InvestGen Archives | Page 42 of 63

Sep

2023

50 Investment Terms and Definitions

By Kaitlyn Farley | Growing Wealth, invest, Investing | Comments Off

Some investment terms and definitions may seem complex, but a little research can take the mystery out of most common investing terminology. That can help investors feel even more confident about starting their investing journey. It’s more or less the same as starting any new endeavor — from rock climbing to investing — at first, you need to get familiar with new words and phrases.

Given the girth of the investment space, the sheer amount of investment terminology investors need to know can be intimidating. But the more you read, invest, and envelope yourself in it, the easier it’ll become. If you’re just starting out, though, it may be helpful to get a big rundown of some of the more common investing terms.

Investment Terminology Every Beginner Investor Needs to Know

Here are a slew of common investing terms and definitions (in alphabetical order) that investors may benefit from committing to memory.

1. Alpha

Alpha is used to gauge the success of an investment strategy, portfolio, portfolio manager, or trader compared with a relevant benchmark. You may also hear alpha defined as “excess return” in that it refers to returns that can be attributed to active management, over and above market returns.

2. Assets

An asset is anything that holds value that can be converted to cash. Personal assets might include your home, a car, other valuables. Business assets might include machinery, patents. When it comes to investing, assets are typically the securities you invest in.

3. Asset Class

An asset class is a group of investments with similar characteristics that is likely to perform differently in the market than another asset class. Types of asset classes include stocks, bonds, real estate, currencies, and more. Given the same market conditions, stocks and bonds often move in opposite directions. Most financial advisors typically recommend you invest in multiple asset classes in order to have a well-diversified portfolio and minimize risk.

4. Asset Allocation Fund

An asset allocation fund is a diversified portfolio consisting of various asset classes. Most asset allocation funds have a mix of stocks, bonds, and cash equivalents. These types of funds can be popular as some advisors stress the importance of having diverse portfolios to minimize potential losses.

5. Beta

Beta refers to how risky or volatile a security or portfolio is compared with the market overall. Calculating the beta of the stocks in your portfolio can help you determine how your portfolio might respond to market volatility. You can also gauge the beta of a stock to help determine how much risk it might add to your portfolio.

6. Bear Market

A bear market occurs when the market declines, typically when broad market indexes fall 20% or more in two months or less. Bear markets can accompany a recession, but not always. They often signal that investors feel pessimistic about their investments’ ability to make money and the market’s ability to rebound.

7. Bull Market

A bull market is the opposite of a bear market, meaning prices are rising or are expected to rise for extended periods of time. Bull markets usually mean security prices are rising for months or even years at a time.

8. Blue Chip

Blue chip companies are generally thought to be well-established, financially sound, and therefore high-quality investments. Blue chip stocks are typically large companies, and many of them are household names. In some cases, blue chips may be more expensive to invest in since they can be considered relatively stable and likely to grow.

9. Bonds

When governments or corporations need to borrow money they issue bonds. Investors who buy the bonds are effectively loaning that entity cash, which will be repaid according to the terms of the bond (e.g. a 10-year bond with an interest rate of 3%). Bonds are often considered to be relatively stable, lower-risk investments compared with stocks.

10. Broker

An investment broker, whether a person or a firm, acts as a middleman to help investors buy and sell securities. Brokers may be necessary because some securities exchanges only allow members of that exchange to make an investment order. A broker’s primary function is to help clients place trades, although many brokers also help clients with market research and investment planning.

11. Diversification

You’ve probably heard that you should aim to have a diversified portfolio. That means investing in a range of asset classes that are likely to behave differently under different market conditions, in order to mitigate risk. A portfolio of only stocks, for instance, could be more vulnerable to market volatility than a portfolio that also included bonds, real estate, commodities, and so on.

12. Dividends

When a company shares their profits with investors, these are called dividends. Dividends are often paid in cash (although they can be paid in stocks). Some companies — e.g. many blue chip firms — pay dividends, but not all companies do. Ordinary dividends are taxed differently than qualified dividends, so you may want to consult a tax professional if you own dividend-paying stocks.

13. Dollar Based Investing

Also called fractional share investing, dollar based investing is a way for investors to buy partial shares of stocks. Instead of buying shares of a company, you instead invest a dollar amount. Dollar based investing is a great way for smaller investors to buy into popular companies that they may otherwise be priced out of.

14. EBITDA

EBITDA is a way to evaluate a company’s performance that is considered more precise than simply looking at net income. EBITDA stands for: earnings before interest, taxes, depreciation, and amortization. To calculate EBITDA, use the following formula: Net Income + Interest + Taxes + Depreciation + Amortization.

15. EBIT

EBIT is a simpler way to calculate a company’s profits than EBITDA, as it’s only one part of the EBITDA equation (literally!). It stands for “earnings before interest and taxes.” It’s calculated using this formula: Net Income + Interest + Taxes.

16. EPS

EPS stands for earnings per share, which is a common way investors measure how well a stock is performing. EPS is calculated by finding a company’s quarterly or annual net income and dividing it by the company’s outstanding shares of stock. Increases in EPS can be a sign that the company’s profit performance is on the upswing, whereas a decrease can be a red flag for investors.

17. ETF

Exchange-traded funds, or ETFs, are similar to mutual funds in that the fund’s portfolio can include dozens or even hundreds of different securities, and investors buy shares of the fund. Unlike mutual funds, ETF shares can be traded like stocks throughout the day (mutual fund shares are traded once a day). Most ETFs are considered lower-cost, passive investments because they track an index, although there are actively managed ETFs.

18. Expense Ratio

An expense ratio is an annual fee investors pay to cover the operating costs of mutual funds, index funds, ETFs and other types of funds. Fees are typically deducted from your investments automatically (you don’t pay a separate charge), and they can reduce your returns over time so it’s wise to shop around for lower fees. Expense ratios are calculated using this formula: Total Funds Costs / Total Fund Assets Under Management.

19. FCF

Free cash flow is the money a company has after it has paid its expenses. This number is important to investors because it can show them how likely it is that a company could have extra cash for dividends or share buybacks. A continuous decrease in free cash flow over a few years can also be a red flag to investors.

20. Growth Stock

Growth stocks are shares in a company that’s growing faster than its competitors, typically showing potential for higher revenue or sales. Growth stock companies may be considered leaders in their industry.

21. Hedge Fund

Hedge funds are usually managed by an LLC or limited partnership that invests in securities and other assets using money from multiple investors. Hedge funds tend to be more risky and expensive than mutual funds or ETFs, which often makes them accessible to more wealthy investors.

22. Index Fund

Index funds are a type of mutual fund that invest in securities that mirror a particular index, such as the S&P 500 Index or the MSCI World Index. Indexes track many different sectors, from smaller U.S. companies to big global companies to various kinds of bonds. Each index acts as a proxy for how that market sector is performing; the corresponding index funds reflect that performance.

23. Interest Rate

The interest rate is the amount a lender charges to borrow money — and it can also mean the amount your cash earns in a savings, money market or CD account. The baseline interest rate in the U.S. is set by the Federal Reserve. This rate in turn influences savings rates, mortgage rates, credit card rates, and more. Generally, when the Federal Reserve lowers interest rates, the stock market tends to rise.

24. Large Cap

A large-cap company has $10 billion or more in market capitalization. These companies are often considered industry leaders, and are relatively conservative, low-risk, and safe investments. A company’s stock may be considered large cap, mid cap, or small cap.

25. Market Cap

Market capitalization, or market cap, is the value of a company’s total outstanding shares. It’s often used to measure a company’s value and build a diversified portfolio. You can calculate market cap by multiplying the number of outstanding shares by the current price per share. Companies with lower market caps usually have more room to grow and usually are associated with newer companies, meaning they can also be riskier.

26. Mid Cap

Mid-cap companies are usually between $2 billion to $10 billion in market capitalization, putting them somewhere between small- and large-cap companies. Many mid-cap companies are in a growth phase, making them attractive to some investors who believe the company may grow into a large-cap over time, although this is not guaranteed to happen.

27. Mega Cap

Mega-cap companies are the largest companies you can invest in, with a market value of $1 trillion or more. Mega-cap stocks are typically industry leaders and household name brands.

28. Mutual Fund

Mutual funds may invest in stocks, bonds, and other securities — or a combination of these (e.g. a blended fund). Mutual funds can also be industry-specific (such as a mutual fund consisting only of energy stocks, green bonds, or tech companies, and so on).

29. Net Income

When talking about investing, net income usually refers to how much a company makes (or its total losses) after it has paid all its expenses. Net income is therefore usually calculated by subtracting a company’s expenses from its revenue. Investors may want to know a company’s net income because it can help determine how profitable the company is, although EBITDA (defined above) is another measure.

30. Over-the-Counter Stocks

Not all stocks are publicly traded. These “private” stocks, often called over-the-counter stocks, usually have to be traded through a broker. Companies may offer OTC stocks if they don’t meet the requirements to be traded publicly. Such companies are often startups or other small companies. So, while these companies may eventually grow to be able to trade publicly, investing in them also carries the risk that they may fold or even engage in fraudulent activity since the market is far less regulated than publicly traded markets are.

31. Price-to-Earnings Ratio

Investors commonly use P/E, or price-to-earnings ratios, to gain insight into how profitable a company is compared to its stock price. In other words, price-to-earnings ratios can help investors decide if the price of a stock is worth it when compared to how much a company is making.

32. Prime Interest Rate

Banks are likely to offer their best customers — those with the best credit histories and the lowest risk of defaulting — a prime interest rate for a loan. The prime interest rate is generally the lowest rate the bank will offer. A bank’s criteria for determining their prime interest rate may vary, but most banks consider the federal funds rate when setting any interest rate.

33. Portfolio Management

Portfolio management simply refers to how you select and manage the investments in your portfolio. There are many different management styles, such as active or passive, growth or value. Additionally, you can elect to manage your own portfolio or hire an individual or group to manage it for you.

34. Preferred Stock

A preferred stock means investors own shares in a company and get scheduled dividends, similar to how bond interest payments work. Preferred socks may not fluctuate in price like common stocks do, meaning they are often less volatile and risky.

35. Profit & Loss Statement

You probably know what profit and losses are, but do you know how to read a company’s P&L, or profit & loss statement? It can help you determine a company’s bottom line, as it can show you how well a company is doing compared to its peers in the same industry. If you’ve never read one before, this article about profit & loss statements could give you some tips on what to look for.

36. Prospectus

Companies that offer stocks, bonds, and mutual funds to investors are required to file a prospectus with the Securities and Exchange Commission that provides details about the investment they are offering (e.g. the expense ratio, the constituents of a fund, and more). Investors can use the prospectus to better understand a given security and how it might fit in their portfolio, or not.

37. Recession

A recession is a period of economic contraction. The National Bureau of Economic Research (NBER) defines a recession further as a decline in monthly employment, personal income, and industrial production. As an investor, a recession may indicate a drop in the value of your portfolio, although this may be temporary: When looking at the history of U.S. recessions, the stock market has always rebounded, sooner or later, after recessions.

38. REIT

Real estate investment trusts (REITs) are a way that investors can further diversify their portfolios. Instead of having the responsibility of managing an investment property yourself, you can invest in REITs, which are generally large-scale real estate projects that investors can help fund in exchange for partial ownership. Most REITs are publicly traded and pay dividends to investors.

39. Retained Earnings

When looking for a company’s net income statement, you may come across the term “retained earnings,” also sometimes called unappropriated profit, uncovered loss, member capital, earnings surplus, or accumulated earnings. In general, retained earnings is the amount of money a company keeps and potentially reinvests after it gives its investors a dividend payout.

As an investor, knowing whether a company had positive retained earnings can help you determine how much money it has to continue growing. If its retained earnings are negative, that could be a sign the company is in debt and may not be a good investment.

40. Return on Equity

Return on equity, sometimes called return on net worth, can help investors compare how well companies are managing their stockholders’ contributions. You can calculate it using this formula: Net income/Average shareholder equity. A higher return on equity can signal to investors that a company is managing its money efficiently.

41. ROI

Return on investment (ROI) is just that: the return you get after making an investment in a stock, bond, mutual fund, and so forth. Investors generally hope for a positive ROI, meaning that their investment has made a profit. While a good ROI will vary depending on the type of investments you’re making, some investors look to the historic return of the stock market (about 7% annually) as a barometer.

42. Small Cap

A small-cap company usually has a market cap of $250 million to $2 billion. Investors may be attracted to a small-cap company because they believe it has growth potential or may be undervalued.

43. SPAC

SPAC stands for special purpose acquisition company. SPACs are shell companies that list shares on an exchange to raise money so they can merge with a privately held company. Once the merger between the public SPAC and the private company is complete, that company is now in effect a public company — which is why a SPAC is sometimes called a backdoor IPO. Many companies may elect to use SPACs instead of traditional IPOs because they are often faster and less expensive.

44. Stocks

If you’ve made it this far, you probably know what a stock is. To review, a stock is a way to buy a piece of ownership into a company. You can buy and sell your stocks depending on whether you anticipate your stocks will decrease or increase in value.

45. Stock Exchange

A stock exchange is the place where you buy, sell, or trade stocks. Common U.S. stock exchanges are the New York Stock Exchange (NYSE) and the Nasdaq.

46. Stop-Loss Order

A stop-loss order can help investors have more control over their stocks. When a stock reaches a certain price that you choose, your broker will sell, buy, or trade that stock. Having a stop-loss order can help you limit how much money you make or lose in the stock market.

47. Target Date Fund

A target date fund is a type of mutual fund that includes a mix of asset classes to provide investors with a portfolio that adjusts over time to become more conservative as they age. Target date funds are often used to help investors plan their retirements. Target funds are typically constructed around various target retirement years (e.g. 2030, 2040, 2050) so investors can pick a date that corresponds with their hoped-for retirement.

48. Value Stock

A value stock is a stock that investors believe is undervalued and/or inexpensive compared to its past prices on the stock market or with its competitors. Investors may consider a stock’s price-to-earnings ratio to help them determine if something is a value stock.

49. Venture Capital

Venture capital is money a startup uses to grow its business. This money usually comes from private investors or venture capital firms. Investors may elect to invest venture capital into startups they believe have the potential to be profitable with time.

50. Yield

Yield is another way of referring to the return of an investment over a set period of time, expressed as a percentage. You may hear the term in relation to bonds (e.g. high-yield bonds), but yield is more accurately a measure of the cash flow an investor gets on the amount they invested in a security during that time period, and is different from total return.

💡 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.

The Takeaway

Getting familiar with a few key investing words and phrases can go a long way in helping you gain confidence when you’re new to investing. Getting fluent with investing terminology is like any other pursuit — there’s a learning curve at first, but the terms will feel more natural as you move forward and start investing regularly.

Learning key investing terms and definitions is only the beginning, though. Putting your knowledge into practice is another thing entirely. Although, it is helpful to know the lingo before diving into investing.

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 are the main investment types?

There are many types of investments, but perhaps the main investment types would include stocks, bonds, funds (mutual funds, index funds, exchange-traded funds), and options, though there are more.

What is the basic rule of investing?

There are many guidelines investors might want to follow, but the basic rule of investing is that you shouldn’t invest more than you’re comfortable losing – which is associated with an investor’s risk tolerance.

Photo credit: iStock/akinbostanci

SoFi Invest®

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

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Sep

2023

What Are Separately Managed Accounts? How Do They Work?

What Is a Separately Managed Account (SMA)?

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

A separately managed account (SMA), also referred to as a managed account, is an investment account that is like a customized portfolio of individual securities. An individual investor owns those securities — which may include stocks, bonds, and other investments — but a professional money manager oversees the account.

High net-worth investors who want to build customized portfolios often use separately managed accounts (or SMAs), which allow them to keep their assets separate, versus pooling funds alongside other investors through a mutual fund or exchange-traded fund (ETF).

Understanding what an SMA is, as well as the differences between these accounts and mutual funds and other types of pooled investments can help you decide if an SMA is the right approach for you.

How SMAs Work

Investors pay a financial professional to manage the separately managed accounts they own. The portfolio manager handles day-to-day decision making, but the investor retains control over the overall SMA investment strategy. That includes making initial decisions about which securities to hold inside a separately managed account.

A wealth management firm may give SMA investors several portfolio options to choose from. These portfolios can include a mix of different securities that reflect a specific investment strategy or goal. For example, SMA investing may focus on:

• Increasing tax efficiency

• Generating current income

• Managing interest rate risk

• Delivering above-average returns through trend trading

• Promoting ESG (environmental, social and governance) principles

Within the portfolio there may be stocks, bonds, cash or cash equivalents, or other assets. Stock investments may include small-cap stocks, as well as mid-cap, or large-cap companies. It would be up to the investor to choose which strategy to follow, based on their individual needs, risk tolerance, and objectives.

Recommended: What Is Market Capitalization?

The fees for separately managed accounts are typically based on a percentage of the assets under management, or AUM. Often, the management firm uses a tiered structure in which the fee decreases as the account balance climbs. So, in some cases, the more you invest in a separately managed account, the less you’ll pay as a percentage of assets for professional management.

Wealth managers may also charge fees based on the type of investment strategy. For instance, you may pay one management fee for an equities-based strategy but a different fee if you focus on fixed income. Generally, separately managed accounts do not carry trading or transaction fees the way there would be in a traditional brokerage account.

How Can SMAs Benefit an Investor?

Separately managed accounts can yield some benefits to investors who can afford them. Generally, SMA investing may be a good fit for higher net worth investors who want to take advantage of professional asset management while still being able to decide what happens with their portfolios.

SMAs sit at the opposite end of the spectrum from robo-advisor accounts. Robo advisors, or automated platforms, typically offer an investing strategy that’s driven by an sophisticated algorithm on the back end. While robo services can vary from company to company, generally the algorithm creates pre-set portfolio options that investors can choose from, based on individual preferences.

Here are some of the key benefits associated with separately managed accounts.

Control, Transparency, and Customization

While an asset manager may make investment decisions on an investor’s behalf, the investor still has the final say on what happens with their portfolio inside a separately managed account.

For instance, if you’re offered a prebuilt portfolio you may be able to exclude certain securities or request that others be added to align with your investment goals. Or you may be able to work with your advisor to hand-pick all the securities that are held inside an SMA, or to change the direction of the strategy in the case of a recession or other market event.

Either way, you always directly own the securities held inside your account.

Tax Benefits

Managing tax liability in an investment portfolio matters. The more tax efficient your portfolio is, the more of your returns you get to keep. With separately managed accounts, a financial advisor or wealth manager can implement tax-loss harvesting strategies to help you get the most from your investment dollars.

Cost

As mentioned, with separately managed accounts, fees are typically asset-based. That means you typically won’t pay commission fees, and since you’re investing in individual securities versus pooled investments (like mutual funds or ETFs), you don’t have to pay fund expense ratios either.

Compared to the fees associated with investing in mutual funds or trading in taxable brokerage accounts, SMAs can be more cost-friendly for investors.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

What Are the Drawbacks of SMAs?

While separately managed accounts may work well for some types of investors, they aren’t necessarily a good fit for everyone. Here are some of the downsides of SMAs to keep in mind.

Investment Minimums

Separately managed accounts typically have higher minimum investment requirements, which may be a barrier to entry for some investors. You may need $50,000 to $100,000 or more to open a separately managed account. The reason being that SMAs provide a highly customized investment portfolio for the investor: hands-on investment management.

By contrast, the investment minimums required to open a traditional self-directed brokerage account can be quite low, depending on the type of account and the institution. Again, this is because a professional manager is not involved.

So if you’re just getting started with investing, you may not qualify for a separately managed account.

Less Diversification

Since separately managed accounts hold individual securities, it’s harder for them to offer the same level of broad-based diversification as a mutual fund or exchange-traded fund (ETF), which could hold hundreds or thousands of different stocks.

SMAs vs Pooled Investment Funds

The main similarity between separately managed accounts and pooled investment funds, e.g. mutual funds and exchange-traded funds, is that SMAs are portfolios of many securities, and the portfolio of a mutual fund or ETF also includes many securities. But SMAs are customized based on the individual investor’s wishes, and managed by a professional investment manager who adheres to the investor’s strategy.

Comparing SMAs and Mutual Funds

With an SMA, your portfolio includes individual securities that you own. A mutual fund, on the other hand, is a pooled investment that includes money from multiple investors.

When you invest in a mutual fund, you don’t get to choose what the fund holds. That’s the job of a fund manager, who decides what to buy or sell, based on the fund’s objectives. So a fund may hold a mix of stocks, bonds, cash or other securities. You, along with the other investors who have pooled their money in the mutual fund, share in the fund’s returns or its losses.

Compared to separately managed accounts, mutual funds can have a much lower initial investment to get started: a hundred dollars versus tens of thousands of dollars (depending on the fund).

And instead of paying an asset-based management fee, mutual funds charge expense ratios. This expense ratio reflects the annual cost of owning the fund.

The Difference Between SMAs and ETFs

The difference between separately managed accounts and exchange-traded funds (ETFs) is similar to the difference between SMAs and mutual funds. Instead of building a portfolio that’s composed of individual securities and managed by a financial professional, you’re pooling money into a fund along with other investors.

This fund can hold hundreds of securities and have specific goals. For example, there are ETFs that invest in gold, in commodities, in biotech, and more.

Many investors begin by putting their money into exchange-traded funds or mutual funds, and then move some of their portfolio into a separately managed account once it grows larger.

The Takeaway

Separately managed funds are a popular way for high net worth investors to have some control over their professionally managed funds when building an investment portfolio. However, if you can’t meet the high minimum investment requirements for a separately managed account, you may want to consider investing in ETFs or mutual funds instead.

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

FAQ

How are SMAs customized?

With an SMA, you can work with your financial advisor and/or investment manager to pick all the securities that are held inside an SMA. You can choose to exclude certain securities or ask that others be added to align with your investment goals. You can also request to change the direction of the strategy in the case of a market event like a recession.

What type of due diligence do you need to do before investing in SMAs?

An investor should do thorough due diligence on the money manager they’re considering working with before setting up an SMA. Investigate the manager’s investment philosophy, approach, and process, inquire about their compliance history, and ask to see performance data, including quarterly returns. Inquire about all the fees involved, including transaction expenses. And finally, find out how the investment manager is compensated and what their incentives are.

What is the difference between a separate account and a separately managed account?

A separate account and a separately managed account are the same thing: an investment vehicle that holds securities and is owned by an investor and managed by a professional financial advisor or money manager. These accounts are sometimes referred to by either name.

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SoFi Invest®

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

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

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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Sep

2023

Cyclical vs Non-Cyclical Stocks: Investing Around Economic Cycles

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

Cyclical investing means understanding how various stock sectors react to economic changes. A cyclical stock is one that’s closely correlated to what’s happening with the economy at any given time. The performance of non-cyclical stocks, however, is typically not as closely tied to economic movements.

Investing in cyclical stocks and non-cyclical stocks may help to provide balance and diversification in a portfolio. This in turn may help investors to better manage risk as the economy moves through different cycles of growth and contraction.

Cyclical vs Non-Cyclical Stocks

There are some clear differences between cyclical vs. non-cyclical stocks, as outlined:

	Cyclical Stocks	Non-Cyclical Stocks
Perform Best During	Economic growth	Economic contraction
Goods and Services	Non-essential	Essential
Sensitivity to Economic Cycles	Higher	Lower
Volatility	Higher	Lower

A cyclical investing strategy can involve choosing both cyclical and non-cyclical stocks. In terms of how they react to economic changes, they’re virtual opposites.

Cyclical stocks are characterized as being:

• Strong performers during periods of economic growth

• Associated with goods or services consumers tend to spend more money on during growth periods

• Highly sensitive to shifting economic cycles

• More volatile than non-cyclical stocks

When the economy is doing well a cyclical stock tends to follow suit. Share prices may increase, along with profitability. If a cyclical stock pays dividends, that can result in a higher dividend yield for investors.

Non-cyclical stocks, on the other hand, share these characteristics:

• Tend to perform well during periods of economic contraction

• Associated with goods or services that consumers consider essential

• Less sensitive to changing economic environments

• Lower volatility overall

A non-cyclical stock isn’t completely immune from the effects of a slowing economy. But compared to cyclical stocks, they’re typically less of a roller-coaster ride for investors in terms of how they perform during upturns or downturns. A good example of a non-cyclical industry is utilities, since people need to keep the lights on and the water running even during economic downturns.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Cyclical Stocks

In the simplest terms, cyclical stocks are stocks that closely follow the movements of the economic cycle. The economy is not static; instead, it moves through various cycles. There are four stages to the economic cycle:

• Expansion. At this stage, the economy is in growth mode, with new jobs being created and company profits increasing. This phase can last for several years.

• Peak. In the peak stage of the economic cycle, growth begins to hit a plateau. Inflation may begin to increase at this stage.

• Contraction. During a period of contraction, the economy shrinks rather than grows. Unemployment rates may increase, though inflation may be on the decline. The length of a contraction period can depend on the circumstances which lead to it.

• Trough. The trough period is the lowest point in the economic cycle and is a precursor to the beginning of a new phase of expansion.

Understanding the various stages of the economic cycle is key to answering the question of what are cyclical stocks. For example, a cyclical stock may perform well when the economy is booming. But if the economy enters a downturn, that same stock might decline as well.

Examples of Cyclical Industry Stocks

Cyclical stocks most often represent companies that make or provide things that consumers spend money on when they have more discretionary income.

For example, that includes things like:

• Entertainment companies

• Travel websites

• Airlines

• Retail stores

• Concert promoters

• Technology companies

• Car manufacturers

• Restaurants

The industries range from travel and tourism to consumer goods. But they share a common thread, in terms of how their stocks tend to perform during economic highs and lows.

Examples of Non-Cyclical Industry Stocks

Non-cyclical industry stocks would be shares of companies that are more insulated from economic downturns than their cyclical counterparts. It may be easier to think of them as companies that are probably going to see sales no matter what is happening in the overall economy. That might include:

• Food producers and grocers

• Consumer staples

• Gasoline and energy companies

Cyclical Stock Sectors

The stock market is divided into 11 sectors, each of which represents a variety of industries and sub-industries. Some are cyclical sectors, while others are non-cyclical. The cyclical sectors include:

Consumer Discretionary

The consumer discretionary sector includes stocks that are related to “non-essential” goods and services. So some of the companies you might find in this sector include those in the hospitality or tourism industries, retailers, media companies and apparel companies. This sector is cyclical because consumers tend to spend less in these areas when the economy contracts.

Financials

The financial sector spans companies that are related to financial services in some way. That includes banking, financial advisory services and insurance. Financials can take a hit during an economic downturn if interest rates fall, since that can reduce profits from loans or lines of credit.

Industrials

The industrial sector covers companies that are involved in the production, manufacture or distribution of goods. Construction companies and auto-makers fall into this category and generally do well during periods of growth when consumers spend more on homes or cars.

Information Technology

The tech stock sector is one of the largest cyclical sectors, covering companies that are involved in everything from the development of new technology to the manufacture and sale of computer hardware and software. This sector can decline during economic slowdowns if consumers cut back spending on electronics or tech.

Materials

The materials sector includes industries and companies that are involved in the sourcing, development or distribution of raw materials. That can include things like lumber and chemicals, as well as investing in precious metals. Stocks in this sector can also be referred to as commodities.

Cyclical Investing Strategies

Investing in cyclical stocks or non-cyclical stocks requires some knowledge about how each one works, depending on what’s happening with the economy. While timing the market is virtually impossible, it’s possible to invest cyclically so that one is potentially making gains while minimizing losses as the economy changes.

For investors interested in cyclical investing, it helps to consider things like:

• Which cyclical and non-cyclical sectors you want to gain exposure to

• How individual stocks within those sectors tend to perform when the economy is growing or contracting

• How long you plan to hold on to individual stocks

• Your risk tolerance and risk capacity (i.e. the amount of risk you’re comfortable with versus the amount of risk you need to take to realize your target returns)

• Where the economy is, in terms of expansion, peak, contraction, or trough

For example, swing trading is one strategy an investor might employ to try and capitalize on market movements. With swing trading, you’re investing over shorter time periods to reap gains from swings in stock prices. This strategy relies on technical analysis to help identify trends in stock pricing, though you may also choose to consider a company’s fundamentals if you’re interested in investing for the longer term.

How to Invest in Cyclical Stocks

Investors can invest in cyclical stocks the same way they do any other type of stock: Purchasing them through a brokerage account, or from an exchange.

One way to simplify cyclical investing is to choose one or more cyclical and non-cyclical exchange-traded funds (ETFs). Investing in ETFs can simplify diversification and may help to mitigate some of the risk of owning stocks through various economic cycles.

The Takeaway

Cyclical stocks tend to follow the economic cycle, rising in value when the economy is booming, then dropping when the economy hits a downturn. Non-cyclical stocks, on the other hand, tend to behave the opposite way, and aren’t necessarily as affected by the overall economy.

Investing around economic cycles is a viable strategy, but it has its potential pitfalls. Investors who do their homework may be able to successfully invest around economic cycles, but it’s important to consider the risks involved.

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 are indicators of cyclical stocks?

A few examples of indicators of cyclical stocks include the earnings per share data reported by public companies, which can give insight into the health of the economy, along with beta (a measure of volatility of returns) and price to earnings ratios.

What is the difference between cyclicality vs. seasonality?

While similar, cyclicality and seasonality differ in their frequency. Seasonality refers to events or trends that are observed annually, or every year, whereas cyclicality, or cyclical variations can occur much less often than that.

How do you mitigate the risk of investing in cyclical stocks?

Investors can use numerous strategies to mitigate the risk of investing in cyclical stocks, such as sector rotation and dollar-cost averaging.

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

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Sep

2023

What Are Pink Sheet Stocks?

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

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

The over-the-counter market may appeal to smaller companies, companies that are reorganizing after bankruptcy or shell companies. A pink sheet stock does not face the same level of regulation as stocks from publicly traded companies that are traded on the New York Stock Exchange or NASDAQ.

What Is a Pink Sheet OTC?

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

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

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

Investors looking for bargain buys may consider dipping into the pink sheets market. But pink sheet stocks — and penny stocks, in particular — can be highly volatile so it’s important to understand both the risks and potential rewards.

Listing Requirements

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

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

Are Pink Sheets and OTC the Same?

The terms pink sheet stocks, and OTC or over the counter, loosely refer to the same thing: Trades that take place outside of the traditional stock exchanges. The company OTC Markets provides quotes for companies listed on the pink sheets, as well as the OTCQX and the OTCQB trading marketplaces.

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

There are also companies that adopt regulatory and reporting standards to list with the Over the Counter Bulletin Board (OTCBB) system. This was another electronic stock quote system that displays stock prices for securities not listed on a national exchange. It had regulation requirements, which means pink sheet stocks wouldn’t be listed, but has ceased operations.

Are Pink Sheets and Stocks the Same?

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

Pink sheet stocks may have much lower valuations than small-cap, mid-cap or large-cap stocks, or they may be newer companies that have yet to establish themselves in the market. This is why it’s possible to buy penny stocks or microcap stocks on the pink sheets for pennies on the dollar.

Companies that Use Pink Sheets

There are many companies that use pink sheet stocks, and that includes some big-name, well-known companies that most people would recognize. That said, most likely wouldn’t be recognizable immediately to the average investor. A quick internet search would yield many results and examples.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Pros and Cons of Pink Sheet Stocks

Pink sheet stocks have benefits and disadvantages, both for the companies that list over the counter and for investors. These may differ from exchange-traded stocks. Here are some of the most important pros and cons to consider when investing in pink sheet stock:

Benefits of Pink Sheet Stocks

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

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

For investors, the appeal of pink sheet stock trading is the potential to pick up stocks at rock-bottom prices. If a company listed on the pink sheets takes off, that could result in significant profits for investors who bought in early. Because there are fewer reporting requirements, it’s possible to find a much broader range of stocks to invest in when trading on the OTC pink sheets.

Disadvantages of Pink Sheet Stocks

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

Investing in pink sheet stocks may have more risk than trading stocks on a major exchange, since there is less transparency around their finances. It can be difficult to “look under the hood,” so to speak, and get an accurate picture of a company’s fundamentals. That means investors are inherently taking on more risk when investing in the pink sheets simply because they may not know exactly what they’re buying.

In addition, pink sheet stocks may be thinly traded, meaning it can be more difficult to buy or sell shares. Allocating assets to pink-sheet stocks may not be appropriate for investors who want or need liquidity within their portfolio.

Finally, investors must consider the fees associated with trading pink sheet stocks, as fees can erode net returns and stock profit.

How to Find Pink Sheet Stocks

Finding pink sheet stocks can be as simple as searching the OTC Markets website. You can use the platform’s stock screener to filter for pink sheet stocks. The filter can tell you at a glance the stock’s ticker symbol, its country of origin, price and trading volume. You can also identify pink sheet stocks by looking for ‘PK’ at the end of their symbol on a stick ticker.

It may be helpful to use an online trading simulator to find pink sheet stocks. A simulator can help you to learn more about pink sheet stocks and penny stocks while simulating trades to estimate potential gains or losses. This can make it easier to familiarize yourself with how pink sheet stocks trade and what kind of volatility you might be able to expect before investing real money.

Pink Sheet Stock Investment Risks

Part of investing strategically means paying attention to risk management. Pink sheet stocks can present greater risk in a portfolio for a few reasons. For starters, there’s less liquidity surrounding these stocks due to lower trading volume. That could make it harder to unload shares of a penny stock or pink sheet stock if you decide that it’s no longer a good fit for your investment strategy.

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

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

Another issue with pink sheet stocks is that they can be susceptible to price manipulation or fraud. Unusual suspects might use shell companies, for example, to trade on the pink sheets for the purpose of laundering money or otherwise defrauding investors. Because there’s so little regulation and transparency surrounding these stocks, it’s important to do thorough research before investing to make sure the company is legitimate.

💡 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.

How to Invest in Pink Sheet Stocks

If you’re interested in investing in pink sheet stocks, you’ll need a brokerage account to get started. Specifically, you need a broker that offers pink sheet trading. Not all brokers offer this service so you may need to research different options for where to trade pink sheet stocks online.

Once you find a brokerage you can decide how much you want to invest in pink sheet stock. Given the higher degree of risk involved, it’s important to consider how much you could realistically afford to lose if a pink sheet stock or penny stock gamble doesn’t pay off. This can help you come up with a number to invest.

When choosing a broker, ask about any applicable commission fees. Brokerages may charge higher trading fees for pink sheet stocks versus stocks that trade on a major exchange, so it’s important to factor cost in when estimating your risk/reward potential.

Pink Sheet Trading Time and Access

Trading pink sheet or OTC stocks occurs during normal market hours: Monday through Friday, 9:30am ET to 4:00pm ET, except on holidays. Investors can also place orders after hours, however.

The Takeaway

Pink sheet stocks, or OTC stocks, are stocks that do not trade on traditional large exchanges, and instead, trade “over the counter.” The over-the-counter market may appeal to smaller companies, companies that are reorganizing after bankruptcy, or shell companies, and listing OTC may be a way to circumvent the IPO process.

Investing in stocks may help you to build wealth for the long term. If you’re new to investing, you may want to start with trading stocks through an online brokerage account before diving into the over the counter market.

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

Why do companies use pink sheets?

Companies may choose to use pink sheets or list their stocks OTC if they can’t meet listing requirements set forth by the SEC, or if they don’t want to go through the IPO process, which can be resource-consuming.

What is the commission on pink sheet penny stocks?

Commissions or fees levied on pink sheet penny stock trading will vary depending on the platform being used to trade them. But in many cases, there are no commissions or fees to execute a trade.

What is the difference between pink sheets vs. OTCBB?

Pink sheets is a term used to describe over the counter, or OTC stocks. OTCBB, on the other hand, is the Over-the-Counter Bulletin Board, and was a quotation service offered by FINRA.

Photo credit: iStock/PeopleImages

SoFi Invest®

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

Sep

2023

The Monte Carlo Simulation & Its Use in Finance

The Monte Carlo Method & Its Uses in Finance

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

A Monte Carlo simulation is a mathematical technique used by investors and others to estimate the probability of different outcomes given a situation where multiple variables may come into play.

Monte Carlo simulations are used in such a wide range of industries — e.g., physics, engineering, meteorology, finance, and more — that the term doesn’t refer to a single formula, but rather a type of multivariate modeling technique. Multivariate modeling is a statistical method that uses multiple variables to forecast outcomes. A Monte Carlo simulation is an example of this type of calculation, which provides a range of potential outcomes using a probability distribution.

What Is the Monte Carlo Method?

A Monte Carlo simulation calculates a probability distribution for any variable that has inherent uncertainty. It then recalculates the results thousands of times over, each time using a different set of random numbers pertaining to each variable, to produce a vast array of outcomes that are then averaged together. In this way, a Monte Carlo analysis enables researchers from many industries to run multiple trials, and thus to define the potential outcome or risk of an event or a decision.

Applying mathematics to investment or business scenarios is difficult precisely because there are so many random variables involved in any single decision or any single investment or portfolio of investments. That’s why a Monte Carlo analysis can be more informative compared with predictive models that use fixed inputs.

The ability to apply mathematics to situations where many elements are probable, and then rank the likelihood of possible outcomes in order to gauge the potential for risk, is a chief advantage of Monte Carlo simulations.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Monte Carlo Method History

Using simulations to solve problems dates back to the 19th century, and perhaps even earlier, when simulations were an experimental way to test theories, analyze data, or support scientific intuition using statistics. But these simulations typically dealt with established deterministic problems. A modern Monte Carlo analysis, however, inverts that structure by using probabilities to solve the problem.

One of the first known uses of a modern Monte Carlo simulation dates back to the 1930s, when physicist Enrico Fermi experimented with an early form of the method to understand the diffusion of neutrons.

Physicists Stanislaw Ulam and John von Neumann are credited with developing and refining the current Monte Carlo method while working at the Los Alamos National Laboratory on nuclear weapons in the 1940s. Of course, the technique needed a code name, and Monte Carlo was chosen because the element of chance also drives the games at a casino (the Monte Carlo region of Monaco is well-known as a gambling hub).

Soon, the simulation method gained traction in the fields of physics, chemistry, and operations research, thanks to its adoption by the Rand Corporation and the U.S. Air Force. From there, it spread to many of the natural sciences, and eventually found its way to finance.

How the Monte Carlo Method is Used in Finance

In terms of practicality in the financial space, the Monte Carlo method has numerous potential uses.

For instance, money managers might use a Monte Carlo analysis to estimate risk levels for different investments when constructing a portfolio. Corporate finance managers might use a Monte Carlo simulation to assess the impact of variables like future sales, commodities prices, interest rates, currency fluctuations, and so on. Brokers might use a Monte Carlo analysis to calculate the risks of stock options.

Monte Carlo Simulation Method

The Monte Carlo simulation works by constructing a model of possible outcomes based on an estimated range of possible conditions. It does this by creating a curve of different variables for each unknown variable, and inserting random numbers between the minimum and maximum value for each variable, and running the calculation over and over again.

A Monte Carlo experiment will run the calculation thousands upon thousands of times. Along the way, it will produce a large number of possible outcomes.

But even for a simple investment, there are a host of factors that will affect its outcome. There are interest rates, regulations, market swings, as well as factors innate to that investment, such as the sales and revenue of the underlying business, or its competitive landscape, or disruptive technology, and so on.

And as an investor seeks to peer further into the future, more possible variables emerge. Using a Monte Carlo simulation to understand those potential investment risks requires using a growing number of inputs as the time horizon grows longer.

After an investor runs a Monte Carlo simulation, the calculation will deliver a range of possible outcomes, with a probability score assigned to each outcome. By weighing the probability scores of different outcomes, an investor can proceed with a better sense of the risks and possible rewards of a given investment decision.

Monte Carlo Simulation Steps

Using a Monte Carlo simulation is a complicated process that requires a background in mathematics, though some investors have created Monte-Carlo-like models using spreadsheet software. Some of those homespun programs can be used to try to project possible price trajectories of a given asset.

If you wanted to get an idea of how the Monte Carlo method could be used to estimate potential stock movements, the steps to do so would look something like the following — but note that this is a very simplistic, pared down model.

• Step 1: Use historical price data of a stock to generate a set of daily returns data

• Step 2: Use that data set to determine further variables, such as standard deviations and variance

• Step 3: Define a random input or variable

• Step 4: Run a simulation (again, this will require software or a program) and analyze the results

In Monte Carlo fashion, the user will repeatedly run the equation an arbitrary number of times, to see how often each outcome occurs. The frequency of each outcome will reflect the likelihood of each outcome.

The results will most likely form a bell curve, with the most likely result in the middle of the curve. But as with any bell curve, those results also indicate that there is an equal chance that the actual result will be either higher or lower than the number in the middle.

Estimating Risk Using the Monte Carlo Method

The Monte Carlo method can be used to determine the likelihood of certain risks when investing, but there are some important things to take into consideration.

For one, a Monte Carlo simulation is only as good as the data that’s programmed into it. No matter how well the simulation is run, its predictive powers can easily be undone by factors that haven’t been added into the equation. For example, when using a Monte Carlo simulation to decide whether or not to buy a given stock, the model could seem to deliver a clear picture of the risks and rewards of the investment.

In that example, the problems arise if the programmer or investor leaves out one single factor, such as macro trends, the effectiveness of company leadership, cyclical factors, political changes, and so on.

There’s a chance that factor could be the one that completely subverts the simulation. And those variables are potentially without limit.

Who Uses Monte Carlo Simulations, and How

Nonetheless, large institutional investors might use Monte Carlo simulations as a tool in their projections and decision making. And its use for investors isn’t limited to hedge fund managers and spreadsheet wizards. There are even online Monte Carlo simulators that can help people save for retirement.

Those tools are designed for the average investor to input some basic information like their savings, and years until retirement to help them understand the likelihood that they will be able to reach their financial goals, and whether they will have enough income in retirement. Those calculators use a generic set of parameters for their calculations, with inputs such as interest rates, and a generic portfolio allocation.

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

The Takeaway

A Monte Carlo simulation is a mathematical technique used to estimate possible outcomes of an uncertain event, such as the movement of securities.

The basis of this analysis is that the probability of different outcomes cannot be determined because random variables cannot be predicted. Therefore, a Monte Carlo simulation will constantly repeat random samples to achieve certain results that can be used to gauge the likelihood of various outcomes, and therefore different risk levels associated with different choices.

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 are the advantages of using the Monte Carlo method compared to other numerical techniques?

Though many other numerical techniques have the same goal as the Monte Carlo method, it may be advantageous in that it tests out numerous random variables and then works to an average, rather than starting from an average — which is not to say that it’ll always provide a superior result than another technique.

How is randomness or probability incorporated into the Monte Carlo method?

The Monte Carlo method incorporates randomness or probability into the mix by using random numbers and distributions of probability, which could include formulas or data sets associated with random variables.

Are there any techniques to improve the efficiency or speed of Monte Carlo simulations?

There are potential techniques and strategies to improve upon the base Monte Carlo method model, and they’re all fairly high-level and abstract (remember, it was developed by physicists at Los Alamos!). For the typical investor, it may not be worth looking too far into.

What are some historical origins and applications of the Monte Carlo method?

The Monte Carlo method’s origins can be traced back to the 1930s and the experiments of physicist Enrico Fermi, and later, others during the 1940s working on nuclear weapon development. It can be used to determine the probability of different outcomes or results that may not easily be predicted.

Photo credit: iStock/PeopleImages

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