InvestHH Archives | Page 10 of 19

Sep

2023

What Is Tax Lien Investing?

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

Tax lien investing involves an investor buys the claim that a local government makes on a property when an owner fails to pay their property taxes. Each year, states and municipalities sell billions of dollars in tax liens to the public.

The lien itself is a legal claim of ownership that a city or county makes against any property whose owner hasn’t paid taxes. The government then sells those claims, usually at auction, to investors. It is considered an alternative investment and a way to get real estate exposure in a portfolio.

How Tax Lien Investing Works

Tax lien investing involves an investor purchasing a property at auction that currently has a tax lien against it. They pay off the lien, and then the property is theirs, typically purchased as an investment.

If an investor wins a tax lien certificate at auction, they must immediately pay the state or local government the full amount of the lien. Then entitled to collect the property’s tax debt, plus interest and penalty fees. The interest that the property owner must repay the investor varies from state to state, but is usually in the 10%-12% range, using a simple interest formula. Some states charge as much as 2% per month on tax liens.

Property Tax Liens Explained

Between 2009 and 2022, historically low interest rates led many income-oriented investors have started to look more closely into buying tax lien certificates as a way to generate more returns from their portfolios. With relatively high interest rates, tax liens offer one way to generate investment income. Unlike many other interest rates, the rates on property taxes aren’t affected by market fluctuations, or decisions by the Federal Reserve. Instead, state statutes set the interest rates on overdue taxes.

That makes tax liens a potentially attractive alternative investment in a period of rock-bottom interest rates. But they come with their own unique risks. For starters, the investor only realizes the high interest rates if the property owner agrees to pay them.

The fact that the property owner is delinquent on their taxes may indicate, however, that they’re in a bad state financially, and unable to pay back the new owner of the lien. In that case, the only way for an investor to recoup the initial cost of buying the lien, plus interest and penalty fees, is to foreclose on the property and sell it. In that situation, the investor gets the money from the proceeds from the sale.

The good news for tax lien investors is that the lien certificate they receive from the local government usually supersedes other liens on the property, including any mortgages on it. That entitles the tax-lien investors to full proceeds from a foreclosure sale in most cases. The only creditor on a property who may have priority over tax-lien investors is the federal government for liens imposed by the Internal Revenue Service.

The bad news is that the lien certificates don’t, in any circumstances, give the investor ownership of the property. In cases where the property owner doesn’t pay the investor the money owed, a tax-deed foreclosure is the only way an investor can get paid.Those proceedings, along with eviction, repairs and other costs, can cut into returns made by the investor.

💡 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.

How to Buy Tax Liens

Not every state allows the public auction of overdue property taxes, but thousands of municipalities and counties across the country currently sell tax debt to the public.

For a new investor, one place to start looking into buying tax liens is by getting in touch with your local tax revenue official. They can point you to the publication of overdue taxes. Most states advertise property tax lien sales for before the actual sale. Most of the time, these advertisements let you know the property owner, the legal description of the property, and the amount of delinquent taxes.

How Do Tax Lien Sales Work?

Tax lien sales often, or mostly, happen at auction. The auctions themselves vary by municipality and state. Some are online, and others are in person. Some operate by having the investors bid on the interest rate. In this auction format, the municipality sets a maximum interest rate, and the investors then offer lower interest rates, with the lowest bidder winning the auction.

In another popular auction format, investors bid up a premium they’re willing to pay on the lien. In this format, the bidder who’s willing to pay the most — above and beyond the value of the lien — wins. But the investor can also collect interest on that premium in many cases.

If that sounds like too much work and research, investors can access this unique asset class by purchasing shares in a tax lien fund run by an institutional investor. Institutional investors may have the research, focus, and experience new investors may not have, or want to develop. Professional investors also have experience with some of the litigation and other expensive pitfalls that can come with a property foreclosure.

Tax Lien Investing Risks

As a financial asset, tax liens offer a unique opportunity for income, but they also have their own set of risks. The first is the property itself. The neighborhood and condition of the property make a difference in the value of the property and the ease with which an investor can sell it.

Another investment risk to keep in mind is that some owners may never pay back the property taxes they owe, and if the value of the property, after foreclosure, may not pay back the money invested in the lien. Investors also may have to deal with a property embroiled in litigation, or on which other creditors have a claim. This is one area where research can make a big difference.

Also, liens don’t last forever. They come with expiration dates, after which the owner can no longer foreclose on the property or collect overdue taxes and interest from the property owner. In some cases, investors will pay taxes on the property to which they own the lien for years, just to keep a claim on the underlying property. This can be a smart strategy if it gets the investor the property at a lower price, but it can also create opportunity costs.

Finally, the overall returns on tax liens are going down in many cases, as more large institutional investors start bidding on tax lien auctions. More bidders drive down the interest rates or drive up the premiums, depending on the auction format.

Benefits to Investing in Tax Liens

Investing in tax liens also has its potential benefits, including the chance of generating outsized returns (but keep the risks in mind, too). Sometimes, properties can be purchased for a relative bargain — such as a few hundred or a few thousand dollars, which can obviously be attractive to investors, though it may not be typical. Tax lien investing is another way to diversify a portfolio as well.

The Takeaway

Tax lien investing involves buying the claim that a local government makes on a property when an owner fails to pay their property taxes. Once an investor buys that claim, they then pay off the back taxes, and take ownership of the property. Each year, states and municipalities sell billions of dollars in tax liens to the public, making for ample opportunity.

Tax lien investment can offer an alternative investment that balances out a diversified portfolio, but it has many risks that individual investors should understand. Of course, there are plenty of other ways that investors can put their money to work for them.

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).

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FAQ

How can you get started in tax lien investing?

Prospective tax lien investors can get in touch with local tax officials to learn more about tax liens in their area, or do some internet searches to find when and where auctions are taking place. They can then bid and potentially win a claim on a property.

What’s the difference between tax liens and mortgage liens?

Tax liens are placed on a property by the government for unpaid property taxes, whereas a mortgage lien is placed on a property by a lender in order to secure it for a borrower failing to pay their home loan.

Are IRS tax liens public record?

IRS tax liens are federal tax liens, and are public record. The IRS will file a public document to alert others in the even that a federal lien is being placed on your property.

Photo credit: iStock/nortonrsx

SoFi Invest®

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

Sep

2023

What Is Efficient Frontier?

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

The efficient frontier is a financial framework that investors can use to build an optimized asset portfolio that attempts to give them the greatest returns within their particular risk profile. In other words, it shows which investment portfolio will be “efficient” or provides a higher expected return for a lower amount of risk. It does not, however, eliminate risk for investors, which is important to keep in mind.

It’s visualized as a curved line on a graph according to an individual’s goals and risk tolerance. The framework is called the efficient frontier or the efficiency frontier because if one’s investments fall within the ideal range, they are working efficiently to achieve one’s goal.

How Does the Efficient Frontier Work?

The efficient frontier concept is a key facet of modern portfolio theory, which was created in 1952 by Harry Markowitz. Essentially, the efficient frontier is the optimal baseline for an investment portfolio. If an investor’s portfolio gives them lower returns because it contains riskier investments, then it may not be as well balanced as it could or should be. It’s also possible for a portfolio to provide returns that are greater than the frontier. As such, as long as a portfolio’s potential returns justify its associated risks, then the portfolio is well-allocated.

Every investor has a different risk tolerance, and their own corresponding goals for portfolio growth. Accordingly, every investor has a different frontier. By adjusting that frontier, the inventors can then see if their current portfolio measures up to the parameters set by the efficient frontier graph, and make changes to their asset allocation accordingly.

💡 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 Is the Efficient Frontier Constructed?

Investors hoping to utilize the efficient frontier concept as a part of their strategy will create a corresponding graph, and apply it to their specific portfolio.

When constructing the graph, expected returns are on the y-axis and the standard deviation of returns, which are a measure of risk, are on the x-axis. Then, they would plot a curve that shows where the ideal or expected portfolio would land on the graph and the standard deviation of returns.

Once the graph is created, the investor can plot a portfolio or individual asset on the graph according to its expected returns and their standard deviation, and then compare it to the efficient frontier curve. The investor can also plot two or more portfolios on the graph to compare them.

A portfolio that falls on the right side of the graph has a higher level of risk, while a portfolio that is low on the graph has lower returns. If an investor finds that their portfolio doesn’t fall on the graph where they would like it to, they can then make decisions about how to reallocate investments to move closer to the goal.

The curved line reflects the diminishing marginal return to risk. Adding more risk to a portfolio doesn’t result in an equal amount of increased return. Portfolios that lie below the curve on the graph are suboptimal because they don’t provide high enough returns to justify their amount of risk. Portfolios to the right of the curve are also suboptimal because they have a high level of risk for their particular level of return.

Again, the portfolios that display the lowest levels of risk are not inherently risk-free, which investors will need to keep in mind.

Efficient Frontier Example

Efficient frontier can be a somewhat difficult concept to visualize, so consider this: Your portfolio contains two assets. Each asset has its own respective expected annual return, and standard deviation — so multiple variables for each asset.

Data sets for each can be put together showing correlated expected returns and standard deviations, and plotted on a graph, as discussed. That graph will reveal the efficient frontier, and help investors determine which portfolio they’d prefer accordingly.

Again, it’s somewhat difficult to visualize, but practically speaking, a visual chart with different portfolios can be helpful in making portfolio decisions.

Benefits of the Efficient Frontier

The primary benefit of the efficient frontier is that it helps investors visualize and understand whether their investment portfolio is performing the way they would like it to. Every investment and portfolio comes with some risk, and oftentimes with more risk there is more reward. But it’s important to make sure that your returns are worth the risk, and to remember that there is no such thing as a risk-free investment or portfolio.

Investors can use the efficient frontier to analyze the current performance of a portfolio and figure out which assets to adjust, potentially liquidate, or reallocate. Investors can also see if a particular asset is giving them the same reward with less risk than other assets. In this case, they might want to sell the higher risk asset and put more funds into the lower risk asset.

How Do Investors Use the Efficient Frontier Model?

Using an efficient frontier model is one method of building a portfolio made of different types of investments that have the optimal balance of risk and return. No portfolio is without risk, and investors do need to reallocate investments on occasion to continue optimizing toward their goal. But the optimal portfolio would have a balance of high-risk, high-reward investments and more stable investments that still get decent returns.

There is often an assumption that investments with greater risk provide greater returns — as noted. Although this is sometimes true, the optimal portfolio holds both high risk and low risk assets, according to the efficient frontier.

If an investor has a higher tolerance to risk, they could choose to own a higher percentage of investments on the right end of the efficient frontier graph with higher risk and higher return. If an investor is more conservative, they could choose to hold lower-risk assets.

Proponents of efficient frontier claim that more diversified portfolios tend to be closer to the efficient frontier line than less diversified portfolios, and therefore have lower levels of risk, though they’re not risk-free.

Limits and Downsides of the Efficient Frontier

The main downside of using the efficient frontier tool is that it creates a curve with a normal distribution, which doesn’t necessarily always match reality. Real investments may vary within three standard variations of the mean curve. This “tail risk” means there are limits to the conclusions you can draw from the efficient frontier graph.

Another issue is that investors don’t always make rational decisions and avoid risk. Market decisions involve many complex factors that the efficient frontier does not factor into its calculations. Instead, the efficient frontier assumes that people always avoid risk and make investing decisions rationally.

Finally, the efficient frontier assumes that the number of investors in a market has no impact on market prices, and that all investors have the same access to borrow money with risk-free interest rates.

Investors using the efficient frontier should understand its limitations and might consider using it in conjunction with other tools for analyzing an investment strategy.

The Takeaway

The efficient frontier is one of many useful methods of analyzing portfolios and creating a long-term investing plan. It involves utilizing a financial framework to build an optimized asset portfolio with aims to maximize their potential gains within their particular risk profile. It also involves visuals to help investors get a better sense of where their portfolio stands. Investors should remember that it is not a tool that will help them completely remove risk from their investment portfolio or allocation.

It’s also a relatively high-level investing concept and tool that many investors may not feel comfortable using. There are plenty of strategies and tools that can be utilized in its stead, of course, and it may be worthwhile to consult with a financial professional if investors feel they’re in over their heads.

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FAQ

What are common assumptions of the efficient frontier model?

Common assumptions of the efficient frontier model include that asset returns will follow a more or less common distribution, that investors will act rationally, and that riskier investments inherently lead to larger returns.

Can the efficient frontier be negative?

The efficient frontier model cannot be negative, as a negative figure would imply that an investor garnered losses from a given set of potential portfolios. That means that the investor was not actually investing.

What is the difference between efficient frontier and efficient portfolio?

The efficient frontier is a set of investment portfolios expected to provide the highest return for a specific risk level. Efficient portfolio, on the other hand, is a single portfolio that provides the highest return for a specific risk level.

Photo credit: iStock/undrey

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

Sep

2023

Pros & Cons of the F.I.R.E Movement

By Krystal Etienne | Budgeting & Goals, invest, Preparing for Retirement | Comments Off

Most people dream of the day that they clock into work for the very last time. In most cases, we imagine that’ll be when we’re in our 60s. But what if you could take the freedom and independence of retirement and experience it 20 or 30 years earlier?

That’s the basic principle of the Financial Independence Retire Early (F.I.R.E) movement, a community of young people who aim to live a lifestyle that allows them to retire in their 30s or 40s rather than their 60s and 70s.

While it may sound like the perfect life hack, attempting to live out this dream comes with some serious challenges. Read on to learn more about the F.I.R.E. movement and the techniques followers use achieve their goal of early retirement. That can help you determine whether any of their savings strategies might be right for you.

What Is the FIRE Movement?

F.I.R.E stands for “financial independence, retire early,” and it’s a movement where followers attempt to gain enough wealth to retire far earlier than the traditional timeline would allow.

The movement traces its roots to a 1992 book called “Your Money or Your Life” by Vicki Robin and Joe Dominguez. F.I.R.E. started to gain a lot of traction, particularly among millennials, in the 2010s.

In order to achieve retirement at such a young age, F.I.R.E proponents devote 50% to 75% of their income to savings. They also use dividend-paying investments in order to create passive income sources they can use to support themselves throughout their retired lives.

Of course, accumulating the amount of wealth needed to live for six decades or more without working is a considerable feat, and not everyone who attempts F.I.R.E. succeeds.

💡 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.

F.I.R.E. vs. Traditional Retirement

F.I.R.E. and traditional retirement both aim to help people figure out when they can retire, but there are major differences between the two.

Retiring Early

Given the challenge many people have of saving enough for retirement even by age 60 or 70, what kinds of lengths do the advocates of the F.I.R.E. movement go to?

Some early retirees blog about their experiences and offer tips to help others follow in their footsteps. For instance, Mr. Money Mustache is a prominent figure in the F.I.R.E. community, and advocates achieving financial freedom through, in his words, “badassity.”

His specific advice includes reshaping simple but expensive habits—like eliminating smoking cigarettes or drinking alcohol, and limiting dining out.

Of course, the basic premise of making financial freedom a reality is simple in theory: spend (much) less money than you make in order to accumulate a substantial balance of savings.

Investing those savings can potentially make the process more attainable by providing, in the best-case scenario, an ongoing passive income stream. However, many people who achieve F.I.R.E. are able to do so in part because of generational wealth or special circumstances that aren’t guaranteed.

For instance, Mr. Money Mustache and his wife both studied engineering and computer science and had “standard tech-industry cubicle jobs,” which tend to pay pretty well—and require educational and professional opportunities not all people can access.

In almost all cases, pursuing retirement with the F.I.R.E. movement requires a lifestyle that could best be described as basic, foregoing common social and leisure enjoyments like restaurant dining and travel.

Target Age for Early Retirement

Early retirement means different things to different people. While some individuals may consider age 55 to be an early retirement, FIRE proponents aspire to retire in their 40s or even in their 30s, if possible.

According to the 2024 SoFi Retirement Survey, 12% of respondents say their target retirement age is 49 or younger. Men were more likely than women to choose this response.

Of those whose target retirement age is 49 or younger:

• 66% have a household income of less than $100,000

• 60% are men,

• 47% are single

• 27% are age 24 or younger

Source: SoFi Retirement Survey, April 2024

Saving Strategies for Retiring Early

Retiring early can involve making some serious adjustments to an individual’s current lifestyle. People who follow the FIRE movement generally try to put 50% to 75% of their income in savings. That can be challenging because once they pay their bills, there may not be much leftover for things like going to the movies or having dinner out.

Of the SoFi survey respondents who say they want to retire at age 49 or younger, 18% are not using any strategies that might help them retire early. Most of the rest are working on it, however — and these are the strategies they’re using to try to retire early:

• 40%: Non-retirement investment accounts (such as brokerage accounts, real estate,and so on)

• 36%: FIRE strategies

• 29%: Maxing out tax advantaged accounts (401(k)s, IRAs, HSAs, etc.)

• 24%: Debt payment strategies such as the snowball and avalanche

• 23%: Roth conversion ladder

• 21%: Working a second job/passive income

Traditional Retirement

Most working people expect to retire sometime around the age of 65 or so. For those born after 1960, Social Security benefits can begin at age 62, but those benefits will be significantly less than they would be if an individual waited until 67, their full retirement age, to collect them.

People saving for traditional retirement typically save much of their retirement funds in tax-incentivized retirement accounts, like 401(k)s and traditional IRAs, which carry age-related restrictions. For example, 401(k)s generally can’t be accessed before age 59½ without incurring a penalty.

Even a traditional retirement timeline can be difficult for many savers. Recent data from the Federal Reserve shows that approximately 25% of Americans have no retirement savings whatsoever. Still, Americans between the ages of 25 to 40 plan to retire at age 59, according to a 2022 survey.

Online calculators and budgeting tools can help you determine when you can retire—and are customizable to your exact retirement goals and specifications.

💡 Haven’t started an IRA yet? Check out: How to Open an IRA

Financial Independence Retire Early: Pros and Cons

Although financial independence and early retirement are undoubtedly appealing, getting there isn’t all sunshine and rainbows. There are both strong benefits and drawbacks to this financial approach that individuals should weigh before undertaking the F.I.R.E. strategy.

Pros of the F.I.R.E. Approach

Benefits of the F.I.R.E. lifestyle include:

• Having more flexibility with your time. Those who retire at 35 or 40, as opposed to 65 or 70, have more of their lifetime to spend pursuing and enjoying the activities they choose.

• Building a meaningful, passion-filled life. Retiring early can be immensely freeing, allowing someone to shirk the so-called golden handcuffs of a job or career. When earning money isn’t the primary energy expenditure, more opportunities to follow one’s true calling can be taken.

• Learning to live below one’s means. “Lifestyle inflation” can be a problem among many working-age people who find themselves spending more money as they earn more income. The savings strategies necessary to achieve early retirement and financial independence require its advocates to learn to live frugally, or follow a minimalist lifestyle, which can help them save more money in the long run—even if they don’t end up actually retiring early.

• Less stress. Money is one of the leading stressors for many Americans. Gaining enough wealth to live comfortably without working could wipe out a major cause of stress, which could lead to a more enjoyable, and healthier, life.

Cons of the F.I.R.E. Approach

Drawbacks of the F.I.R.E. lifestyle include:

• Unpredictability of the future. Although many people seeking early retirement thoroughly map out their financial plans, the future is unpredictable. Social programs and tax structures, which may figure into future budgeting, can change unexpectedly, and life can also throw wrenches into the plan. For instance, a major illness or an unexpected child could wreak havoc on even the best-laid plans for financial independence.

• Some find retirement boring. While never having to go to work again might sound heavenly to those on the job, some people who do achieve financial security and independence and early retirement struggle with filling their free time. Without a career or specific non-career goals, the years without work can feel unsatisfying.

• Fewer professional opportunities. If someone achieves F.I.R.E. and then discovers it’s not right for them—or must re-enter the workforce due to an extenuating circumstance—they may find reintegration challenging. Without a history of continuous job experience, one’s skill set may not match the needs of the economy, and job searching, even in the best of circumstances, may be difficult.

• F.I.R.E. is hard! Even the most dedicated advocates of the financial independence and early retirement approach acknowledge that the lifestyle can be difficult—both in the extreme savings strategies necessary to achieve it and in the ways it changes day-to-day life. For instance, extroverts might find it difficult to forgo social activities like eating out or traveling with friends. Others may find it challenging to create a sense of personal identity that doesn’t revolve around a career.

Investing for F.I.R.E.

Investing allows F.I.R.E. advocates—and others—to earn income in two important ways: dividends and market appreciation.

Dividends

Shareholders earn dividend income when companies have excess profits. Dividends are generally offered on a quarterly basis, and if you hold shares of a stock you could earn them.

However, because dividend payments depend on company performance, they’re not guaranteed, those relying on them to live should have other income sources (including substantial savings accounts) as a back up income stream.

Market Appreciation

Investors can also earn profits through market appreciation when they sell stocks and other assets for a higher price than what they initially paid for them.

Even for those who seek retirement at a traditional pace, stock investing is a common strategy to create the kind of compound growth over time that can build a substantial nest egg. There are many accounts built specifically for retirement investing, such as 401(k)s, IRAs, and 403(b) plans.

However, these accounts carry age-related restrictions and contribution limits which means that those interested in pursuing retirement on a F.I.R.E. timeline will need to explore additional types of accounts and saving and investing options.

For example, brokerage accounts allow investors to access their funds at any point—and to customize the way they allocate their assets to maximize growth.

The Takeaway

Whether you’re hoping to retire in a traditional fashion, shorten your retirement timeline, or are just looking to increase your wealth to achieve shorter-term financial goals, like buying a new car—investing can be one of the most effective ways to reach your objectives.

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

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

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Sep

2023

Navigating the IPO Lock-up Period

By Inyoung Hwang | Growing Wealth, invest, Investing | No Comments

Following an initial public offering, or IPO, many companies and investment bankers will tie your stock up in a lock-up period to stop you from cashing out too quickly and help keep the share price steady.

That may be frustrating if you’re an early employee and investor in a company that’s about to go public, as you may be expecting the value of your stock to skyrocket after the initial public offering, and were hoping to sell some shares. But lock-up periods serve a purpose, and stakeholders will need to know how to navigate them.

Key Points

• An IPO lock-up period is a period after a company goes public during which some early employees and investors aren’t allowed to sell their shares.

• Companies or investment banks self-impose the lock-up period contractually, usually lasting between 90 and 180 days.

• The purpose of the lock-up period is to stop early investors from cashing out too quickly and maintain a steady share price.

• Companies may also use the lock-up period to avoid flooding the market with shares and to prevent insider trading.

• Regular investors may want to pay attention to the lock-up period when investing in IPOs, as it can affect the risk of investing in the company.

What Is an IPO Lock-up Period?

As a part of the IPO process, the IPO lock-up period is the length of time after a company goes public, during which some early employees or investors in the company aren’t allowed to sell their shares.

These restrictions are not mandated by the Securities and Exchange Commission (SEC), but rather are self-imposed contractually by companies or the investment banks that were hired to advise and manage the IPO process.

Lock-periods can be any length of time, but usually they’re between 90 and 180 days after the IPO. Companies may also decide to have multiple lock-up periods that end on different dates and allow different groups of people to sell their shares at different times.

How the IPO Lock-Up Period Works

Here’s an example of an IPO lock-up period: When one lock-up period ends company executives might be allowed to sell their shares, while a subsequent lock-up ending means regular employees can sell their shares.

What Does “Going Public” Mean?

When a company has an IPO, it is offering shares of the company for sale to the public stock market for the first time. The company is shifting at this point from a privately held company to a publicly traded company. This is the origin of the phrase “going public,” which you may have heard bandied around in reference to IPOs.

When a company is private, ownership is limited and can be tightly controlled. But when a company goes public, anyone can buy shares. But at this point there may be a lot of fingers in the pie already. Company founders, early employees, and even venture capitalists may already own shares or have stock options in the company.

💡 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.

What Is IPO Underwriting?

Before a company goes public it often goes through an underwriting process in which an underwriter — usually an investment bank — advises the IPO process and helps come up with the business’ valuation. The most common way they do this is by agreeing to buy a company’s entire inventory of stock.

Then to alleviate the risk of holding all of this stock, the underwriter will allocate shares of the company to institutional investors before the IPO.

The underwriter will try to drum up so much interest in the stock that more people will want it than there are shares available. This will lead to the stock being oversubscribed, which will hopefully support its price when it hits the market.

Recommended: What Sets IPO Valuations

How IPO Lock-ups Get Used

A company or its underwriters might use the lock-up period as another tool to bolster the share price during the IPO.

Shares held by the investment bank or institutional investors can be sold during an initial public offering, but the shares held by company insiders — including founders, executives, employees, and venture capitalists — may be subject to a lock-up period.

With Silicon Valley tech startups in particular, a greater proportion of compensation may be paid out with equity options or restricted trading units. In order to avoid flooding the market with shares when employees exercise these contracts, the lock-ups restrictions mean that these shareholders are not able to sell their stock until this period is over.

Recommended: Guide to Tech IPOs

What Is the Purpose of a Lock-up Period?

Ensuring Share-Price Stability

Insiders, like employees and angel investors, can potentially own far more shares in a company than are initially available to the general public. The last thing a company wants during an IPO is to have these extra shares flood the market.

Since share price is set by supply and demand, extra shares can drive down the price of the stock. And that’s not a good look, especially when a company is trying to impress investors and raise capital.

Avoiding Insider Trading

Company insiders may face other restrictions beyond the lock-up period. That’s because they might have information that can help them predict how their own stock might do that is not available to the general public.

Though insider trading can be legal if properly controlled and documented, it is not legal when based on information the public doesn’t have yet. So, depending on when a lock-up period ends, company insiders may have to wait extra time before selling their shares.

For example, if a company is about to report its earnings around the same time a lock-up period is set to end, insiders may have to wait for that information to be public before they can sell any shares.

Public Image

Finally, lock-up periods can be a way for companies to keep up appearances. When those closest to the company hold their shares, it can signal to investors that they have confidence in the strength of the company.

If company insiders start to dump their stock, investors may get suspicious and be tempted to sell their shares as well. As demand falls, the price of the stock usually does, too.

Even if the insiders were trying to cash in their stocks for no other reason than simply wanting the money, public perceptions may change and damage the company’s reputation. The lock-up period may have an effect by keeping this from happening — at least while the newly public company gets off its feet.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

What’s an Example of a Lock-up Period?

For example, let’s say Business X — a unicorn company — went public with an IPO in March 2022. The company used a system of multiple lock-ups with different expiration dates. The first lock-up expired in July 2022, and allowed early investors and insiders to sell up to 400 million shares of the company.

As new shares hit the market the stock dropped by as much as 5%, and it closed the day down just over 1%. A second lock-up expired in August 2022, allowing regular employees to sell their pre-IPO shares in the company. When this lock-up ended, employees were allowed to sell more than 780 million shares of Business X on the open market.

What Does the Lock-up Period Mean for Employees with Stock Options?

Restrictions imposed during a lock-up period usually apply to any stock options someone has been given as an employee before an IPO. Stock options are essentially an agreement with a company that allows its employees to buy stock in the company at a predetermined price.

The thinking behind this type of compensation is that the company is trying to align employees’ incentives with its own. Theoretically, by giving employees stock options, the employees will have an interest in seeing the company do well and increase in value.

There’s usually a vesting period before employees can exercise their stock options, during which the value of the stock can increase. At the end of the vesting period, employees are able to exercise their options, sell the stock, and keep the profits.

It’s possible that the company will issue stock options before it goes public. If stock options vest before the IPO, employees may have to wait until after the lock-up period to exercise their options. However, stocks may not vest until after the lock-up period, in which case the restrictions don’t have much bearing on the employee’s ability to exercise their stock options.

How Does the IPO Lock-Up Period Affect Investors?

When buying IPO stocks as a regular investor, you likely don’t have access to shares of a company before it goes public. Even so, you still might want to pay attention to the lock-up period. Investing in IPOs can be tricky and are generally considered risky.

The underwriters will probably do everything they can to make sure that stock prices go up when company shares hit the market. But in the end, no one really knows what will happen during an IPO.

Reading the IPO Prospectus

What’s more, investors interested in buying a stock that’s about to go public don’t really have much information to go on to help them figure out what kind of value they’re getting. When they’re private, companies don’t have to divulge very much information about their inner workings to the SEC.

However, before going public they will make documents available, including the Form S-1 and the red herring prospectus that can give investors some clues about a company’s business model and what they plan to do with the money they raise. Investors can also look at what happened when similar companies went public and whether they did well.

Waiting to Buy Until After Lock-ups End

This is all to say that with little idea of what a company’s stock will do when the company goes public, regular investors may want to hold off before they invest. Investors may even want to hold off until the lock-up period is over.

When the lock-up ends and insiders and employees can finally sell their shares, the stock price may experience some volatility as the new shares enter the market, potentially causing drops in a stock’s price.

Some investors may try to take advantage of the dip that can occur when a lock-up period ends. For example, if investors see that a company’s financial health is good during the first stages of its public life, they may use the expiration of the lock-up period as a chance to buy shares at a “discount.”

They may feel that if the stock’s fundamentals were good before the lock-up ended, the company is in good financial health and the stock should rebound. Timing the market, however, isn’t necessarily a good idea for all investors, especially those not used to taking a deep dive into the fundamentals of a company’s financials. It’s also not guaranteed to produce good results.

The Takeaway

Lock-up periods are agreed-upon periods between early investors and employees of a company and underwriting investment bankers during which selling of shares is prohibited. Having such stakeholders hold off on selling their shares can help the stock price of a newly public company stay more stable.

An initial public offering’s lock-up period can be hard to navigate. Yet, they can be really exciting for investors looking to get in on the ground floor and employees or insiders looking to cash in on their shares or stock options.

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.

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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

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

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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Sep

2023

What Are Assets Under Management (AUM) and Why Do They Matter?

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

Assets under management (AUM) refers to the total market value of client funds managed by a person or a financial institution, such as financial advisory firms, brokerages, and mutual funds. The term may refer to funds managed for an individual client or total clients.

Typically, the higher an institution’s AUM, the higher their earnings, so it’s a measure they’re often looking to increase. That said, institutions have different meanings of AUM. So it’s important to have a good understanding of why AUM matters and how it is calculated before using it as a metric to decide whether or not to invest with a financial institution or a fund.

What Is AUM?

As mentioned, assets under management (AUM) refers to the total market value of client funds being managed by an individual or financial firm. To calculate AUM, a firm adds up the total value of the securities they manage, such as stocks, bonds, treasury notes, or futures contracts. However, there are some differences in the ways that organizations do this calculation.

For example, some banks might include cash deposits in AUM, while others may only include assets over which they have discretion. While the Securities and Exchange Commission (SEC) has rules about what can and cannot be included in AUM, different firms may interpret these rules differently.

💡 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.

Factors Impacting AUM

AUM, also known as funds under management, is not a static figure, and several factors that can cause the number to fluctuate.

Inflows and Outflows

As clients and investors increase or decrease the amount of money they have invested with a firm or in an investment fund, the total AUM will change. For example, if investors sell off shares of a mutual fund, AUM will likely start to fall. Or if a client at a financial advisory firm decides to use that firm to manage more of their money, that firm’s AUM will likely go up.

Market Shifts

Market shifts can also have a big impact on AUM, as the value of the securities in which the firm or fund has invested changes. For example, in a year when the stock market does poorly, assets managed by an advisory firm may decrease in value. During a market sell off, AUM often goes down for many firms. When markets do well, AUM will increase.

Dividends

If a firm or portfolio manages investments that pay dividends and the firm reinvests those dividends instead of distributing them, AUM can also grow.

A Moving Measure

The factors above mean that AUM is constantly in flux. How dramatic the fluctuations are depends on how many investors are shifting their money, as well as the types of investments AUM includes. For example, funds with a lot of volatile investments, such as stocks, may see broader swings in AUM than funds that hold more stable investments, such as bonds.

Recommended: Understanding How Bond Markets Work

Is a Larger AUM Better?

A larger AUM can be a plus or minus depending on circumstances. For banks, asset managers, and other financial institutions, larger AUM can be a sign of prestige and a measure of success. That’s because a larger AUM can determine things like compensation and bonuses for managers and how the company ranks against its peers. Larger AUM often also means higher revenues for the company.

However, larger AUM isn’t always a positive factor. For example, in actively managed mutual funds where a manager is looking to outperform a benchmark, large inflows of cash that boost AUM may hinder their goals. That’s because allocating large amounts of money quickly can be difficult to do without changing the price of the investments being bought or sold. To compensate for this issue, the fund may purchase other types of investment that cause it to shift away from its initial focus, a process called style drift.

Investors may consider the size of a fund as an indicator of the ease by which they can buy and sell shares in a mutual fund or an exchange-traded fund (ETF). High net assets and trading volumes suggest that the fund is highly liquid and investors should have no problem buying and selling shares at any time.

It can also be helpful to understand how a firm’s AUM has changed over time, and how they compare to peers.

Recommended: Top ETF 9 ETF Trends for 2023

Why is AUM Important?

AUM can have a big impact on individual investors’ decisions as they consider where to put their money. Companies often use their AUM as a selling point when they market themselves to clients. They contend that the larger the AUM, the more client interest and participation there is. In other words, AUM signals a vote of confidence in a firm. On the flip side, the lower the AUM, the fewer clients are interested in working with the institution or fund — theoretically anyway.

But AUM doesn’t always tell a full story. One firm with a handful of high-net-worth clients might have a higher AUM than a firm with dozens of clients with less savings. In this case, more clients actually chose to work with the firm with a lower AUM. So investors should be careful to look at other factors, such as investment approach, when determining who they want to work with.

Or a firm could decide to limit the number of investors it works with in order to provide more personalized service. In that case, the AUM might be lower, though the service could be better.

AUM can also have an impact on the investment fees that you pay. Many firms charge clients based on a percentage of their individual AUM, the money they hold with the firm personally. That percentage often goes down as the client’s AUM goes up.

💡 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.

AUM Regulation

AUM may determine how financial advisors must comply with certain regulations. Firms with $100 million or more in AUM must register with the SEC, disclosing their AUM and a host of other information, each year.

In addition to information about AUM, Form ADV contains disclosures about disciplinary events involving advisors and their key personnel. Investors can access this information through the SEC’s Investment Advisor Public Disclosure website and use it to make informed decisions when choosing an advisor or money manager.

The Takeaway

As you choose funds to invest in — or firms to invest with — it’s important to understand their AUM. When it comes to investment funds, AUM can help you get a sense of the size of the fund and how easily you will be able to buy and sell shares.
When it comes to choosing an advisory firm or other financial institutions, AUM can help you understand the size of the firm.

That said, investors should consider a wide array of other factors, including the fees, fund’s performance and manager’s experience, when choosing investments and the professionals who can help manage their portfolios.

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.

SoFi Invest®

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

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Public Image

What’s an Example of a Lock-up Period?

What Does the Lock-up Period Mean for Employees with Stock Options?

How Does the IPO Lock-Up Period Affect Investors?

Reading the IPO Prospectus

Waiting to Buy Until After Lock-ups End

The Takeaway

What Are Assets Under Management (AUM) and Why Do They Matter?

What Is AUM?

Factors Impacting AUM

Inflows and Outflows

Market Shifts

Dividends

A Moving Measure

Is a Larger AUM Better?

Why is AUM Important?

AUM Regulation

The Takeaway

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