Mar
13
2024
What is a Glide Path?

Guide to Glide Paths for 401(k)

By | invest, Investing, Preparing for Retirement | Comments Off on Guide to Glide Paths for 401(k)

Asset managers use a “glide path” to determine how the asset allocation of a target-date retirement fund will change based on the number of years until the fund’s target date. Each target-date fund has its own glide path, though they typically begin with a more aggressive allocation that gets more conservative over time.

The idea behind most target date fund glide paths is that investors with a longer-term time horizon should have a higher percentage of their portfolio in riskier assets, like stocks, since they have time to recover from short-term volatility. As their retirement date approaches (or once they’ve started retirement), investors likely will benefit from a more conservative portfolio that protects the assets they’ve already accumulated.

What Is a Glide Path?

The glide path is the formula that asset managers choose when they put together a target-date mutual fund that determines how and when that portfolio will adjust its asset allocation over time.

Target-date funds (and their glide paths) are common investment choices in 401(k) accounts, as well as in other types or retirement accounts, such as a Roth or traditional IRA set up through a brokerage account.

A key component to saving for retirement is having a suitable mix of investments that allow for portfolio diversification. Early on, most glide paths focus on stocks that typically offer the greatest potential to grow in value over time and then shift to bonds and other fixed-income investments according to the investor’s risk tolerance to manage volatile price swings as they grow older.

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Understanding Glide Path

The glide paths within target-date funds aim to create a set-it-and-forget-it investing option for retirement savers, who may get diversification based on their time horizon within a single fund. Investors who are younger and have 20 to 30 years until retirement typically need to maximize their portfolio growth, which requires a much higher allocation toward stocks.

By comparison, someone who is nearing retirement or has already retired, may need to scale back on their portfolio risk. Glide path investing automatically reallocates the latter investor’s portfolio toward bonds which are typically lower risk investments with lower returns compared to stocks but provide portfolio stability. That also generally means that younger investors in a target-date fund will typically have higher 401(k) returns than older investors.

Types of Glide Paths for Retirement Investing

There are different glide path strategies depending on an investor’s risk tolerance and when they plan to retire. Typically, target-date funds have a declining glide path, although the rate at which it declines (and the investments within its allocation vary depending on the fund).

Declining Glide Path

A declining glide path reduces the amount of risk that a target-date fund takes over time. In general, it makes sense for retirees or those approaching retirement to reduce their investment risk with a more conservative portfolio as they age. A decreasing glide path is the more common approach used. It involves a higher equity risk allocation that steadily declines as retirement approaches.

Static Glide Path

Some target-date funds may have a static glide path during some years. During this time, the investment mix would remain at a set allocation, such as 60% stocks and 40% bonds. Managers maintaining portfolios that have a static glide path rebalance them regularly to maintain this allocation.

Rising Glide Path

Some specialists believe that the glide path should begin to rise again once an investor reaches retirement age, taking on more risk over time. This argument takes the position that increasing risk in a retiree’s portfolio could reduce volatility in the early stages of retirement when the portfolio is at risk of losing the most wealth in the event of a stock market decline.

An increasing glide path may be an option to consider for retirees with pension benefits or higher withdrawal rates or those who are working in retirement. If a retiree understands the risk involved and is comfortable taking it on, this strategy might make sense, however, generally speaking, the rising glide path is the least utilized method for retirement planning.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Choosing the Right Glide Path

If you’re saving for retirement in a 401(k), there may only be one target-date option available to you based on your target-retirement age. However, if you have choices within your 401(k) or you’re choosing a target-date fund within an individual retirement account or another investment vehicle, you’ll want to look for a target-date fund with a strategy that aligns with your investment view.

One rule of thumb uses the “rule of 100,” which subtracts the investor’s age from 100 to determine the percentage of your portfolio that should be in stocks. However, some managers use glide paths that decline more or less quickly than that.

Some target-date funds also incorporate alternative assets, such as private equity or real estate, in addition to traditional stocks and bonds.

”To” or “Through” Retirement

When glide paths reach retirement date, they can take one of two approaches, either a “To” or “Through” approach. A “To” retirement glide path is a target-date fund strategy that reaches its most conservative asset allocation when retirement starts. This strategy generally holds lower exposure to risk assets during the working phase and at the target retirement date. This means, at retirement, it reduces exposure to riskier assets, like equities, and moves into more conservative assets, like bonds.

“Through” glide paths tend to maintain a higher allocation toward riskier assets as investors accumulate savings at their target retirement date and years into retirement. This means exposure to equities in retirement tends to be higher, at least in the first few years of retirement.

In choosing which path is best suited to you, you must determine your risk tolerance and how aggressive or conservative you are able to be. This includes deciding how much exposure to equities you can afford to have. Decreasing exposure to stocks means investors may not have to worry as much about a portfolio that fluctuates in value, whereas an increased exposure to equities may mean a portfolio with more volatility that could have potential for greater gains over time.

The Takeaway

Glide paths are formulas that investment managers create to determine the level of risk in a target-date fund. The idea is that a portfolio automatically adjusts itself based on risk tolerance that changes as the investor ages, allowing for a more hands-off approach.

Glide paths are common investment choices in retirement accounts such as 401(k)s and IRAs. As you’re determining your retirement savings strategy, carefully consider whether they may make sense for you.

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FAQ

What does glide path approach mean?

A glide path refers to a formula that asset managers use to determine the allocation mix of assets in a target-date retirement portfolio and how it changes over time. A target-date retirement portfolio tends to become more conservative as the investor ages, but there are multiple glide paths to take account to a retiree’s risk tolerance.

What is a retirement glide path?

A retirement glide path is the approach within a target-date fund that includes a diversified portfolio of stocks and bonds. Retirement glide paths typically start out with a more aggressive mix of investments and get more conservative over time.

Which type of mutual fund follows a glide path?

Target-date retirement funds are the most common type of mutual fund that follows a glide path. However managers may also use glide paths for other time-focused, long-term investments, such as 529 retirement accounts.

What is an example of a glide path?

Here is one example of a glide path: Say an investor plans to retire in 2050 and buys a target-date 2050 fund. If the investor is using a declining glide path strategy, it will automatically reduce the amount of risk that the target-date fund takes over time. So, for instance, the target-date fund might have 70% stocks and 30% bonds at the beginning, but over time, the amount allocated to stocks will steadily decline, and the amount allocated to bonds will steadily increase —making the portfolio more conservative as the investor approaches retirement.

What are the benefits of a glide path?

Benefits of a glide path may include making investing easier because the process of changing asset allocation is automatic, and allowing for an essentially hands-off approach since glide paths are professionally managed. However, there are drawbacks to consider as well, including possibly higher management fees for some target-date funds.

Photo credit: iStock/akinbostanci

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

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

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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.
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Mar
12
2024

What Is 401(k) Plan Benchmarking?

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on What Is 401(k) Plan Benchmarking?

Benchmarking a 401(k) retirement plan refers to how a company assesses their plan’s design, fees, and services to ensure they meet industry and ERISA (Employee Retirement Income Security Act) standards.

Benchmarking 401(k) plans is important for a few reasons. First, the company offering the plan needs to be confident that they are acting in the best interests of employees who participate in the 401(k) plan. And because acting in the best interests of plan participants is part of an employer’s fiduciary duty, benchmarking can help reduce an employer’s liability if fiduciary standards aren’t met.

If a company’s plan isn’t meeting industry benchmarks, it may be wise for an employer to change plan providers. Learn more about how benchmarking works and why it’s important.

How 401(k) Benchmarking Works

While a 401(k) is a convenient and popular way for participants to invest for retirement, the company offering the plan has many responsibilities to make sure that its plan is competitive. That is where 401(k) benchmarking comes into play.

An annual checkup is typically performed whereby a company assesses its plan’s design, evaluates fees, and reviews all the services offered by the plan provider. The 401(k) plan benchmarking process helps ensure that the retirement plan reduces the risk of violating ERISA rules. For the firm, a yearly review can help reduce an employer’s liability and it can save the firm money.

ERISA, the Employee Retirement Income Security Act, requires that the plan sponsor verifies that the 401(k) plan has reasonable fees. ERISA is a federal law that mandates minimum standards that retirement plans must meet. It helps protect plan participants and beneficiaries.

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The Importance of 401(k) Plan Benchmarking

It is important that an employer keep its 401(k) plan up to today’s standards. Making sure the plan is optimal compared to industry averages is a key piece of retirement benchmarking. It’s also imperative that your employees have a quality plan to help them save and invest for retirement. Most retirement plan sponsors conduct some form of benchmarking planning, and making that a regular event — such as annually — is important so that the employer continuously complies with ERISA guidelines.

Employers have a fiduciary responsibility to ensure that fees are reasonable for services provided. ERISA also states that the primary responsibility of the plan fiduciaries is to act in the best interest of their plan participants. 401(k) benchmarking facilitates the due diligence process and reduces a firm’s liability.

How to Benchmark Your 401(k) Plan: 3 Steps

So, as an employer, how exactly do you go about benchmarking 401(k) plans? There are three key steps that plan sponsors should take so that their liability is reduced, and the employees get the best service for their money. Moreover, 401(k) benchmarking can help improve your service provider to make your plan better.

1. Assess Your 401(k) Plan Design

It’s hard to know if your retirement plan’s design is optimal. Two gauges used to figure its quality are plan asset growth and the average account balance. If workers are continuously contributing and investments are performing adequately compared to market indexes, then those are signs that the plan is well designed.

Benchmarking can also help assess if a Roth 401(k) feature should be added. Another plan feature might be to adjust the company matching contribution or vesting schedule. Optimizing these pieces of the plan can help retain workers while meeting ERISA requirements.

2. Evaluate Your 401(k) Plan Fees

A 401(k) plan has investment, administrative, and transaction fees. Benchmarking 401k plan fees helps ensure total costs are reasonable. It can be useful to take an “all-in” approach when assessing plan fees. That method can better compare service providers since different providers might have different terms for various fees. But simply selecting the cheapest plan does not account for the quality and depth of services a plan renders. Additional benchmarking is needed to gauge a retirement plan’s quality. Here are the three primary types of 401(k) plan fees to assess:

•   Administrative: Fees related to customer service, recordkeeping, and any legal services.

•   Investment: Amounts charged to plan participants and expenses related to investment funds.

•   Transaction: Fees involved with money movements such as loans, withdrawals, and advisory costs.

3. Evaluate Your 401(k) Provider’s Services

There are many variables to analyze when it comes to 401(k) benchmarking of services. A lot can depend on what your employees prefer. Reviewing the sponsor’s service model, technology, and execution of duties is important.

Also, think about it from the point of view of the plan participants: Is there good customer service available? What about the quality of investment guidance? Evaluating services is a key piece of 401(k) plan benchmarking. A solid service offering helps employees make the most out of investing in a 401(k) account.

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

Investing for Retirement With SoFi

Investing for retirement is more important than ever as individuals live longer and pension plans are becoming a relic of the past. With today’s technology, and clear rules outlined by ERISA, it can be easier for workers to take advantage of high-quality 401(k) plans to help them save and invest for the long term.

For the company offering the plan, establishing a retirement benchmarking process is crucial to keeping pace with the best 401(k) plans. Reviewing a plan’s design, costs, and services helps workers have confidence that their employer is working in their best interests. Benchmarking can also protect employers.

If your company already has a 401(k) plan that you contribute to as an employee, you might also consider other individual retirement accounts to open. You can learn more about various options available, such as IRAs. There are different types of IRAs, including traditional and Roth IRAs. You may want to explore them to see which might be best to help you reach your retirement savings goals.

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


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FAQ

How often should a 401(k) be benchmarked?

It’s considered a best practice to benchmark a 401(k) annually to make sure the plan complies with ERISA guidelines. Making sure that the plan’s fees are reasonable and acting in the best interests of plan participants is part of an employer’s fiduciary duty. Benchmarking facilitates the due diligence process and reduces an employer’s liability if fiduciary standards aren’t met.

How do I benchmark my 401(k) fees?

To benchmark your 401(k) fees, take an “all-in” approach by calculating the service provider fees plus the investment expenses for the plan. This helps you compare your plan’s fees to fees charged by other service providers. In addition, assess the plan’s quality by looking at administrative fees (fees related to customer service and recordkeeping, for instance), investment fees (expenses related to investment funds and amounts charged to participants in the plan), and transaction fees (fees related to moving money, such as withdrawals or loans).

Photo credit: iStock/MicroStockHub

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

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

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.

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


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

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Mar
08
2024
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Stock Buyback: What It Means & Why It Happens

By | Growing Wealth, invest, Investing, Terminology | No Comments

One of the most popular ways a company can use its cash is through a stock buyback. Over the past five years, according to S&P Dow Jones Indices, big companies have spent more than $3.9 trillion repurchasing their own shares to boost shareholder value. Because of this significant activity, investors need to know the basics of stock buybacks and how they work to feel confident in making investment decisions.

What Is A Stock Buyback?

A stock buyback, also known as a share repurchase, is when a company buys a portion of its previously issued stock, reducing the total number of outstanding shares on the market. Because there are fewer total shares on the market after the buyback, each share owned by investors represents a greater portion of company ownership.

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How Do Companies Buy Back Stock?

Companies can repurchase stock from investors through the open market or a tender offer.

Open market

A company may buy back shares on the open market at the current market price, just like a regular investor would. These stock purchases are conducted with the company’s brokers.

Tender offers

A company may also buy back shares through a tender offer. One type of tender offer, the fixed-price offer, occurs when a company proposes buying back shares from investors at a fixed price on a specific date. This process usually values the shares at a higher price than the current price per share on the open market, providing an extra benefit to shareholders who agree to sell back the shares.

Another type of tender offer, the dutch auction offer, will specify to investors the number of shares the company hopes to repurchase and a price range. Shareholders can then counter with their own proposals, which would include the number of shares they’re willing to give up and the price they’re asking. When the company has all of the shareholders’ offers, it decides the right mix to buy to keep its costs as low as possible.

Why Do Companies Buy Back Stock?

Stock buybacks are one of several things a company can do with the cash it has in its coffers, including paying the money out to shareholders as a dividend, reinvesting in business operations, acquiring another company, and paying off debt. There are several reasons why a company chooses to buy back its stock rather than some of these other options.

1. Increases Stock Value

One of the most common reasons a company might conduct a share buyback is to increase the value of the stock, especially if the company considers its shares undervalued. By reducing the supply of shares on the market, the stock price will theoretically go up as long as the demand for the stock remains the same. The rising stock price benefits existing shareholders.

Recommended: Understanding Capital Appreciation on Investments

2. Puts Money Into Shareholders’ Hands

A company’s stock buyback program can be used as an alternative to dividend payments to return cash to shareholders, specifically those investors who choose to sell back their shares to the company. With dividend payments, companies usually pay them regularly to all shareholders, so investors may not like it if a company reduces or suspends a dividend. Stock buybacks, in contrast, are conducted on a more flexible basis that may benefit the company because investors do not rely on the payments.

3. Takes advantage of tax benefits

Many investors prefer that companies use excess cash to repurchase stock rather than pay out dividends because buybacks have fewer direct tax implications. With dividends, investors must pay taxes on the payout. But with stock buybacks, investors benefit from rising share prices but do not have to pay a tax on this benefit until they sell the stocks. And even when they sell the stock, they usually pay a lower capital gains tax rate.

4. Offsets dilution from stock options

Companies will often offer employee stock options as a part of compensation packages to their employees. When these employees exercise their stock, the number of shares outstanding increases. To maintain an ideal number of outstanding shares after employees exercise their options, a company may buy back shares from the market.

5. Improves financial ratios

Another way stock buybacks attract more investors is by making the company’s financial ratios look much more attractive. Because the repurchases decrease assets on the balance sheet and reduce the number of outstanding shares, it can make financial ratios like earnings per share (EPS), the price-to-earnings ratio (PE Ratio), and return on equity (ROE) look more attractive to investors.

What Happens to Repurchased Stock?

When a company repurchases stock, the shares will either be listed as treasury stock or the shares will be retired.

Treasury stocks are the shares repurchased by the issuing company, reducing the number of outstanding shares on the open market. The treasury stock remains on its balance sheet, though it reduces the total shareholder equity. Shares that are listed as treasury stock are no longer included in EPS calculations, do not receive dividends, and are not part of the shareholder voting process. However, the treasury stock is still considered issued and, therefore, can be reissued by the company through stock dividends, employee compensation, or capital raising.

In contrast, retired shares are canceled and cannot be reissued by the company.


💡 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 Pros and Cons of a Stock Buyback for Investors

When a company announces a stock buyback, investors may wonder what it means for their investment. Stock buybacks have pros and cons worth considering depending on the company’s underlying reasoning for the share repurchase and the investor’s goal.

Pros of a Stock Buyback

Tender offer premium

Investors who accept the company’s tender offer could have an opportunity to sell the stock at a greater value than the market price.

Increased total return

Investors who hold onto the stock after a buyback will likely see a higher share price since fewer outstanding shares are on the market. Plus, each share now represents a more significant portion of company ownership, which may mean an investor will see higher dividend payments over time. A higher stock price and increased dividend boosts an investor’s total return on investment.

Tax benefits

As mentioned above, a stock buyback might also mean a lower overall tax burden for an investor, depending on how long the investor owned the stock. Money earned through a stock market buyback is taxed at the capital gains tax rate. If the company issued a dividend instead of buying back shares, the dividends would be taxed as regular income, typically at a higher rate.

Recommended: Investment Tax Rules Every Investor Should Know

Cons of a Stock Buyback

Cash could be spent elsewhere

As mentioned above, when companies have cash, they can either reinvest in business operations, acquire a company, pay down debt, pay out a dividend, or buy back stock. Engaging in a share repurchase can starve the business of money needed in other areas, such as research and development or investment into new products and facilities. This hurts investors by boosting share price in the short term at the expense of the company’s long-term prospects.

Poorly timed

Companies may sometimes perform a stock buyback when their stocks are overvalued. Like regular investors, companies want to buy the stock when the shares are valued at an attractive price. If the company buys at a high stock price, it could be a bad investment when the company could have spent the money elsewhere.

Benefits executives, not shareholders

Stock buybacks might also be a convenient tactic to benefit company executives, who are often compensated by way of stock options. Also, some executives earn bonuses for increasing key financial ratios like earnings per share, so buying back stock to improve those ratios potentially benefits insiders and not all shareholders.

The Takeaway

Like almost everything else to do with the stock market, the benefits and drawbacks of stock buybacks aren’t exactly straightforward. Investors need to ask themselves a few questions when analyzing the share repurchases of a company, like “why is the company conducting the buyback?” and “does the company have a history of delivering good returns?” Answering these questions can help investors decide whether a stock buyback is the best thing for a company.

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FAQ

Is a stock buyback positive or negative?

Stock buybacks have advantages and disadvantages for investors and companies. For instance, buybacks may increase the stock value and increase dividend payments to shareholders over time. However, stock buybacks may not be the best way for a company to spend its money in the long-term, and they may potentially benefit company executives more than shareholders.

When should a company do a stock buyback?

A company may do a stock buyback when it has the cash available and wants to increase the value of the stock, improve financial ratios, consolidate ownership, or drive demand for the stock.

Do I lose my shares in a buyback?

You won’t lose your shares in a buyback unless you want to sell them. The way a buyback works is that a company buys back stock from any investors who want to sell it. But you are under no obligation to sell your stock back to the company — it’s up to you whether to keep your stock or sell it back.

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

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

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.

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


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

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Mar
01
2024
How Does Inflation Affect Retirement?

How Does Inflation Affect Retirement?

By | invest, Investing, Preparing for Retirement | Comments Off on How Does Inflation Affect Retirement?

For retirees on a fixed income, inflation can have a significant influence on their ability to maintain their budget. That’s because as inflation rises over time, that fixed income will lose value.

That could mean that retirees need to scale back their spending or even make drastic changes to ensure that they don’t run out of money. The average rate of inflation was 8% in 2022, the highest inflation rate in 40 years. By January 2024, the inflation rate had dropped to 3.1%.

When it comes to their retirement money, 90% of Americans ages 60 to 65 say inflation is their biggest concern, according to a 2023 survey by Nationwide. However, by planning ahead, it is possible to minimize some of the impact of inflation on your nest egg.

Read on to learn more about inflation and retirement and what you can do to help protect your savings.

What Is Inflation?

Inflation is the rate at which prices of goods and services increase in an economy over a period of time. This can include daily costs of living such as gas for your car, groceries, home expenses, medical care, and transportation. Inflation may occur in specific segments of the economy or across all segments at once.

There are multiple causes for inflation but economists typically recognize that inflation occurs when demand for goods and services exceeds supply. In an expanding economy where more consumers are spending more money, there tends to be higher demand for products or services which can exceed its supply, putting upward pressure on prices.

When inflation increases, the purchasing power of money, or its value, decreases. This means as the price of things in the economy goes up, the number of units of goods or services consumers can buy goes down.

How does inflation affect retirement? When purchasing power declines, the value of your savings and investments goes down. While the dollar amount does not change, the amount of goods or services those dollars can buy falls. In retirement, inflation can be especially harmful, since retirees typically don’t have an income that goes up over time.

Concerns about inflation and retirement may even push back the age at which some people think they can afford to retire.

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5 Ways that Could Potentially Minimize the Impact of Inflation on Retirement

While inflation can seem like a challenging or even scary part of retirement, there are several investment opportunities that may help you maintain purchasing power and reduce the risk of inflation.

1. Invest in the Stock Market

Investing in stocks is one way to potentially fight inflation. A diversified portfolio that includes equities may generate long-term returns that are higher than long-term inflation. While past performance does not guarantee future returns, over the past 10 years, the average annualized return for the S&P 500 has been 12.39%. Even when inflation is factored in, investors still have substantial returns when investing in stocks. When adjusted for inflation, the average annualized return over the past 10 years is 9.48%.

However, stocks are risk assets, which means they are sensitive to market volatility. These price swings may not feel comfortable to investors who are in retirement so retirees tend to allocate a smaller portion of their portfolio to stocks to help manage market risk.

How much you may decide to allocate to stocks depends on a number of factors such as your risk tolerance and other sources of income.

2. Use Tax-Advantaged Retirement Vehicles

To maximize the amount of savings you have by the time you reach retirement, start investing as early as you can in young adulthood in retirement accounts such as employer-sponsored 401(k)s or Individual Retirement Accounts (IRA). The more time your money has to grow, the better.

With 401(k)s and traditional IRAs, the money in them grows tax-deferred; you pay income tax on withdrawals in retirement, when you might be in a lower tax bracket than you were during your working years.

Another option is a Roth IRA. With this type of IRA, you pay taxes on the money you contribute, and then you can withdraw it tax-free in retirement.

Recommended: How to Open an IRA: 5-Step Guide for Beginners

3. Do Not Over-Allocate Long-Term Investments With a Low Rate of Return

Risk averse investors may be tempted to keep their nest egg invested in securities that are not subject to major price swings, or even to keep their money in a savings account. However, theoretically, the lower the risk investors take, the lower the reward may be. When factoring in fees and inflation, ultra-conservative investments may only break even or perhaps lose value over time.

While they offer a guaranteed return, high-yield savings accounts, for example, typically don’t earn enough interest to beat inflation in the long run. Since savings account rates are not higher than inflation rates, the buying power of your savings will continue to decline. That’s particularly important for retirees who are often living off their savings and investments, rather than off of an income that rises with inflation.

Because of this, retirees may want to consider keeping a portion of their investments in the stock market.

💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

4. Make Sure You Understand Inflation-Protected Securities

Treasury inflation-protected securities or TIPS, which are backed by the federal government, are designed to help protect investments against inflation. The principal value of the investment increases when inflation goes up and if there’s deflation, the principal adjusts lower per the Consumer Price Index.

However, for some investors, TIPS may have disadvantages. TIPS typically pay lower interest rates than other government or corporate securities. That generally makes them less than ideal for individuals like retirees who are looking for investment income. Also, unless inflation is quite high, and unless they are held for the long-term, TIPS may not offer much inflation-protection. There are also potential tax consequences to consider when the bonds are sold or reach maturity.

Finally, because they are more sensitive to interest rate fluctuation than other bonds, if an investor sells TIPS before they reach maturity, that individual could potentially lose money depending on the interest rates at the time.

Be sure to carefully weigh all the pros and cons of TIPS to decide if they make sense for your portfolio.

5. Buy Real Estate or Invest in REITs

Retirees may also consider investing in real assets. Real estate is typically an inflation hedge because it holds intrinsic value. During periods of inflation, real estate may not only be able to preserve its value, but it might also increase in value. One of the daily costs impacted by inflation is the cost of housing.

That’s why rental income from real estate historically has kept up with inflation. Investing in real estate investment trusts (REITs), may be another way for retirees to diversify their investment portfolio, reduce volatility, and add to their fixed-income. Just be sure to understand the potential risks involved in these investments.

Inflation Calculator for Retirement

It’s important to factor inflation into your plans as you’re saving for retirement. One way to do that is using a retirement calculator, like this one from the Department of Labor, which accounts for how inflation will impact your purchasing power in the future. That calculator uses a 3% inflation rate for retirement planning, but inflation fluctuates and could be higher or lower in any given year.

The Takeaway

While inflation can have an impact on a retirement portfolio, there are ways to protect the purchasing power of your money over time. Allocating a portion of your portfolio to stocks and other investments aimed at minimizing the impact of inflation may help.

Another way to curb the impact of inflation during retirement is to reduce expenses, which allows the money that you have to go further.

And starting to save for retirement as early as possible could help you accrue the compounded returns necessary to counteract rising prices in the future.

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 inflation good or bad for retirees?

A small amount of inflation each year is a normal part of the economic cycle. But over time, inflation eats away at the value of the dollar and purchasing power of your nest egg is diminished. This can have a negative effect on a retirement investment portfolio or savings.

How can I protect my retirement savings from inflation?

There are several Investing strategies you can use to protect retirement savings from inflation. These include diversifying your portfolio with inflation hedges including TIPS (treasury inflation-protected securities) and investments that typically provide a high rate of return. It’s important to keep saving for retirement even if you don’t have a 401(k).

Does your pension increase with inflation?

Some pensions have a cost of living adjustment on their monthly payments, so they increase over time. However, this is not the case for all pensions. When inflation increases this can affect your benefits.

Photo credit: iStock/RgStudio

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

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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.


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

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.

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Feb
27
2024

What Is Liquidity In Stocks?

By | Growing Wealth, invest, Investing | Comments Off on What Is Liquidity In Stocks?

Liquidity in stocks generally refers to how quickly an investment can be bought or sold and converted into cash. The easier an investment is to sell, the more liquid it is. Plus, liquid investments generally do not charge large fees when you need to access your money.

For the average investor, liquidity is an important consideration when building a portfolio, as it’s an indicator of how easy it is to access their savings. That can be important to know and understand when sizing up your overall strategy.

Key Points

•   Liquidity in stocks refers to how quickly an investment can be bought or sold and converted into cash.

•   Market liquidity refers to how quickly a stock can be turned into cash, while accounting liquidity relates to meeting financial obligations.

•   Stocks are generally considered liquid assets, but some stocks may be less liquid, especially those traded on foreign exchanges.

•   Share turnover and bid-ask spread are metrics used to assess a stock’s liquidity.

•   Liquidity risk is the risk of not finding a buyer or seller for assets, which can affect prices.

Types of Liquidity

Liquidity comes in two forms: Market liquidity and accounting liquidity. Here’s how the two are different.

Market Liquidity

Market liquidity refers to how quickly a stock can be turned into cash. High market liquidity means there’s a high supply and demand for an asset. That, in turn, makes it easy for buyers to find sellers and vice versa. As a result, transactions can be completed quickly, even when stock values are dropping.

Accounting Liquidity

Accounting liquidity is related to an individual’s or company’s ability to meet their financial obligations, such as regular bills or debt payments.

For an individual, being liquid means they have enough cash or marketable assets (such as stocks) on hand to meet their obligations.

Companies measure liquidity slightly differently by comparing current assets and debt. In addition to cash and marketable assets, current assets also include inventories and accounts receivable, the money customers owe on credit for goods or services they’ve purchased.

Investors may pay attention to company liquidity if they are researching that company’s stock as a potential buy. Companies with higher liquidity may be in better shape than those in risk of defaulting on their debt.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

*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.

How Liquid Are Different Assets?

An investor’s financial portfolio may be made up of a number of different assets of varying liquidities, including cash, stocks, bonds, real estate, and savings vehicles like certificates of deposit (CDs). Cash is the most liquid asset; there is nothing an investor needs to do to convert it into spendable currency.

On the other hand, an investment property is an example of a relatively illiquid asset, as it might take a long time for an investor to sell it should they need access to their money.

CDs are also relatively illiquid assets because they require investors to tie up their money for a preset period of time in exchange for higher interest rates than those available in regular savings accounts. Individuals who need their money early may have to pay hefty fines to access it.

Stocks generally fall on the relatively liquid side of the liquidity spectrum. Stocks that are easy to buy and sell and said to be highly liquid. Stocks with low liquidity may be tougher to sell, and investors may take a bigger financial hit as they seek buyers.

What Is Liquidity Risk?

Liquidity risk is the risk that an individual won’t be able to find a buyer or seller for assets they wish to trade during a given period of time, which can lead to adverse effects on the price. Liquidity risk is higher for complex investments or investment vehicles like CDs that may charge penalties to liquidate or access funds early.

Are Stocks a Liquid Asset?

For the most part, stocks that are traded on a public exchange are considered liquid assets. Some stocks, like those traded on foreign exchanges, may be less liquid as it takes more time to execute a trade.

Generally speaking, when an individual wishes to execute a trade, they use a brokerage account to issue a buy or sell order. The broker then helps match the individual with other buyers and sellers hoping to take the opposite action.

This process can take a little bit of time. Most stock trades settle within a two-day period. A stock trade executed on a Wednesday would typically settle on Friday. Settlement is the official transfer of stocks from a seller’s account to the buyer’s account, and cash from the buyer to the seller.

Because it can take some time for trades to be executed, there can be a difference in price between when an individual places an order and when that order is fulfilled.

How to Calculate a Stock’s Liquidity

One way to figure out a stock’s liquidity is by looking at a metric known as share turnover. This financial ratio compares the volume of shares traded and the number of outstanding shares. A stock’s volume is the number of shares that have been bought or sold over a given period. Outstanding shares refer to all of the shares held by a company’s shareholders.

Higher share turnover indicates high liquidity; investors have an easier time buying and selling. Investors might want to pay close attention to low share turnover, as this can indicate they may have a difficult time selling shares if they need to.

Another measure of a stock’s liquidity is the bid-ask spread. Bid price is the price an individual is willing to pay at a given point in time. The ask price is the price at which a buyer is willing to sell. The bid-ask spread is the difference between the two.

For highly liquid assets, the bid-ask spread tends to be pretty small — as little as a penny. This indicates that buyers and sellers are generally in agreement over what the price of a stock should be. However, as bid-ask spread grows, it is an indication that a stock is increasingly illiquid.

A wide spread can also indicate that a trade may be much more expensive to execute. For example, there may not be enough trade volume to execute an entire order at one price. If prices are rising, an order can become increasingly pricey.

💡 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.

Examples of Liquid Stocks

The most liquid stocks tend to be those that receive the most interest from investors. The large companies that are tracked by the S&P 500 Index.

Why Stock Liquidity Is Important for Investors

The relative liquidity provided by stocks can be a boon to investors. Stocks help provide the growth needed for investors to meet their savings goals. They are also relatively easy to buy and sell on the market, allowing investors to access their savings quickly when they need it.

The Takeaway

Liquidity is a measure of the ability to turn assets into cash without losing value. So it’s an important metric for investors to pay attention to as they construct their portfolios. But liquidity is just one of many factors to consider when investing.

Investors may want to know how liquid their holdings are so that they can choose the appropriate mix of investments that align with their risk tolerance. It may be comforting to some to know that they can sell investments with relative ease, rather than have their money tied up for the long-term.

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

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

FAQ

What is good liquidity for a stock?

Good liquidity for a stock refers to an investor’s ability to sell the stock in exchange for cash. If a stock is liquid, then it should be relatively easy to sell. If a stock is illiquid, or has bad liquidity, it may be more difficult.

What is a “Liquidity Ratio?”

A liquidity ratio is a financial ratio that can help an investor determine a company’s ability to pay off its debt obligations, particularly in the short-term. There are several liquidity ratios that can be utilized.

Is a higher liquidity better?

Generally, yes, a higher liquidity is better for investors, as it can signal that a company is performing well, and that its stock is in demand. It can also be easier for an investor to sell that stock in exchange for cash.

Photo credit: iStock/insta_photos

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

Claw Promotion: Customer must fund their Active Invest account with at least $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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