Jul
27
2023
Understanding the Gold Silver Ratio

Understanding the Gold/Silver Ratio

By | Financial Independence, Growing Wealth, invest, Investing | Comments Off on Understanding the Gold/Silver Ratio

The gold-to-silver Ratio, also known as the silver-to-gold Ratio or “Mint Ratio,” is a metric that indicates the amount of silver required to buy an ounce of gold. For example, if the silver-gold ratio is 40:1, then it would take 40 ounces of silver to buy one ounce of gold.

This ratio fluctuates daily as the spot price of an ounce of gold and silver changes. This ratio is used by investors determining whether and how they want to invest in precious metals.

It’s a measurement that’s been around for thousands of years. Understanding how the two assets’ price relationship allows investors, governments, and manufacturers to compare and trade gold and silver in real-time.

Recommended: How to Invest in Precious Metals

How Is the Gold-Silver Ratio Calculated?

Investors calculate the gold-silver ratio by dividing the price of one ounce of gold by the price of one ounce of silver: e.g. how many ounces of silver equal one ounce of gold. For example, if one ounce of silver is $20 and one ounce of gold is $1,600, then the silver-gold ratio would be 80:1.

Unlike other physical items, precious metals are weighed by the Troy Ounce, an historic unit of measurement dating back to the Middle Ages equaling roughly 31.1 grams.

By comparison, the standard ounce equals about 28.35 grams. The price of one Troy Ounce of gold and silver fluctuates daily based on the spot price or current price at which the metal is trading.

Whereas most precious metals and commodities have futures contracts traded on the market, the spot price uses real-time price data. Premiums, or additional seller fees added to the price by metal retailers and merchants do not factor into the spot price or the gold-silver ratio.


💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.

What Is the Historical Gold-Silver Ratio?

In modern times, the gold-silver ratio fluctuates daily. Before the 20th century, however, governments set the ratio between the two metals as part of their monetary policy, with many relying on a bi-metallic standard. The U.S. government set a gold-silver ratio of 15:1 with the Coinage Act of 1792, and adjusted the standard to 16:1 in 1834.

During the 20th century, nations started to migrate away from the bi-metallic currency standard and for some off the gold standard entirely to fiat currencies. This created more volatility in the metal prices.

Since then, gold and silver prices have traded independently of one another as alternative assets in the free market, resulting in a fluctuating gold/silver ratio.

When the United States abandoned the gold standard in 1971, the gold/silver ratio was 20.54:1. In 1985, it reached 51.68:1 and hasn’t fallen below that level since. It has climbed steadily upward since 2011, reaching an average 82.73 in mid-2023.

Within each year, however, there is significant day-to-day volatility. The ratio hit a record high of 124:1 in March 2020.

Recommended: 7 Investment Opportunities in 2023

Why Does the Gold-to-Silver Ratio Matter?

The gold/silver ratio can be useful to both traders and consumers of precious metals.

Traders

Investors focused on commodities or hard assets keep a close eye on the gold/silver ratio. When the gold/silver ratio is higher than expected, this signals to analysts and traders that silver’s price may be undervalued relative to gold. Conversely, an extremely low number could indicate that gold is undervalued.

Movement in the ratio may also shed light on the current demand or market sentiment toward either metal. A tightening of the ratio may indicate higher silver demand or lower gold demand. Investors in precious metals may compare this ratio to the current supply and demand of each asset to determine whether the fundamentals warrant the price change or if the ratio reflects heightened price speculation.

Consumers

For manufacturers purchasing precious metals such as gold and silver en masse to produce electronics and various consumer goods, the gold-silver ratio may help determine whether or not it’s a good time to buy more metal quantities or buy a futures contract that could offer a more favorable price.

This is a common strategy among various industries that rely heavily on imported materials to produce goods. Companies often hire in-house traders, analysts, or outside consultants to determine price forecasts of required commodities and will buy when the market is favorable and hedge when the outlook is less optimistic.


💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

Can You Trade the Gold/Silver Ratio?

The gold-silver ratio is used in investing and trading to determine when one metal is undervalued or overvalued and thus a good value investment. However, like any other security, commodities carry some risks for investors.

Sometimes precious metals are extremely volatile and experience wild price swings, and sometimes gold and silver experience long periods of minimal price movement and volatility compared to other types of investments such as equities, commodities, and cryptocurrency. In fact many investors consider precious metals a store of wealth and allocate to it as part of their investors’ long-term investment portfolios.

The Takeaway

Measuring one asset against another is one way to determine an asset’s value, and Understanding the ratio, and the direction it’s moving, can help you make decisions about any precious metals allocations within your portfolio.

The SoFi Invest investment app can help you gain exposure to precious metals like gold and silver. You can use the platform to purchase exchange-traded funds (ETFs) that invest in specific commodities, or buy mining companies that produce such metals.

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.

Photo credit: iStock/fizkes

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.


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

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 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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Jul
26
2023
How to Use Social Media for Investing Tips: The Smart Way

How to Use Social Media for Investing Tips: The Smart Way

By | Growing Wealth, invest, Investing | Comments Off on How to Use Social Media for Investing Tips: The Smart Way

Social media has become an important news source for many people, including investors looking for ideas to guide their strategy. That said, social media users must be careful when sifting through the vast quantities of information on the web to make sure they’re relying on legitimate sources.

There are a variety of social media platforms that investors use for information, including Twitter, Facebook, LinkedIn, Stocktwits, and even TikTok. While there are potential benefits to using social media to invest, there are also plenty of pitfalls.

Why Understanding Social Media Investing Is Important

In 2013, the Securities and Exchange Commission (SEC) allowed companies to start using social media platforms like Facebook and Twitter to communicate information to investors. As long as companies tell investors which website to check, they can use social media to announce information like company metrics that may influence stock price. Individuals interested in investing in a particular company may want to follow that company directly to stay abreast of breaking news.

Social media can also be an important place to gather information from analysts and financial bloggers who post their thoughts about stocks and news events or upcoming IPOs. Since these folks are typically reacting to news, following them may be a way to stay on top of popular investment trends. More than a third of young investors say that they now use social media to look into possible investments, making it their most popular source of investing information ideas.

Recommended: 10 Popular Investing Trends

Recently, social media has entered the investment space in a new way with the rise of meme stocks. Meme stocks are companies that experience increased volume in trades due to hype on social media. Perhaps the original, and most famous, meme stock is GameStop. Retail investors encouraged each other to buy shares of the company over the subreddit message board r/wallstreetbets to force a short squeeze among hedge fund investors betting against the stock. Together these retail investors drove the share price up nearly 8,000% by late January 2021 to $86.88 a share.

Because investor sentiment, rather than company fundamentals, often fuels meme stock price increases, they can be extremely volatile. While meme stock investing can be exciting, it can also expose investors to large amounts of risk. As of July 2023, GameStock was down to $23.50 a share.

💡 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 Use Social Media When Investing

Individuals aren’t the only ones using social media to guide their investing decisions. Fully 80% of institutional investors said that social media is part of their regular workflow. If you want to use social media as a way to inform your investment decisions, there are a few strategies to consider.

1. Follow Companies in Which You Invest (or Want to Invest)

Directly following a company’s social media accounts ensures the information you receive is timely and accurate.

2. Follow Informed Experts

Follow news sources, journalists, and analysts who cover the companies and sectors, such as healthcare or electric vehicles, in which you’re interested. Consider people who have large followings, a good clue that they provide information that is useful to a broad range of investors.

3. Use Tech Tools

Some brokerages offer social media tools such as social sentiment trackers that aggregate and analyze information that’s posted on social media sites. For example, some firms use software to compile information from Tweets, blog posts, and messages. Others offer in-house social media platforms that allow investors to communicate with each other to discuss trading ideas. Or they may offer crowd-sourced research and analysis, using a website or app to gather ideas and opinions from the public at large. For example, analysts, investors and academics might weigh in with their thoughts on earnings estimates.

It’s important for investors to beware that these tools can be inaccurate or misleading. Data gathered from social media may be old, or contain hidden agendas. Read all disclosures offered by social sentiment tools to understand how they collect data and any risks or conflicts of interest.

Recommended: Understanding Market Sentiment

Social Media Investing Mistakes to Avoid

While social media can be a helpful tool for investors, it also has several pitfalls that investors should understand.

1. Impulsive Decisions

Information driven by social media, such as discussion boards or buy/sell indicators based on social sentiment can drive investors toward emotional investing, especially when information appears in real time. Impulsive investments carry additional risks. Trading securities without proper due diligence can lead you to buy stocks as prices are peaking, or sell as prices tumble, locking in losses and missing out on potential rebounds. Avoid allowing social media to feed the tendency to time the market.

💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.

2. Failing to Do Your Own Research

Think of information you get from social media as a jumping-off point, something that sparks your interest and leads you to do more research.

For example, if someone posts about how great they think a stock is, take a look at the company’s financials yourself. Look at past and present earnings reports to understand trends. You can find out this and other information on a company’s quarterly report. Look at the annual report as well. It will let you know about any risks the company foresees in its future. In addition, look at what a number of analysts are predicting the company’s earnings will be in the future.

You may also want to consider broader economic indicators or market measures, such as the Fear & Greed Index.

3. Trusting Bots

Bots are programs—not humans—built to engage on social media. It’s not always clear what their agenda is, and they certainly don’t have your best interests in mind. There are several signs that an account could be a bot, including:

• No profile picture

• Strange numbers of characters in the account name

• Posting at irregular hours

• Repetitive, formulaic language

• Repeated posting on the same subject or the the link

The Takeaway

Social media has become an important way to gather investment information. But learning to recognize reliable sources is critical to finding accurate and useful information to create a strategy whether you’re investing in stocks, bonds, options, or other financial securities. What’s more, investors must understand the behavioral biases that social media investing can trigger, namely the temptation to time the market.

To avoid this pitfall, create and follow a long-term financial plan. Use social media to research stocks and funds that fit your plan, including your time horizon and tolerance for risk.

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).


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

Photo credit: iStock/GOCMEN

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.

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

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

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Jul
25
2023
woman studying at cafe mobile

Popular Options Trading Terminology to Know

By | Growing Wealth, invest, Investing | Comments Off on Popular Options Trading Terminology to Know

Trading stocks can help investors build wealth over time. But for investors interested in more advanced investment strategies, options trading might be worth looking into – but be warned, options trading is its own world, with its own jargon.

When an investor trades options, they aren’t trading individual shares of stock. Instead, they’re trading contracts to buy or sell stocks and other securities under specific conditions. Beyond this, there are a number of important options trading strategies investors commonly use when trading options. In order to effectively deal in options, an investor might also want to familiarize themselves with certain lingo.

First, Understand What You Are Trading

Before learning the trading terms, it helps to have a firm grasp of what options trading is and what it involves. In layman’s terms, when you’re trading options, you’re investing in an option to buy or sell a stock, rather than the stock itself.

Again, this is a form of derivative trading, and there are numerous options trading strategies that can be put to use, too. It’s not exactly the same as trading stocks, and is often more complicated. For that reason, investors should know what they’re getting into before trading options.

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

Options Trading Terms to Know

When it comes to options trading, these are some of the most important trading terms to understand.

Call Option

A call option is an options contract that gives the purchaser of the option the right to buy shares of a stock or another security at a fixed price. This price is called the “strike price.”

When an investor buys a call option, the option to buy is open for a set time period. The expiration date is the date when the call option is voided — though some options positions are automatically closed or exercised if they are in the money. Standard options contracts are no more than 90 days.

Put Option

A put option gives a purchaser the right to sell shares of a stock at the strike price by a specified day. When getting to know puts and calls definitions, it’s important to remember that each one has:

•   A strike price

•   An expiration date

Strike Price

With a call option or put option, the strike price is one of the most important trading terms to know.

In a call option, the strike price is the price at which an investor may buy the underlying stock associated with the contract. In a put option, the strike price is the price at which they may sell the underlying stock.

The gap between the strike price and the actual price of a stock determines whether an investor is “in the money” or “out of the money.”

In the Money

When discussing stock movements, it’s typical to think in terms of whether a stock’s price is up, down, or flat. With options, on the other hand, there’s different language used to describe whether an investment is paying off or not, and it’s often described as “in the money” versus “out of the money.”

An option is in the money when the correlation between the strike price and the stock price is leaning in a buyer’s favor. Which way this movement needs to go depends on whether they have a call option or put option.

With a call option, a buyer is in the money if the strike price is below the stock’s actual price. Say, for example, you place a call option to purchase a stock at $50 per share but its actual price is $60 per share. You’d be up, or in the money, by $10 per share.

Put options are the opposite. An option buyer is in the money with a put option if the strike price is higher than the actual stock price.

Out of the Money

Being out of the money with call or put options means the option buyer doesn’t stand to reap any financial gain from exercising the option. Whether a call or put option is out of the money depends on the relationship between the strike price and the actual stock price.

A call option is out of the money when the strike price is above the actual stock price. A put option is out of the money when the strike price is below the actual stock price.

At the Money

Being “at the money” is another scenario an options buyer could run into with options trading.

In an at-the-money situation, the strike price and the stock’s actual price are the same. If the buyer of the option sells the option, they can make or lose money. If they exercise the option, they will lose money because of the premium paid.

Volatility Crush

When trading options, it’s important to understand stock volatility and how it can impact trading outcomes.

Volatility is a way to track up or down swings in a stock’s price across trading sessions. Implied volatility is a way of measuring or estimating which way a stock’s price might go in the future.

A volatility crush happens when there’s a sharp decline in a stock’s implied volatility that affects an option’s value. Specifically, this means a downward trend that can detract from a call or put option’s value.

Volatility crushes can happen after a major event that affects or could affect a stock’s price. For example, investors might see a volatility crush after a company releases its latest earnings report or announces a merger with a competitor.

Bid/Ask Price

When trading options, it’s helpful to know how bid and ask prices work.

The bid price is the highest price a buyer is willing to pay for an option. The ask price is the price a seller is willing to accept for an option. The difference between the bid price and ask price is known as the spread.

Holder and Writer

Other trading terms investors may hear associated with options are “holder” and “writer.” The person or entity buying an options contract may be referred to as the holder. The seller of an options contract can also be referred to as the writer of that contract.

An option is exercised when the buyer chooses to invoke their right to buy or sell the underlying security.

💡 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 Options Trading

Options trading can offer both advantages and disadvantages for investors.

Pros of Options Trading

•   Lower entry point. Unless an investor is able to purchase fractional shares, purchasing individual stock shares with higher price points can get expensive. Investing in options, on the other hand, may be more accessible for investors with a limited amount of money to put into the market.

•   Downside protection for buyers. If the stock’s price isn’t moving in the direction a buyer anticipated, they don’t have to exercise their option to buy. This can limit losses.

•   Greater flexibility. An investor has control over exercising the option to capitalize on the stocks rise or fall accordingly. An investor could exercise an option to buy and keep the shares, or buy and then resell them. Or they could choose not to exercise their option at all.

Cons of Options Trading

Options trading can be risky for sellers. Trading stocks is risky, but trading options have the potential to be more so for investors on the selling end of a contract. An investor might end up being out of the money on an options contract — but even that doesn’t determine the extent of the loss. The risk comes from the selling of uncovered puts and calls.

The Takeaway

Trading options can be appealing to investors who think an asset’s price will go up or down, or who want to attempt to offset risk from assets that they own. But before an investor engages in options trading, it’s a good idea to get familiar with put and call definitions and other options trading terms.

Knowing the specific jargon and terminology used by options traders can help investors cut through the noise and make better decisions. Of course, if you’re uneasy or unfamiliar with options terminology, you’d probably be better off learning more before starting to make trades.

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.

SoFi Invest®

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

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

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 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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Jul
20
2023
Mortgage Backed Securities, Explained

Mortgage-Backed Securities, Explained

By | Financial Independence, Growing Wealth, invest, Investing | Comments Off on Mortgage-Backed Securities, Explained

Mortgage-backed securities are bond-like investments made up of a pool of mortgages. When you purchase a mortgage-backed security, you’re buying a small portion of a collection of loans that a government-sponsored entity or a financial institution has packaged together for sale.

Investors may refer to these loans as MBS, which stands for mortgage-backed securities. Investing in mortgage-backed securities allows investors to get exposure to the real estate market without taking direct ownership of properties or making direct loans to borrowers. Mortgage-backed securities offer benefits to other stakeholders as well, namely loan-issuing banks, private lenders, and investment banks who issue them.

Mortgage-backed securities have a stained reputation due to their role in the housing market collapse in 2008. However, that crisis led to increased regulation, and depending on your investment goals, there may be a case for including mortgage-backed securities in a diversified portfolio.

What Is a Mortgage-Backed Security?

Mortgage-backed securities are asset-backed investments, in which the underlying assets are mortgages.

Government entities and some financial institutions issue mortgage-backed securities by purchasing mortgages from banks, mortgage companies, and other loan originators and combining them into pools, which they sell to investors.

The financial institution then securitizes the pool, by selling shares to investors who then receive a monthly distribution of income and principal payments, similar to bond coupon payments, as the mortgage borrowers pay off their loans.


💡 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 a Mortgage-Backed Security Works

When dealing with mortgage-backed securities, banks essentially become middlemen between the homebuyer and the investment industry.

The process works as follows:

1.    A bank or mortgage company originates a home loan.

2.    The bank or mortgage company sells that new loan to an investment bank or government-sponsored entity, and uses the sale money to create new loans.

3.    The investment bank or government-sponsored entity combines the newly purchased loan into a bundle of mortgages with similar interest rates.

4.    This investment bank assigns the loan bundle to a Special Purpose Vehicle (SPV) or Special Investment Vehicle (SIV) which securitizes the bundles of loans. This creates a separation between the mortgage-backed securities and the investment bank’s primary services.

5.    Credit rating agencies review the security and rate its riskiness for investors. The SPV or SIV then issues the mortgage-backed securities on the trading markets.

When the process operates as intended, the bank that creates the loan maintains reasonable credit standards and makes a profit by selling the loan. They also have more liquidity to make additional loans to others. The homeowner pays their mortgage on time and the mortgage-backed securities holders receive their portion of the principal and interest payments.

Recommended: Investing 101 Guide

Who Sells Mortgage-Backed Securities?

While some private financial institutions issue mortgage-backed securities, the majority come from government-sponsored entities. Those include Ginnie Mae, the Government National Mortgage Association; Fannie Mae, the Federal National Mortgage Association; and Freddie Mac, the Federal Home Loan Mortgage Corporation.

The U.S. government backs and secures Ginnie Mae’s mortgage-backed securities, guaranteeing that investors will receive timely payments. Fannie Mae and Freddie Mac do not have the same guaranteed backing, but they can borrow directly from the Treasury when needed.

What Are the Risks of Investing in Mortgage-Backed Securities?

Like all alternative investments, mortgage-backed securities carry some risks that investors must understand. One such risk is prepayment risk, in which mortgage borrowers pay off their mortgages (often because they move or refinances), reducing the yield for the holder of the MBS. Mortgage defaults could further decrease the value of mortgage-backed securities.

Other risks include housing market fluctuations and liquidity risk.

Recommended: Opportunity Cost and Investments

Types of Mortgage-Backed Securities

There are several different types of mortgage-backed securities.

Pass-Through

A Pass-Through Participation Certificate or Pass-Through is the simplest type of MBS. They are structured as trusts, in which a servicer collects mortgage payments for the underlying loans and distributes them to investors.

Pass-through mortgage-backed securities typically have stated maturities of five, 15, or 30 years, though the term of a pass-through may be lower. With pass-throughs, holders receive a pro-rata share of both principal and interest payments earned on the mortgage pool.

Residential Mortgage-Backed Securities (RMBS)

Residential mortgage-backed securities are mortgage-backed securities based on loans for residential homes.

Commercial Mortgage-Backed Securities (CMBS)

Commercial mortgage-backed securities are mortgage-backed securities based on loans for commercial properties, such as apartment buildings, offices, or retail spaces or industrial properties.

Collateralized Debt Obligations (CDOs)

These securities are similar to mortgage-backed securities in that CDOs are also asset-backed and may contain mortgages, but they may also include other types of debt, such as business, student, and personal loans.

Collateralized Mortgage Obligations (CMO)

CMOs or Real Estate Mortgage Investment Conduits (REMICs) is a more complex form of mortgage-backed securities. A CMO is a pool of mortgages with similar risk categories known as tranches. Tranches are unique and can have different principal balances, coupon rates, prepayment risks, and maturity rates.

Less-risky tranches tend to have more reliable cash flows and a lower probability of being exposed to default risk and thus are considered a safer investment. Conversely, higher-risk tranches have more uncertain cash flows and a higher risk of default. However, higher-risk tranches are compensated with higher interest rates, which can be attractive to some investors with higher risk tolerance.

Recommended: Exploring Different Types of Investments

Mortgage-Backed Securities and the 2008 Financial Crisis

Mortgage-backed securities played a large role in the financial crisis and housing market collapse that began in 2008. By 2008, trillions of dollars in wealth evaporated, prominent companies like Lehman Brothers and Bear Stearns went bankrupt, and the global financial markets crashed.

At the time, banks had gotten increasingly lenient in their credit standards making risky loans to borrowers. One reason that they became more lenient was because they were able to sell the loans to be packaged into mortgage-backed securities, meaning that the banks faced fewer financial consequences if borrowers defaulted.

When home values fell and millions of homes went into foreclosure, the value of all those mortgage-backed securities and CDOs plummeted, indicating that they had been riskier assets than their ratings indicated. Many investors lost money; many homeowners foreclosed on their homes.

An important lesson from that time is that mortgage-backed securities have risks associated with the underlying mortgage borrower’s ability to pay their mortgage.


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

MBS Today

Residential mortgage-backed securities now face far more government scrutiny than they did prior to the financial crisis. MBS mortgages must now come from a regulated and authorized financial institution and receive an investment-grade rating from an accredited rating agency. Issuers must also provide investors with disclosures including sharing information about their risks.

Investors who want exposure to mortgage-backed securities but don’t want to do the research or purchases themselves might consider buying an exchange-traded fund (ETF) that focuses on mortgage-backed securities.

The Takeaway

Mortgage-backed securities are complex investment products, but they have benefits for investors looking for exposure to the real estate debt without making direct loans. While they do have risks, they may have a place as part of a diversified portfolio for some investors.

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.

Photo credit: iStock/sturti

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.


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

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 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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Jul
19
2023
Investing in Small Cap Stocks

Investing in Small Cap Stocks

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Investing in Small Cap Stocks

Small cap stocks are stocks in smaller companies, typically those worth between $250 million and $2 billion. Small cap stocks often have high growth potential, which makes them a potentially attractive investment. However, while investors may see higher returns with these stocks, they may also mean higher volatility and risk levels.

For investors considering adding small cap stocks to their portfolios, it’s essential to understand how these stocks work and the advantages and disadvantages that come with this type of investment.

What Are Small Cap Stocks?

With a market cap between $250 million and $2 billion, small cap companies are usually moderately young companies. Small cap stocks typically have some growth potential, but they may not have a longstanding market history. Therefore, these stocks are considered to be riskier than mid-cap stocks or large cap stocks.


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

Understanding Market Capitalization

Market capitalization, or market cap, is a measure of an individual company’s value. The market cap represents the value of total outstanding shares. Investors can use this value to compare similar companies as well as consider future growth predictions.

To calculate a company’s market cap, multiply the total number of outstanding shares by the current share price. For example, let’s say a company has 15 million outstanding shares at a share price of $25 per share. Using this calculation, the company’s market cap would be $375 million.

Due to share price fluctuations, the market cap fluctuates over time. To find the number of outstanding shares, investors can review the “capital stock” numbers on a company’s balance sheet. This information is updated during the quarterly filings with the Securities and Exchange Commission (SEC).

Are Small Cap Stocks a Good Investment?

Small cap stocks may be a good investment as part of a diversified portfolio, but there are risks. The market cap of a company can give investors an idea of the risk and reward of purchasing individual stocks. Purchasing small cap stocks may be riskier than buying stocks of larger companies because the companies are often still in growth mode. In addition, small cap companies often have fewer resources than large-cap companies, and may have less access to liquidity.

Due to these factors, any market dip can negatively impact small cap stocks. Conversely, smaller companies often have higher upside potential, and small cap growth stocks may deliver higher returns than their peers. Still, investors who choose these investments may have to weather market volatility along the way to growth.

Pros of Investing in Small Cap Stocks

There are several benefits to allocating some of your portfolio into small cap stocks.

Growth Potential

When comparing large cap stocks to small cap stocks, small cap stocks tend to have a higher growth potential over the long-term. For much of the stock market’s history, small cap stocks had higher returns than large-cap stocks, and other asset classes.

This growth potential makes small cap stocks an attractive investment choice for investors. They tend to perform particularly well after recessions, during economic expansion.

They’re Often Undervalued

Analysts usually spend less time analyzing small cap stocks, so they get less attention from investors which can lead to lower demand — and lower prices. Therefore, investors may be able to leverage the inefficiencies of the market for potentially better returns.

Financial Institutions Don’t Increase Stock Prices

Specific regulations may not allow financial institutions such as hedge funds and mutual funds to heavily invest in small cap stocks. Therefore, it’s unlikely that large investments from financial institutions will artificially increase the stock price.

Cons of Investing in Small Cap Stocks

While small cap stocks have their benefits, there are also several drawbacks that investors should consider.

High Risk

Investing in small cap stocks tends to have significant risk for investors. Since they’re often younger companies, small cap companies do not always have a time-tested business model. If the company’s management can not make appropriate adjustments to the business model, it may yield poor financial or operational results.

Also, because small cap companies may lack the resources such as capital or access to financing that larger companies have, they may struggle to expand the business or fill in cash flow gaps, especially if the economy hits hard times.

Research May Be Time-Consuming

Due to the limited availability of research and analysis done on small cap stocks, investors may have to spend a significant amount of time researching each investment option.

Minimal Liquidity

Small cap stocks tend to have less liquidity than large cap company stocks. Since there are fewer shares available, investors may not be able to purchase the stock. Conversely, investors may not be able to sell their shares at a reasonable price. The liquidity of small cap stocks adds to the risk of investing in this type of stock.

How to Invest in Small Cap Stocks

Investors can purchase small cap stocks through a brokerage firm or an individual investment account. Since there’s often less public information available about small cap stocks, investors must do their own due diligence in researching companies to understand their potential risks and returns.

Investors who don’t have the time or expertise to determine which individual small cap stocks to buy can invest in small cap companies by purchasing mutual funds or exchange-traded funds (ETFs) that track a broader range of small cap indexes. Some funds may also have unique characteristics within them, such as growth- or value-oriented stocks.

Buying mutual funds and ETFs allow investors to pool funds with other investors to sell and buy buckets of market securities. This type of investing aims to mitigate risks by diversifying investments. Instead of investing in a single company, fund investors are purchasing shares in dozens or hundreds of companies. Investing in mutual funds and ETFs is more of a passive investment strategy that doesn’t require investors to make trades actively.


💡 Quick Tip: Are self directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Diversifying With Small Cap Stocks

Even though small cap mutual funds and ETFs provide diversification within a specific asset class, investors can further reduce their risk exposure by expanding portfolio diversification into a broader mix of assets.

Depending on market conditions, different types of stocks may perform differently. The concept can apply to stocks of companies that vary in sizes. Depending on what the market is doing, small, medium, and large companies may either beat the market returns or underperform.

When diversifying a portfolio, investors may start by determining their investment goals, risk tolerance, and time horizon. Then, by assessing these factors, they can decide an appropriate asset allocation to determine the portfolio’s percentage that may include stocks. A typical example is a portfolio composed of 60% stocks and 40% bonds.

Investors use the same factors (time horizon, goals, and risk tolerance) to decide the mix of stocks that will go into the portfolio’s stock percentage portion. Then, as market fluctuations happen, allocations of the portfolio will perform inversely.

For instance, as small cap stocks are rising, mid cap stocks may fall. In this case, small cap stock prices’ upward movement can offset the decrease in mid cap stock prices, thus mitigating losses.

The Takeaway

Small cap stocks are shares of companies with market caps ranging from $250 million to $2 billion. Although small cap stocks have the potential for long-term growth, they tend to come with more risk. With this in mind, building a diversified portfolio with a broader range of investments can help minimize your risk exposure.

But, attempting to build an entire portfolio from scratch and keep it balanced can be time-consuming and a risky venture if you’re an average investor. Instead, many investors choose to get small cap exposure by purchasing mutual funds and exchange-traded funds (ETFs), which mimic the returns of indices that track stocks meeting certain criteria.

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.

Photo credit: iStock/Erikona

SoFi Invest®

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

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

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 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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