Prior to the passage of the Act, traders used wash trading to manipulate markets and stock prices. The Commodity Futures Trade Commission (CFTC) also enforces regulations regarding wash trading, including guidelines that bar brokers from profiting from wash trade activity.

It’s important to distinguish between wash trading and a wash sale, which is an IRS rule. The IRS wash sale rule does not allow investors to deduct capital losses on their taxes from sales or trades of stocks or other securities in particular circumstances.

Under the IRS rules, a wash sale occurs when an investor sells or trades stocks at a loss and within 30 days before or after the sale they:

• Purchase substantially identical stock or securities

• Acquire substantially identical stock or securities in a fully taxable trade

• Acquire a contract or option to buy substantially identical stock or securities, or

• Acquire substantially identical stock for your individual retirement arrangement (IRA) or Roth IRA

Wash sale rules also apply if an investor sells stock and their spouse or a corporation they control buys substantially identical stock. When a wash sale occurs, an investor is not able to claim a tax deduction for those losses.

Essentially, the IRS wash sale rule is a tax rule. Wash trading is a form of intentional market manipulation.

Difference Between Wash Trading & Market Making

Market making and wash trading are not the same thing. A market maker is a firm or individual that buys or sells securities at publicly quoted prices on-demand, and a market maker provides liquidity and facilitates trades between buyers and sellers. For example, if you’re trading through an online broker you’re using a market maker to complete the sale or purchase of securities.

Market making is not market manipulation. A market maker is, effectively, a middleman between investors and the markets. While they do profit from their role by maintaining spreads on the stocks they cover, this is secondary to fulfilling their purpose of keeping shares and capital moving.

Recommended: What Is a Brokerage Account?

How to Detect & Avoid Wash Trading

The simplest way to avoid wash trading as an investor is to be aware of what constitutes a wash trade. Again, this can mean the intent to manipulate the markets by placing similar trades within a short timeframe.

Investors may notice red flags that may signal wash trading, such as multiple trades that have identical quantities and prices, repeated buying and selling between certain traders, and unusual trading patterns or volumes. Financial institutions and regulators also monitor trading data to identify or help prevent manipulative or abusive trading.

To avoid a wash sale, conversely, an investor could be mindful of the securities they are buying and selling and the timeframe in which those transactions are completed. So selling XYZ stock at a loss, then buying it again 10 days later to sell it for a profit would likely constitute a wash sale if they executed the trade and attempted to deduct the initial loss on their taxes.

It’s also important to understand how the 30-day period works. The 30-day rule extends to the 30 days prior to the sale and 30 days after the sale. So effectively, an investor could avoid the wash sale rule by waiting 61 days to replace assets that they sold in their portfolio.

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

The Takeaway

Wash trading involves selling certain securities and then replacing them in a portfolio with identical or very similar securities within a certain time period. This is typically done with the intent to manipulate the market. Wash trading is illegal.

Wash trading is not to be confused with the wash sale rule. For investors, understanding when the IRS wash sale rule applies can help them comply with tax guidelines. Those who are unclear about it, may wish to consult with a financial or tax professional.

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

FAQ

What’s considered wash trading

Wash trading is an illegal practice in which an investor buys and sells the same or a nearly identical security with the intent of falsely implying increased trading activity. It’s a form of market manipulation that could deceive other investors into making trades.

What’s the difference between wash trading and the wash sale rule?

Wash trading is an illegal practice with an intent to manipulate the market. The wash sales rule is a tax rule that says an investor cannot sell stock or securities for a loss and then buy substantially identical shares within 30 days before or after the sale and claim the deduction of the sale on their taxes.

Is a wash sale illegal?

No, a wash sale is not illegal. A wash sale is a tax rule that does not allow investors to claim a tax deduction if they sold a stock for a loss and then bought a substantially similar stock or security within 30 days before or after the sale.

How do day traders avoid wash sales?

To properly follow the IRS wash sales rule, an investor can wait for more than 30 days before or after the sale of a stock or security for a loss — meaning for a total of 61 days — before purchasing one that’s identical or substantially identical and then claiming the deduction for the sale on their taxes.

Photo credit: iStock/mapodile

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

SOIN-Q325-105

Oct

2025

Understanding the Different Types of Mutual Funds

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

Table of Contents

How Mutual Funds Work
9 Types of Mutual Funds
What’s the Difference Between Mutual Funds and ETFs?
FAQ

A mutual fund is a portfolio or basket of securities (often stocks or bonds) where investors pool their money. Nationally, there are more than 7,000 mutual funds investors can choose from, spanning equity funds, bond funds, growth funds, sector funds, index funds, and more.

Mutual funds are typically actively managed, where a manager or team of professionals decides which securities to buy and sell, although some are passively managed, where the fund simply tracks an index like the S&P 500. The main differences among mutual funds typically come down to their investment objectives and the strategies they use to achieve them.

Key Points

• Mutual funds pool money from many investors to build a diversified portfolio of securities.

• Equity funds are higher risk, but have the potential to offer higher long-term growth; bond funds are typically lower risk, but may provide steady income.

• Money market funds are structured to be highly illiquid and low risk, typically appropriate for short-term investments

• Index funds passively track market indices, and may offer lower fees and tax efficiency.

• Balanced funds have a (typically) fixed allocation of stocks and bonds, which may be suitable for moderate risk investors.

How Mutual Funds Work

Mutual funds pool money from many investors to buy a diversified mix of securities, known as a portfolio. These may include:

• Stocks

• Bonds

• Money market instruments

• Cash or cash equivalents

• Alternative assets (such as real estate, commodities, or precious metals)

Mutual funds are typically open-end funds, which means shares are continuously issued based on demand, while existing shares are redeemed (or bought back). In contrast, a closed-end fund issues a set number of shares at once during an initial public offering.

You can buy mutual fund shares through a brokerage account, retirement plan, or sometimes directly from the financial group managing the fund. For example, you might hold mutual funds inside a taxable investment account, within an individual retirement account (IRA) with an online brokerage, or as part of your 401(k) at work.

One of the main advantages of mutual funds is the potential for diversification. If one holding underperforms or loses value, the other investments in the fund may help offset those losses, reducing overall portfolio risk.

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

Alternative investments,
now for the rest of us.

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

9 Types of Mutual Funds

Before adding mutual funds to your portfolio, it’s important to understand the different types. Some funds aim for growth, while others focus on steady income. Certain mutual funds may carry a higher risk profile than others, though they may offer the potential for higher rewards.

Knowing more about the different mutual fund options can make it easier to choose investments that align with your goals and tolerance for risk.

1. Equity Funds

• Structure: Typically open-end

• Risk Level: High

• Goal: Growth or income

• Asset Class: Stocks

Equity funds primarily invest in stocks to pursue capital appreciation and potential income from dividends. The types of companies an equity fund invests in will depend on the fund’s objectives.

For example, some equity funds may concentrate on blue-chip companies that tend to offer consistent dividends, while others may lean toward companies that have significant growth potential. Equity funds can also be categorized based on whether they invest in large-cap, mid-cap, or small-cap stocks.

Investing in equity funds can offer the opportunity to earn higher rewards, but they tend to present greater risks. Since the prices of underlying equity investments can fluctuate day to day or even hour to hour, equity funds tend to be more volatile than other types of mutual funds.

2. Bond (Fixed-Income) Funds

• Structure: Typically open-end; some closed-end

• Risk Level: Low

• Goal: Steady income

• Asset Class: Bonds

Bond funds invest in debt securities, such as government, municipal, or corporate bonds. They give investors a convenient way to access the fixed-income market without buying individual bonds. Some bond funds try to mirror the broad bond market and include short- and long-term bonds from a wide variety of issuers, while other bond funds specialize in certain types of bonds, such as municipal bonds or corporate bonds.

Generally, bond funds tend to be lower risk compared to other types of mutual funds, and bonds issued by the U.S Treasury are backed by the full faith and credit of the U.S. government. However, bonds are not risk-free. Bonds are typically sensitive to interest rate risk (meaning their market value fluctuates inversely with changes in interest rates), as well as credit risk (since a bond’s value is directly tied to the issuer’s ability to repay its debt).

3. Money Market Funds

• Structure: Open-end

• Risk Level: Low

• Goal: Income generation

• Asset Class: Short-term debt instruments

Money market funds invest in high-quality, short-term debt from governments, banks or corporations. This may include government bonds, municipal bonds, corporate bonds, and certificates of deposit (CDs). Money market funds may also hold cash and cash equivalent securities.

Money market funds can be labeled according to what they invest in. For example, Treasury funds invest in U.S. Treasury securities, while government money market funds can invest in Treasuries as well as other government-backed assets.

In terms of risk, money market funds are considered to be very low risk. That means, however, that money market mutual funds tend to produce lower returns compared to other mutual funds.

It’s also worth noting that money market funds are not the same thing as money market accounts (MMAs). Money market accounts are deposit accounts offered by banks and credit unions. While these accounts can pay interest to savers, they’re more akin to savings accounts than investment vehicles. While money market accounts may be covered by the Federal Deposit Insurance Corporation (FDIC), money market funds may alternatively be insured by the Securities Investor Protection Corporation (SIPC).

4. Index Funds

• Structure: Open-end

• Risk Level: Moderate

• Goal: To replicate the performance of an underlying market index

• Asset Class: Stocks, bonds, or both

Index funds are designed to match the performance of an underlying market index. For example, an index fund may attempt to mirror the returns of the S&P 500 Index or the Russell 2000 Index. The fund does this by investing in some or all of the securities included in that particular index, a process that’s typically automated. Because of this, index funds are considered passively managed, unlike actively managed funds where a manager actively trades to try to exceed a benchmark.

Because index funds need much less hands-on management and don’t require specialized research analysts, they’re generally lower cost than actively managed funds. They’re also considered to be more tax-efficient due to their potentially longer holding periods and less frequent trading, which may result in fewer taxable events. However, an index fund may include both high- and low-performing stocks and bonds. As a result, any returns you earn would be an average of them all.

5. Balanced Funds

• Structure: Open-end

• Risk Level: Moderate

• Goal: Provide both growth and income

• Asset Class: Stocks and bonds

Balanced funds, sometimes referred to as hybrid funds, typically contain a fixed allocation of stocks and bonds for investors interested in both income and capital appreciation. One common example of a balanced fund is a fund that invests 60% of its portfolio in stocks and 40% of its portfolio in bonds.

By holding both growth-oriented equities (stocks) and stability-focused, fixed-income securities (bonds) in one portfolio, these funds aim to provide a middle ground between the high-risk/high-return profile of equity funds and the low-risk/low-return profile of bond funds. Balanced funds automatically maintain their asset allocation and may make sense for moderately conservative, hands-off investors seeking long-term growth potential.

6. Income Funds

• Structure: Open-end

• Risk Level: Low to moderate

• Goal: Provide steady income

• Asset Class: Bonds, income-generating assets

Income funds are designed with the goal of providing investors with regular income through interest or dividends, rather than focusing mainly on long-term growth. Some income funds focus on bonds, such as government, municipal, or corporate bonds, while others mix equities with bonds to offer a diversified approach to income generation.

Though not risk-free, income funds are generally lower risk than funds that prioritize capital gains. This type of mutual fund can be appealing to investors who value stability and regular cash flow, such as retirees. Income funds may also help balance risk in any investor’s portfolio, especially in uncertain markets.

7. International Funds

• Structure: Mostly open-end

• Risk Level: High

• Goal: Growth or income outside the U.S.

• Asset Class: Global equities and bonds (excluding U.S. securities)

International mutual funds invest in securities and companies outside of the U.S. This sets them apart from global funds, which can hold a mix of both U.S. and international securities. Some international funds focus on developed economies, while others target emerging markets, which may offer higher growth but come with higher risk.

Adding international funds to a portfolio can increase diversification and access to global opportunities if you’ve primarily invested in U.S. companies or bonds so far. But keep in mind that international funds can carry unique risks, including the risk of currency volatility and changing economic or political environments, especially in emerging markets.

8. Specialty Funds

• Structure: Open or closed-end

• Risk Level: Varies

• Goal: Thematic or sector-specific investing

• Asset Class: Equities, bonds, alternatives

A specialty fund concentrates on a specific sector, industry, or investment theme, such as technology, health care, or clean energy. They allow investors to target specific opportunities and expand their portfolios beyond traditional stocks or bonds. Specialty funds can offer exposure to assets like real estate, commodities, or even precious metals. You could also use specialty funds to pursue specific investing goals, such as investing with environmental, social, and governance (ESG) principles in mind.

Because of their narrower focus, specialty funds frequently offer less diversification, which means they may come with higher potential risks. This type of mutual fund is generally best suited for investors with a deep understanding of the target market.

💡 Quick Tip: Spreading investments across various securities may help ensure your portfolio is 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.

9. Target Date Funds

• Structure: Typically open-end

• Risk Level: Declines over time

• Goal: Retirement planning

• Asset Class: Mix of stocks, bonds, and short-term investments

Target date funds are mutual funds that adjust their asset allocation automatically so the fund becomes more conservative as the target (typically retirement) date approaches. For example, if you were born in 2000 and plan to retire at 65, you would invest in a 2065 fund. As you get closer to retirement age, your target date fund will gradually become more conservative, increasing its allocations to bonds, cash, or cash equivalents.

Like mutual funds, target date funds are offered by nearly every investment company. In most cases, they’re recognizable by the year in the fund name. If you have a 401(k) at work, you may have access to various target date funds for your portfolio.

While target date funds offer a “set it and forget it” option for retirement planning, they are a one-size-fits-all solution that does not account for an individual’s unique financial situation, risk tolerance, or outside assets. Some investors may prefer a more aggressive or conservative allocation than the one the fund provides.

What’s the Difference Between Mutual Funds and ETFs?

It can be easy to confuse exchange-traded funds (ETFs) with mutual funds, since they have a number of similarities. Both are baskets of securities designed to provide diversification. And both can hold stocks, bonds, or a mix, or follow specific themes or strategies.

However, ETFs and mutual funds differ in several key ways:

• Trading: ETFs trade throughout the day like stocks, while mutual funds are priced only once daily after the market closes.

• Liquidity: Because they trade on exchanges throughout the day, ETFs are generally more liquid than traditional mutual funds.

• Management: Most EFTs are passively managed, while mutual funds are typically actively managed.

• Cost: Because they are largely passively managed, EFTs often carry lower expenses ratios.

The Takeaway

Mutual funds are among the most accessible and flexible investment options available. With choices ranging from conservative money market funds to aggressive equity and specialty funds, there’s a fund for nearly every type of investor.

The best mutual fund for you depends on your goals, time horizon, and tolerance for risk. Whether you’re seeking steady income, long-term growth, international exposure, or a hand-off retirement plan, understanding the different types of mutual funds can help you build a portfolio that supports your financial future.

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

FAQ

What are the four main types of mutual funds?

The four main types of mutual funds are equity funds, debt funds, money market funds, and hybrid funds.

Equity funds invest primarily in stocks and aim for long-term capital growth. Debt funds focus on fixed-income securities like bonds, offering relatively stable returns. Money market funds invest in short-term, low-risk instruments such as Treasury bills. Hybrid funds combine equity and debt securities in varying proportions to balance risk and reward. Each type suits different investor goals, risk tolerances, and time horizons.

What is the 7-5-3-1 rule in SIP?

The 7-5-3-1 rule in SIP (systematic investment plan) is a guideline for disciplined investing. The 7 suggests staying invested for at least seven years to reap the benefits of compounding and market growth. The 5 suggests diversifying your investments across at least five different mutual fund categories to help reduce risk. The 3 is about overcoming three common mental hurdles investors face (disappointment, frustration, and panic). The 1 suggests increasing your SIP amount every year to improve your return potential in the long term.

Which type of mutual fund is best?

The “best” type of mutual fund depends on your goals, risk tolerance, and time horizon. For long-term wealth creation, equity funds often provide the highest growth potential but come with more risk. For those prioritizing stable returns, debt funds or money market funds may be a favorable choice. Investors seeking balance may prefer hybrid funds. The best fund is one that is aligned with your unique financial objectives.

Photo credit: iStock/simonapilolla

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. 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.

Mutual Funds (MFs): 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 clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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 emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.

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

S&P 500 Index: The S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an investment product, but a measure of U.S. equity performance. Historical performance of the S&P 500 Index does not guarantee similar results in the future. The historical return of the S&P 500 Index shown does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. This should not be considered a recommendation to participate in IPOs and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation. 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 more information on the allocation process please visit IPO Allocation Procedures.

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

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

Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®

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