InvestGen Archives | Page 41 of 64

Sep

2023

What Is Yield to Call? Formula & Examples

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

An investor calculating yield to call is getting an idea of how much their overall bond returns will be. Specifically, yield to call refers to the total returns garnered by holding onto a bond until its call date. That doesn’t apply to all bonds, naturally, but can be very important for many investors to understand.

For investors who utilize bonds — callable bonds, in particular — as a part of their investment strategy, having a deep understanding of yield to call can be critical.

What Is Yield to Call?

As mentioned, yield to call (often abbreviated as “YTC”) refers to the overall return earned by an investor who buys an investment bond and holds it until its call date. Yield to call only concerns what are called callable bonds, which are a type of bond option.

With callable bonds, issuers have the option of repaying investors the value of the bond before it matures, potentially allowing them to save on interest payments. Callable bonds come with a call date and a call price, and the call date always comes before the bond itself matures.

A little more background: in a YTC scenario, ”yield” refers to the total amount of income earned over a period of time. In this case, the yield is the total interest a bond purchaser has accrued since purchasing the bond.

How Yield to Call Works

If an investor buys a callable bond, they’ll see interest payments from the bond issuer up until the bond reaches maturity. The callable bond also has a call date, and the investor can choose to hold onto the bond until that date. If the investor does so, then YTC amounts to the total return the investor has received up until that date.

Yield to call is similar to yield to maturity, which is the overall interest accrued by an investor who holds a bond until it matures. But there are some differences, especially when it comes to how YTC is calculated.

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Yield to Call Formula

The raw yield to call calculation formula looks like this:

Yield to Call Formula:

Yield to call = (coupon interest payment + ( The call price – current market value ) ÷ time in years until call date ) ÷ (( call price + market value ) ÷ 2)

An investor should have all of the variables on-hand to do the calculation. Before we run through an example, though, here’s a breakdown of those variables:

• Yield to call: The variable we are trying to solve for!

• Coupon interest payment: How much the bondholder receives in interest payments annually.

• Call price: The predetermined call price of the callable bond in question.

• Current market value: The bond’s current value.

• Time until call date: The number of years until the bond’s first call date arrives

The yield-to-call calculation will tell an investor the returns they’ll receive up until their bond’s call date. A bond’s value is roughly equal to the present value of its future earnings or cash flows — or, the return, at the present moment, that the bond should provide in the future.

How to Calculate Yield to Call

It can be helpful to see how yield to call looks in a hypothetical example to further understand it.

Yield to Call Example

For this example, we’ll say that the current face value of the bond is $950, it has an annual coupon interest payment of $50, and it can be called at $1,000 in four years.

Here’s how the raw formula transforms when we input those variables:

Yield to call = ($50 + ( $1,000 – $950 ) ÷ 4 ) ÷ (( $1,000 + $950 ) ÷ 2)

YTC = $25 ÷ $975

YTC = 0.0256 = 2.56%

Interpreting Yield to Call Results

Once we know that our hypothetical, callable bond has a yield to call of 2.56%, what does that mean, exactly? Well, if you remember back to the beginning, yield to call measures the yield of a bond if the investor holds it until its call date.

The percentage, 2.56%, is the effective return an investor can expect on their bond, assuming it is called before it matures. It’s important to remember, too, that callable bonds can be called by the issuer at any time after the call date. So, just because there is an expected return, that doesn’t necessarily mean that’s what they’ll see.

Yield to call calculations make a couple of big assumptions. First, it’s assumed that the investor will not sell the bond before the call date. And second, the calculation assumes that the bond will actually be called on the call date. Because of these assumptions, calculations can produce a number that may not always be 100% accurate.

Yield to Call Comparisons

Two calculations that are similar to YTC are “yield to maturity,” and “yield to worst.” All three calculations are related and offer different methods for measuring the value that a bond will deliver to an investor.

A different type of yield calculation would be needed if you wanted to try and measure the overall interest you’d earn if you held a bond to maturity. That’s different from measuring the overall interest you’d earn by simply holding the bond until its call date.

Yield to Call vs Yield to Maturity

YTC calculates expected returns to a bond’s call date; yield to maturity calculates expected returns to the bond’s maturity date. Yield to maturity gives investors a look at the total rate of return a bond will earn over its entire life, not merely until its call date (if it has one).

Yield to Call vs Yield to Worst

Yield to worst, or “YTW,” measures the absolute lowest possible yield that a bond can deliver to an investor. Assuming that a bond has multiple call dates, the yield to worst is the lowest expected return for each of those call dates versus the yield to maturity. Essentially, it gives a “worst case” return expectation for bondholders who hold a bond to either its call date or for its entire life.

If a bond has no call date, then the YTW is equal to the yield to maturity — because there are no other possible alternatives.

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The Takeaway

Learning what yield to call is and how to calculate it, can be yet another valuable addition to your investing tool chest. For bond investors, YTC can be helpful in trying to figure out what types of returns you can expect, especially if you’re investing or trading callable bonds.

It may be that you never actually do these calculations, but having a cursory background in what the term yield to call means, and what it tells you, is still helpful information to keep in your back pocket.

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FAQ

What is the advantage of yield to call?

Yield to call helps investors get a better idea of what they can expect in terms of returns from their bond holdings. That can help inform their overall investment strategy.

How do you calculate yield to call in Excel?

Calculating yield to call can be done the old fashioned way, with a pen and paper, or in a spreadsheet software, of which there are several. An internet search should yield results as to how to calculate YTC within any one of those programs.

Is yield to call always lower than yield to maturity?

Generally, an investor would see higher returns if they hold a bond to its full maturity, rather than sell it earlier. For that reason, yield to call is generally lower than yield to maturity.

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Sep

2023

Guide to Morningstar Ratings

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

Morningstar is a highly regarded financial services firm whose mission revolves around providing investors with the research and tools, including Morningstar ratings, they need to make informed decisions in their portfolios.

Those tools, used by individual investors as well as institutional investors and financial advisors, include Morningstar fund ratings, which can help investors gauge how well various mutual funds and exchange-traded funds (ETFs) have performed over time.

What are Morningstar Ratings?

In simple terms, the Morningstar ratings system is a tool investors can use to compare financial securities such as mutual funds and ETFs. And if you’re wondering whether Morningstar ratings are legitimate, the answer is yes. Even FINRA, the Financial Industry Regulatory Authority, uses Morningstar ratings.

Morningstar reviews of mutual funds and ETFs reflect different metrics, depending on which ratings system is being applied. The main Morningstar ratings investors may turn to learn more about a particular investment are the Star Ratings and Analyst Ratings. (Morningstar also has a separate ratings system for individual stocks.)

These ratings can be helpful to investors for a variety of reasons — whether they’re trying to diversify their portfolio, or some research into socially responsible investing, and trying to find securities that fit their strategy.

How Morningstar Ratings Work

As Morningstar itself describes, the ratings system uses a methodology based on specific categories and risk-adjusted return measures. The company will only rate a fund that’s been around for more than three years. Morningstar also updates its ratings on a monthly basis.

You can use these ratings to select from the funds available in your 401(k), or to decide which funds to add to an IRA or a taxable brokerage account.

Recommended: Investing in Growth Funds

The “Star Rating” Explained

The Morningstar Star Rating system, more simply referred to as star rating, is a quantitative ranking of mutual funds and ETFs. Introduced in 1985, the star rating looks backward at a fund’s past performance, then assigns a rating from one to five stars based on that performance.

As mentioned, Morningstar reviews ETFs and mutual funds with a record of more than three years, so newer funds do not receive a star rating until they’re reached this milestone. The rating methodology utilizes an enhanced Morningstar risk-adjusted return measure. Specifically, the star ratings system looks at each fund’s three-, five-, and 10-year risk-adjusted returns.

Star ratings can serve as a report card of sorts for comparing different funds, based on how they’ve performed historically. The Morningstar ratings are not forward-looking, as past performance is not a foolproof indicator of future behavior. But investors can use the ratings system as a starting off point for conducting fund research when deciding where to invest.

If you’re looking for a tool to help you compare mutual funds or exchange-traded funds at a glance based on past performance, the star rating system can help.

The “Analyst Rating” Explained

The Morningstar Analyst Rating takes a different approach to ranking funds and ETFs. Instead of looking backward, the qualitative analyst rating looks forward to assess a fund’s ability to outperform similar funds or a market benchmark. Rather than using stars, funds receive a rating of Gold, Silver, Bronze, Neutral or Negative, based on the analyst’s outlook for performance.

The firm does not update analyst ratings as frequently as star ratings. Morningstar reviews for analyst ratings are reevaluated at least every 14 months. The firm typically assigns analyst ratings to funds with the most interest from investors or the most assets.

When ranking funds, analysts look at three specific metrics:

• People

• Process

• Parent

Performance is also taken into account within the People and Process pillars. In order to earn a Gold, Silver or Bronze rating, an analyst must determine that an active fund can beat its underlying benchmark when adjusted for risk.

Generally speaking, these Morningstar reviews go into more detail, in terms of the analysis, ranking, and comparison of funds. If you’re an active trader or a buy-and-hold investor you might use the Morningstar analyst ratings to get a feel for what a particular mutual fund might do next, which can be helpful when an investor is, for example, trying to pick an ETF.

How Morningstar Measures Volatility

Morningstar uses a few key volatility measurements as it aims to minimize risk and maximize returns through strategic diversification. Chief among those measurements are standard deviation, mean, and the Sharpe ratio.
It’s a somewhat complicated process, but using these three measurements in tandem helps Morningstar get a handle on volatility and make appropriate ratings decisions.

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Example of a Morningstar Rating

Morningstar star ratings are free to access for investors on the company’s website, and it’s relatively easy to find plenty of examples of Morningstar ratings on the platform. For instance, to find a star rating for a particular fund or ETF you’d simply search for it using its name or ticker symbol. You can also view Morningstar ratings and picks for funds by category, such as small-cap funds or U.S. index funds.

Here’s an example of a Morningstar rating for the Calvert International Responsible Idx I fund (CDHIX). This fund, which is in the foreign large-blend category and is an index fund, has a four-star rating from Morningstar. You can see at a glance that the fund has an expense ratio of 0.29%, a minimum investment of $100,000 and just over $867 million in assets, as of August 2023.

Are Morningstar Ratings Accurate?

Morningstar fund ratings are designed to be a guide to use as you invest, rather than the absolute word on how well a fund is likely to perform. That’s to say that there’s always going to be risk involved when investing, so don’t expect any rating to be a sure-thing.

So, how well do Morningstar ratings perform over time and are they an accurate guide for investing?

According to Morningstar’s own analysis of its ratings system, the star ratings can be a useful jumping-off point for investors. That analysis resulted in three key findings:

• Funds with higher star ratings tend to have lower expense ratios and be cheaper for investors to own

• Higher rated funds tend to be less volatile and experience less dramatic downward swings when the market is in flux

• Funds that received higher star ratings tended to produce higher returns for investors compared to funds with lower ratings

The analysis didn’t look specifically at how star ratings and fund performance aligned through different bull and bear markets. But the ultimate conclusion Morningstar drew is that the Star Ratings tend to steer investors toward cheaper funds that are easier to own and stand a better chance of outperforming the market.

Use Expense Ratios

According to Morningstar, fees are one of the best predictors of future performance, at least for Star Ratings. For funds and ETFs, that means it’s important to consider the expense ratio, which represents the cost of owning a fund annually, calculated as a percentage of fund assets.

Actively managed funds typically carry higher expense ratios, as they require a fund manager to play an important role in selecting fund assets. Passively managed funds and ETFs, on the other hand, often have lower expense ratios.

So which one is better? The answer is that it all comes down to performance and returns over time. A fund with a higher expense ratio is not guaranteed to produce a level of returns that justify higher fees. Likewise, a fund that has a lower expense ratio doesn’t necessarily mean that it’s a poor investment just because it’s cheaper to own. Morningstar’s research found that the average one-star fund cost significantly more than the average five-star fund.

As you do your own research in comparing funds and ETFs, consider both performance and cost. This can help you find the right balance when weighing returns against fees.

How Should Investors Use Morningstar Ratings?

How much do Morningstar ratings matter in the grand scheme of things? The answer is, it depends on what you need from investment research tools.

Morningstar reviews of mutual funds and ETFs can be helpful for comparing investments, especially if you’re just getting started with the markets. Morningstar is a respected and trusted institution and both the Star and Analyst Ratings are calculated using a systematic approach. The reviews aren’t just thrown together or based on a best guess.

They’re designed to be a guide and not a substitute for professional financial advice. So, for instance, you may use them to compare two index funds that track the same or a similar benchmark. Or you may use them to compare two ETFs that are representative of the same market sector.

Risks of Morningstar Ratings

Morningstar Ratings are not an absolute predictor of how a mutual fund or ETF will perform in the next five minutes, five days, or five years. After all, there’s no way to perfectly predict how any investment will perform as the market changes day to day or even minute-to-minute.

One risk to avoid with Morningstar ratings is relying on them solely as your only research tool and not doing your own independent research. Again, that means checking expense ratios as well as looking at the underlying assets of a particular fund and its investment strategy (i.e. active vs. passive) to determine how well it aligns with your goals and risk tolerance.

Looking only at Morningstar reviews without doing your own due diligence could cause you to invest in funds that aren’t the best fit for your portfolio. Or you may overestimate how well a fund will perform, only to be disappointed later. For those reasons, it’s important to look under the hood, so to speak, to ensure that you fully understand what you’re investing in before buying in.

Morningstar Ratings for Funds

As discussed, Morningstar’s rating system mostly focuses on funds, including index funds, mutual funds, and ETFs. The company also has a ratings system for individual stocks, but its bread and butter is its focus on funds. And, as a quick refresher, it uses a data-driven, quantitative methodology for determining those rankings.

Also, as it bears repeating, a good Morningstar rating does not mean that an investment is risk-free.

Other Investment Risk Rating Providers

Morningstar is just one of many companies that offers investment ratings. An internet search will likely yield many results. But it’s a list that includes many familiar names, such as Bloomberg, Nasdaq Market Data Feeds, S&P Global Market Intelligence, MarketWatch, Thomson Reuters, and others.

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Trading Stocks With SoFi

Having research tools can help you make educated decisions about where and how to invest. Morningstar Ratings are one tool you can use. When you’re ready to invest and apply the knowledge you’ve acquired, the next step is opening an online brokerage account. But keep in mind that there are many ratings services on the market, and that Morningstar’s ratings are far from the only research tool out there.

It’s also important for investors to keep in mind that all investments involve risk, whether they’re highly-rated or not. Be sure to do your due diligence before investing, but know there’s always a chance that things could turn sour on you.

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FAQ

How reliable are Morningstar ratings?

Morningstar ratings are generally considered to be high-quality in the financial industry, but that doesn’t mean that its ratings are always spot-on. All investing involves risk, and even a high rating doesn’t guarantee that an investment will pan out.

Is a Morningstar rating of “5” good?

Morningstar uses a scale of one to five “stars” to rate investments, with five stars being the highest, or best-quality investment. So, yes, a five-star rating is generally considered good, although not risk-free.

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Sep

2023

Averaging Down Stocks: Meaning, Example, Pros & Cons

By AJ Smith | Growing Wealth, invest, Investing | Comments Off

Averaging down stocks refers to a strategy of buying more shares of a stock you already own after that stock has lost value — effectively buying the same stock, but at a discount. In other words, it’s a way of lowering the average cost of a stock you already own.

It’s similar to dollar-cost averaging, where you invest the same amount of money in the same securities at steady intervals, regardless of whether the prices are rising or falling.

While this strategy has a potential upside — if the stock price then rises again — it does expose investors to greater risk.

Table of Contents

What Is Averaging Down?
Example of Averaging Down
Why Average Down on Stock
Pros and Cons of Averaging Down
Tips for Averaging Down on Stock
The Takeaway

What Is Averaging Down?

By using the strategy of averaging down and purchasing more of the same stock at a lower price, the investor lowers the average price (or cost basis) for all the shares of that stock in their portfolio.

So if you buy 100 shares at one price, and the price drops 10%, for example, and you decide to buy 100 more shares at the lower price, the average cost of all 200 shares is now lower.

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Example of Averaging Down

Consider this example: Imagine you’ve purchased 100 shares of stock for $70 per share ($7,000 total). Then, the value of the stock falls to $35 per share, a 50% drop.

To average down, you’d purchase 100 shares of the same stock at $35 per share ($3,500). Now, you’d own 200 shares for a total investment of $10,500. This creates an average purchase price of $52.50 per share.

Potential of Gain Averaging Down

If the stock price jumps to $80 per share, your position would be worth $16,000, a $5,500 gain on your initial investment of $10,500. In this case, averaging down helped boost your average return. If you’d simply bought 200 shares at the initial price of $70 ($14,000), you’d only see a gain of $2,000.

Potential Risk of Averaging Down

As with any strategy, there’s risk in averaging down. If, after averaging down, the price of the stock goes up, then your decision to buy more of that stock at a lower price would have been a good one. But the stock continues its downward price trajectory, it would mean you just doubled down on a losing investment.

While averaging down can be successful for long-term investors as part of a buy-and-hold strategy, it can be hard for inexperienced investors to discern the difference between a dip and a warning sign.

Why Average Down on Stock

Some investors may use averaging down stocks as part of other strategies.

1. Value Investing

Value investing is a style of investing that focuses on finding stocks that are trading at a “good value” — in other words, value stocks are typically underpriced. By averaging down, an investor buys more of a stock that they like, at a discount.

But in some cases, a stock may appear undervalued when it’s not. This can lead investors who may not understand how to value stocks into something called a value trap. A value trap is when a company has been trading at low valuation metrics (e.g. the P/E ratio or price-to-book value) for some time.

While it may seem like a bargain, if it’s not a true value proposition the price is likely to decline further.

2. Dollar-Cost Averaging

For some investors, averaging down can be a way to get more money into the market. This is a similar philosophy to the strategy known as dollar-cost averaging, as noted above, where the idea is to invest steadily regardless of whether the market is down or up, to reap the long-term average gains.

3. Loss Mitigation

Some investors turn to this strategy to help dig out of the very hole that the lower price has put them into. That’s because a stock that has lost value has to grow proportionally more than it fell in order to get back to where it started. Again, an example will help:

Let’s say you purchase 100 shares at $75 per share, and the stock drops to $50, that’s a 33% loss. In order to regain that lost value, however, the stock needs to increase by 50% (from $50 to $75) before you can see a profit.

Averaging down can change the math here. If the stock drops to $50 and you buy another 100 shares, the price only needs to increase by 25% to $62.50 for the position to be profitable.

Pros and Cons of Averaging Down

As you can see, averaging down stocks is not a black-and-white strategy; it requires some skill and the ability to weigh the advantages and disadvantages of each situation.

Pros of Averaging Down

The primary benefit to averaging down is that an investor can buy more of a stock that they want to own anyway, at a better price than they paid previously — with the potential for gains.

Whether to average down should as much be a decision about the desire to own a stock over the long-term as it is about the recent price movement. After all, recent price changes are only one part of a stock’s analysis.

If the investor feels committed to the company’s growth and believes that its stock will continue to do well over longer periods, that could justify the purchase. And, if the stock in question ultimately turns positive and enjoys solid growth over time, then the strategy will have been a success.

Cons of Averaging Down

The averaging down strategy requires an investor to buy a stock that is, at the moment, losing value. And it is always possible that this fall is not temporary — and is actually the beginning of a larger decline in the company and/or its stock price. In this scenario, an investor who averages down may have just increased their holding in a losing investment.

Price change alone should not be an investor’s only indication to buy more of any stock. An investor with plans to average down should research the cause of the decline before buying — and even with careful research, projecting the trajectory of a stock can be difficult.

Another potential downside is that the averaging down strategy adds to one particular position, and therefore can affect your asset allocation. It’s always wise to consider the implications of any shift in your portfolio’s allocation, as being overweight in a certain asset class could expose you to greater risk of loss.

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

Tips for Averaging Down on Stock

If you are going to average down on a stock you own, be sure to take a few preparatory steps.

• Have an exit strategy. While it may be to your benefit to buy the dip, you want to set a limit should the price continue to fall.

• Do your research. In order to understand whether a stock’s price drop is really an opportunity, you may need to understand more about the company’s fundamentals.

• Keep an eye on the market. Market conditions can impact stock price as well, so it’s wise to know what factors are at play here.

The Takeaway

To recap: What is averaging down in stocks? Simply put, averaging down is a strategy where an investor buys more of a stock they already own after the stock has lost value.

The idea is that by buying a stock you own (and like) at a discount, you lower the average purchase price of your position as a whole, and set yourself up for gains if the price should increase. Of course, the fly in the ointment here is that it can be quite tricky to predict whether a stock price has simply taken a dip or is on a downward trajectory — so there are risks to the averaging down strategy for this reason.

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Sep

2023

How Many Stocks Should I Own?

By AJ Smith | Growing Wealth, invest, Investing | No Comments

One rule of thumb is to own between 20 to 30 stocks, but this number can change depending on how diverse you want your portfolio to be, and how much time you have to manage your investments. It may be easier to manage fewer stocks, but having more stocks can diversify and potentially protect your portfolio from risk.

Diversification means having a variety or diversity of holdings within a portfolio or between portfolios. It is one of the most important concepts in building a portfolio.

Portfolio diversification can come in two forms:

• Basic diversification — investing in a diverse array of asset classes, such as stocks, bonds, exchange-traded funds (ETFs), and real estate.

• Diversification within asset classes — owning, for example, shares of various companies and different types of companies (like large, medium, and small companies; international and domestic companies; and those in different industries) within a portfolio of stocks or bonds.

How Many Different Stocks Should You Own?

While there is no one right answer to the question how many stocks should I own?, a diversified portfolio makes sense for many investors. Diversification helps provide the possibility of mitigating risk by spreading out portfolio holdings across different assets, or different types of a single asset.

While asset allocation and diversification are related, asset allocation is generally thought of in terms of the broader asset classes (stocks, bonds, cash), and how the proportion of each might impact your exposure to risk and reward over time.

Diversification offers a more sophisticated way to manage the potential for risk and reward by diversifying across and within asset classes. That way if a given company or asset class performs poorly for an idiosyncratic reason (for instance, maybe there’s a change in leadership or a supply chain breakdown), the risk of underperformance could be reduced, because even if one holding in your portfolio suffers a negative impact, the others likely may not.

In this way, diversification also aims to smooth out volatility. If you own stocks for companies in different industries, when one sector gets hit — say, commodity prices crash in mining — stocks in a different sector where commodities are a major cost, like manufacturing, may go up.

This can also be true across different types of investments like stocks vs. bonds, which don’t always move in the same direction.

Thus the logic of owning an array of stocks, in different sectors, may be beneficial. It also leads to another question: how many different stocks should you have in your portfolio?

How Many Stocks Should You Have in a Diversified Portfolio?

As mentioned, one school of thought says to have between 20 and 30 stocks in your portfolio to achieve diversification, but there are no hard and fast rules.

In stock funds — large collections of stocks managed by professionals like mutual funds, exchanged-traded funds (ETFs) and target date funds — the average number of stocks can vary widely, from a few dozen to a few thousand different companies.

In considering diversification across asset classes, it makes sense to consider individual risk thresholds. One example is a typical investment approach used for retirement: A portfolio might be more heavily tilted towards stock when the individual is younger and can wait for those investments to grow, transitioning toward fixed-income instruments over time, as the individual’s risk tolerance goes down and they get closer to drawing on that money for retirement.

💡 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.

How Many Stocks Can You Buy?

Now you may be wondering, how many shares of stock should I buy? The number of stocks you can buy will depend mainly on:

• Trading rules set by the company

• Your budget

• The amount of time you have to manage your investments

There is no universal limit on how many stocks an investor can purchase. However, companies may have rules in place that prevent traders from buying up a large number of shares.

With all that in mind, you can buy as many shares as your budget allows. Be aware that there may be fees associated with your stock purchases.

How Many Shares Are in a Company?

It varies. Companies of all sizes and revenue amounts can have a wide range of outstanding shares. Some large-cap companies might have billions of shares; smaller companies may have far less.

Generally, the fewer shares a company has, the more expensive their stock is likely to be. That’s because market capitalization is calculated by multiplying outstanding shares by the stock price.

For instance, let’s say Company A is currently trading at around $250 a share. Company B, which has a little more than double the number of outstanding shares as Company A, could be trading at around $125 per share.

Rules for Day Traders

Another consideration regarding how many stocks you can buy are day trading rules.

According to Financial Industry Regulatory Authority (FINRA) rules, a pattern day trader is:

Any customer who executes four or more “day trades” within five business days, provided that the number of day trades represents more than 6 percent of the customer’s total trades in the margin account for that same five business day period.

A day trade would include buying and selling or selling and buying the same stock in a day.

Pattern day traders can only trade in margin accounts and must have a minimum of $25,000 in their accounts. If you are not a designated pattern day trader, you cannot buy and sell and/or sell and buy the same stock four or more times in a five-day period.

For more information about day trading rules and maximums, contact your brokerage directly.

Getting the Right Balance in Your Stock Holdings

Another approach to diversification is to invest in broad market indices, which track entire industries or even the entire market. Index funds, which are mutual funds that track indexes, and ETFs, some of which also track indexes and which can be bought and sold like stocks, have made it simpler for investors to achieve diversification by using a single investment vehicle.

Balancing a Portfolio with Index Funds

Though John “Jack” Bogle, founder of the Vanguard Group, launched the renowned Vanguard 500 Index Fund in late 1975, it wasn’t the first of its kind. The vision to put investors in the driver’s seat by offering them a low-cost way to invest in the entire market was shared by other institutions, and it caught on quickly with investors.

And no wonder: A mutual fund that tracks the entire S&P 500 Index, a collection of about 500 large-cap U.S. stocks, offers investors a low-cost way to access the performance of the biggest companies in America. These companies are distributed across numerous industries, like information technology, finance, healthcare, and energy. These large-cap funds are still used as a general barometer for the health of the market.

Today, index funds seek to track a wide array of indexes — there are thousands of different market indexes in the U.S. alone — using investor capital to invest in every stock or bond or other security in that particular index. They typically have to buy the stock in accordance with its “weight” in the index, typically its market capitalization, or the overall value of a publicly traded company’s shares. This means that the fund will be more heavily invested in the shares of the more valuable companies in that index.

Index funds make it easy for the average investor to buy into the market and achieve instant diversification. They’re affordable, too, with lower fees thanks to taking expensive fund managers out of the equation.

Diversifying with ETFs

Although there was a precursor to the modern exchange-traded fund established in Canada in 1990, generally speaking, State Street Global Advisors is credited with launching the first full-fledged ETF in the U.S. in 1993.

Since then, ETFs have become one of the most popular vehicles for investors — in part because they offer many of the same benefits as index mutual funds, like low fees and greater diversification.

While an ETF can be traded like a stock throughout the day, they don’t need to be made up of stocks. ETFs can be composed of bonds, commodities, currencies, and more. ETFs allow an investor to track the overall performance of the group of assets that the ETF is made up of — and, like a stock, the ETF’s price changes constantly based on the volume and demand of buying and selling throughout the day.

ETF “sponsors,” the investment companies that create and manage the funds, rely on complex trading mechanisms with other sophisticated participants in the market to keep an ETF’s value very close to the value of the underlying components (the stocks, bonds, commodities, or currencies) that it’s supposed to represent.

In terms of diversification, it’s important to note that ETFs are generally passive vehicles, meaning that most ETFs are not actively managed, but rather track broad market indices like the S&P 500, Russell 2000, MSCI World Index, and so on.

That said, some ETFs are actively managed, and may focus on a niche part of the market or specific sector in order to maximize returns.

When aiming to diversify your ETF holdings, bear in mind that the ETF wrapper, or fund structure, does not offer diversification in and of itself. Investors must look to the underlying constituents of the fund — the term of art for the various securities the ETF is invested in — to ensure proper diversification.

For example, an ETF that tracks the Russell 2000 Index of small-cap stocks, is typically invested in the roughly 2000 constituents of that index. In theory, that ETF would offer you a great deal of diversification — but only within the universe of smaller U.S. companies. If you also invested in a mid-cap and large-cap ETF, you would then achieve greater diversification in terms of your equity exposure overall.

How Many ETFs Should I Own?

As with stocks, deciding the right number of ETFs for your portfolio depends on your goals and risk tolerance. Perhaps the first question to ask is whether you’re going to use ETFs as a complement to other assets in your portfolio, or whether you’re constructing an entire portfolio only of ETFs.

ETFs as a Complement

As noted above, a single ETF could own a few dozen companies or a couple of thousand. If your portfolio is tilted toward equities, and you wanted to balance that with more bonds, a bond ETF could supply a variety of fixed-income options. This would add diversification in terms of asset classes.

Or, let’s say your portfolio included a large-cap mutual fund (or several large cap stocks) and bonds. But within those two asset classes you were not well diversified. You could consider adding a small- or mid-cap equity ETF and a bond ETF to broaden your exposure. In this example, perhaps you’d need two to four ETFs.

An All-ETF Portfolio

Constructing a portfolio based on ETFs is another option. In this case you could use as few as 5 or 6, or as many as 10 or 20 ETFs, depending on your aims. Some questions to ask yourself:

• Is cost a factor? Would you consider actively managed ETFs, which tend to be more expensive, or only passive ones?

• Is the time spent managing your portfolio a priority?

• How much diversification do you want? It’s possible to create a very basic portfolio using just two: a broad-market equity ETF (or even a global market ETF) and a total bond market ETF.

• Might you be interested in including some niche ETFs in sectors you’ve researched that seem promising (such as biotech, clean water, robotics)? Although there are mutual funds that provide access to these markets as well, ETFs can often do so at a lower cost. Be sure to check with your broker or other professional.

Choosing Stocks vs Investing in Funds

When it comes to buying individual stocks, there’s a lot to consider. And while there is typically plenty of available information about a given company — including its past financial results — that can inform a thoughtful decision, its value going forward will be determined by things that are unknown. Is the industry overall going to grow or shrink? Could the performance of that company be affected by political events overseas or at home? Are there potential disruptors and competitors who could challenge its current share of the market?

In addition, the performance of a company is not the same as the performance of that company’s stock. A company might have consistent profits in a growing industry and a politically placid environment. But the price of that stock might be high. When it comes to buying, it’s important to consider the potential of future price increases. If a stock has already done well in the past, the future growth and appreciation could be minimal.

In building a diverse stock portfolio on your own, you’ll likely go through this research and consideration process with many stocks.

Index funds and ETFs, by contrast, offer instant diversification thanks to their structure as pooled investment vehicles. And chances are, if there’s something an investor is passionate about, there’s an ETF for that. There are funds for clean energy, ones that focus on machine learning and artificial intelligence, as well as organic food and farming, just to name a few.

When it comes to investing in index funds, the process is a bit different. Once an investor figures out what kind of market they’d like to track — like all the stocks in the S&P 500 — they can look at two important factors. The first is “tracking error”: How well does the fund track the index? The second is cost. All things being equal, a less expensive fund — a fund with lower fees and lower costs devoted to marketing, trading, and compensation — could mean more potential profits for the buyer.

No matter how an investor builds a diverse stock portfolio, and how diverse that portfolio is, it’s important to remember that all investments come with risks that include the potential for loss.

The Takeaway

Rather than focusing on how many stocks you should or shouldn’t own, it’s probably more useful for investors to think about diversification when it comes to their portfolio holdings. Diversification — investing in more than one stock or other investment — is an important consideration when building a portfolio.

Building a diverse stock portfolio can be achieved in a variety ways, whether an investor lets their passions for an industry or certain companies guide them, or they are attracted to the ease and low barrier to entry of an ETF. The key is to find the approach that works for you.

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

FAQ

How many stocks should you own with $1K, $10K, or $100K?

The amount of money you have to invest is just one factor in deciding how many stocks to own. The number of stocks you own depends on how much research you’re willing to do and the time you have to do it, your goals, and your risk tolerance, as well as your budget.

Remember, diversifying your portfolio is critical to help mitigate risk. That’s true no matter how much money you’re investing. You may decide that investing in mutual funds or EFTs is the best way for you to diversify, even if you have $10K or $100K to spend.

Can you over-diversify a portfolio?

While diversifying a portfolio can help mitigate risk, it is possible to over-diversify a portfolio. At a certain point, owning too many stocks (50, say) can reduce an investor’s profit potential. In that case, it may be better to invest in index funds instead of individual stocks. But keep in mind that whether you invest in stocks or funds, all investments come with risks that include the potential for loss.

How many different sectors should you invest in?

There is no one right answer or hard and fast rule for how many sectors you should invest in. It’s generally wise to spread your holdings over several different sectors rather than concentrating on just one or two. For instance, you might want to invest in technology, consumer goods, healthcare, and energy. This can help diversify your portfolio so that your holdings aren’t too heavily concentrated in one or two areas. But again, all investments come with risk and the potential for loss. Be sure to determine your risk tolerance before choosing your investments.

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

Sep

2023

What Are Real Estate Options? Advantages for Buyers

Understanding the Basics of Real Estate Options

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

Another way to invest in real estate is through buying or selling real estate options. With an options contract, a buyer is granted the right to purchase a property for a specific price by a specific date, but they are not obligated to buy it.

In order to purchase this option, the buyer of the contract pays the seller a premium.

This is a flexible and typically less expensive way to enter the real estate market that may also help reduce risks involved in single property investment.

What Are Real Estate Options?

Real estate options are contracts between a potential buyer and seller. They grant the buyer the exclusive right to purchase a particular property within terms set in the contract. But the buyer doesn’t have to purchase the property.

However, if the buyer decides to exercise the option and purchase the property, the seller is obligated to sell the property at the agreed-upon price. Once the agreement is entered into, the property owner can’t sell to anyone else within the time period set in the option.

An options contract for a purchase is also known as a call option, whereas an option to sell would be called a put option.

Recommended: Call vs Put Options: Main Differences

How Do Options in Real Estate Work?

Generally, real estate options set a particular purchase price and are valid for anywhere from six months to one year. The buyer doesn’t have to purchase the property, but if they want to, the seller is obligated to sell to them even if the market price has gone up.

The buyer pays what is known as a “premium” in options terminology to enter into the contract. If they decide not to buy the property, the property owner (the seller) keeps that premium.

Real estate options are most often used in commercial real estate, but they can be used by retail investors as well. They aren’t sold on exchanges, and each contract is specific for the property it represents. Usually a contract is only for a single property, not multiple properties.

Real estate options are similar to stock options in that they set a specific price, premium, and period of time for a contract related to an underlying asset. Options can be exercised early or at the expiration date. They can also be sold to another investor.

• Most of the benefits involved in real estate options tilt in the buyer’s favor.

• If the property value goes up a few months into the contract, the buyer can exercise the contract and purchase the property, and sell it for a profit.

• If the property value drops, the buyer can simply let the option expire — thus losing only the premium they paid, which is typically a small percentage of the value of the underlying asset or property in this case.

If the buyer decides not to exercise the contract, they can sell it to another buyer at a potentially higher premium (and pocket the difference).

For a seller, there is the potential for them to make a profit if the buyer exercises their option to purchase the property. They may also profit if the buyer doesn’t exercise the option — at which point they can keep the premium amount, and then sell the contract (or the property) to someone else.

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

Lease Options

In addition to real estate options for purchases, there are also lease options. These are rent-to-own agreements between a buyer and seller. They let someone lease a property with the option to buy it after a certain amount of time, but not the obligation.

Generally with a lease option, some or all of the rental payment goes towards the purchase. Some lease options lock in a particular price, but others just give the buyer the exclusive right to buy at whatever the market price is.

Although lease options can be great for buyers, they are also more expensive than simply renting a property since they involve a premium. For this reason, it’s important for a buyer to carefully consider the contract and their future plans before entering into a lease option agreement.

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

2 Advantages of Real Estate Options for Buyers

Options are a common investing strategy for commercial real estate investors. There are several reasons a buyer might enter into a real estate option contract with a seller.

It Can Allow Time for the Buyer to Amass Funds

One might choose a real estate option if they want to secure a piece of land or property at a certain price but they need some time to get funds in order for the purchase.

A Real Estate Option Locks in a Price

If a buyer thinks the price of a property might go up, they can purchase an option to lock in the current market price. However, some real estate options are not completely set in their sale prices. There may be clauses in the contract to determine what the final sale price will actually be.

2 Advantages of Real Estate Options for Investors

Real estate investors can also use options to their advantage.

It’s a Lower-Risk Way to Develop Property

For example, let’s say an investor finds a property they’re interested in developing into housing. The investor needs to create a plan for the property and get other investors involved before they can buy it, so they purchase a real estate option to give them the exclusive right to buy the land.

The investor can make a profit by bringing in investors at a higher rate than the option. They can then buy the land and sell it to the developers they brought in to make a profit.

If they aren’t able to get developers and investors involved before the contract expires then they simply don’t buy the land.

An Investor Can Buy and Sell Real Estate Options

Investors can also make a profit just on buying and selling real estate options contracts rather than the properties themselves. This is a much less capital-intensive way to get involved in real estate investing.

For instance, an investor might find a property they expect will increase in value in the coming months. They purchase a real estate option to buy the land at the current market rate within the next year, pay a premium, and wait.

At any point during the period of the agreement the investor can either act on the contract and buy the property, or they can sell the contract to someone else. Let’s say the value of the property increases three months into the contract. The investor can find another investor who wants to purchase the contract for them for a higher price than the premium the original investor paid.

Whether any investor buys the property or not, the seller of the property keeps the premium.

The Takeaway

Real estate options are a way for investors to get involved in real estate investing without directly buying properties. As with any other kind of options, the investor buys the right to buy or sell at a certain price, but is not obligated to do so.

Qualified investors who are ready to try their hand at options trading, despite the risks involved, might consider checking out SoFi’s options trading platform. The platform’s user-friendly design allows investors to trade through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors.

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

Photo credit: iStock/Melpomenem

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.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOIN0723075

What Is Yield to Call? Formula & Examples

What Is Yield to Call?

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How Yield to Call Works

Yield to Call Formula

How to Calculate Yield to Call

Yield to Call Example

Interpreting Yield to Call Results

Yield to Call Comparisons

Yield to Call vs Yield to Maturity

Yield to Call vs Yield to Worst

The Takeaway

FAQ

What is the advantage of yield to call?

How do you calculate yield to call in Excel?

Is yield to call always lower than yield to maturity?

Guide to Morningstar Ratings

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How Morningstar Ratings Work

The “Star Rating” Explained

The “Analyst Rating” Explained

How Morningstar Measures Volatility

Example of a Morningstar Rating

Are Morningstar Ratings Accurate?

Use Expense Ratios

How Should Investors Use Morningstar Ratings?

Risks of Morningstar Ratings

Morningstar Ratings for Funds

Other Investment Risk Rating Providers

Trading Stocks With SoFi

FAQ

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Is a Morningstar rating of “5” good?

Averaging Down Stocks: Meaning, Example, Pros & Cons

What Is Averaging Down?

Example of Averaging Down

Potential of Gain Averaging Down

Potential Risk of Averaging Down

Why Average Down on Stock

1. Value Investing

2. Dollar-Cost Averaging

3. Loss Mitigation

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Pros and Cons of Averaging Down

Pros of Averaging Down

Cons of Averaging Down

Tips for Averaging Down on Stock

The Takeaway

How Many Stocks Should I Own?

How Many Different Stocks Should You Own?

How Many Stocks Should You Have in a Diversified Portfolio?

How Many Stocks Can You Buy?

How Many Shares Are in a Company?

Rules for Day Traders

Getting the Right Balance in Your Stock Holdings

Balancing a Portfolio with Index Funds

Diversifying with ETFs

How Many ETFs Should I Own?

ETFs as a Complement

An All-ETF Portfolio

Choosing Stocks vs Investing in Funds

The Takeaway

FAQ

How many stocks should you own with $1K, $10K, or $100K?

Can you over-diversify a portfolio?

How many different sectors should you invest in?

Understanding the Basics of Real Estate Options

What Are Real Estate Options?

How Do Options in Real Estate Work?

Lease Options

2 Advantages of Real Estate Options for Buyers

It Can Allow Time for the Buyer to Amass Funds

A Real Estate Option Locks in a Price

2 Advantages of Real Estate Options for Investors

It’s a Lower-Risk Way to Develop Property

An Investor Can Buy and Sell Real Estate Options

The Takeaway

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