InvestHL Archives | Page 44 of 52

Jun

2023

What is the Difference Between EBIT and EBITDA?

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

EBIT and EBITDA are two common ways to calculate a company’s profits, and investors may come across both terms when reviewing a company’s financial statements. Though they appear similar, they can present two very different views of a company’s income and expenses.

If you’re an investor or you own a business, it’s important to understand the difference between EBIT and EBITDA and know why the distinction matters.

What Is EBIT?

EBIT is a way to measure a company’s operating income. So, what does EBIT stand for in finance? It’s an acronym that stands for “earnings before interest and taxes”.

Here’s a look at what each of those components means:

• Earnings: This is the net income of a company over a specified period of time, such as a quarter or fiscal year.

• Interest: This refers to interest payments made to any liabilities owed by the company, including loans or lines of credit.

• Taxes: This refers to any taxes a company must pay under federal and state laws.

The formula for calculating EBIT is simple.

EBIT = Net income + Interest + Taxes

The EBIT calculation assumes you know a company’s net income. To determine net income, you would use this formula:

Net income = Revenue – Cost of Goods Sold – Expenses

In this formula, revenue means the total amount of income generated by goods or services the company sells. Cost of goods sold refers to the cost of making or acquiring any goods the company sells, including labor or raw materials. Expenses include operating costs such as rent, utilities or payroll.

EBIT should not be confused with EBT, or earnings before tax. Earnings before tax is used to measure profits with taxes factored in, but not any interest payments the company owes. You may use this metric to evaluate companies that are subject to different taxation rules at the state level.

You can find EBIT listed on a company’s income or profit and loss statement alongside other important financial ratios, such as earnings per share (EPS).

Is Depreciation Included in EBIT?

The short answer is no, depreciation is not included in the context of the EBIT formula. But you will see depreciation factored in when calculating EBITDA.

What EBIT Tells Investors

Knowing the EBIT for a company can tell you how financially healthy that company is based on its business operations. Specifically, EBIT can tell you things like:

• How much operating income a company needs to stay in business

• What level of earnings a company generates

• How efficiently the company uses earnings when debt obligations aren’t factored in

EBIT can be useful in determining how well a company manages business operations before external factors like debt and taxes come into play. It can also help to create a framework for evaluating whether certain actions, such as a stock buyback, are a true sign that a company is struggling financially.

You can also use EBIT to determine interest coverage ratio. This ratio can tell you how easily a company is able to pay interest on outstanding debt obligations. To find the interest coverage ratio, you’d divide a company’s earnings before interest and taxes by any interest paid toward debt for the specific time period you’re measuring. As an investor, this ratio can give you insight into how well a company is able to keep up with its current debts and any debts it may take on down the line.

What Is EBITDA?

EBITDA is another acronym you may see on financial statements that stands for “earnings before interest, taxes, depreciation, and amortization”. In terms of the first three terms, the breakdown is exactly the same as for EBIT. Plus there are two new additions:

• Depreciation: This term is used to refer to the decline in an asset’s value over time due to things like regular use, wear and tear or becoming obsolete.

• Amortization: This term also applies to a decline in value but instead of a tangible asset, it can be used for intangible assets. Amortization can also be referred to in the context of borrowing. For example, a business loan amortization schedule would show how the balance declines over time as payments are made.

So what is the EBITDA formula? It looks like this:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Alternately, you can substitute this formula instead:

EBITDA = Operating Profit + Depreciation + Amortization

In this formula, operating profit is the same thing as EBIT. So to calculate EBITDA, you’d first need to calculate earnings before interest and taxes.

You should be able to find all the information you need to calculate EBITDA on a company’s income statement, though you may also need a cash flow statement for an accurate calculation.

EBIT vs EBITDA: Which is Better?

Compared to EBIT, EBITDA offers a clearer snapshot of a company’s net cash flow and how money is moving in or out of the business.

Calculating the earnings before interest, taxes, depreciation, and amortization can offer a fuller picture of a company’s financial health in terms of how operational decision-making affects profitability. It can also be useful when calculating valuations for different companies and/or comparing a business to its competitors.

While EBIT and EBITDA can be a starting point for choosing where to put your money, it’s also helpful to consider other fundamental ratios such as earnings per share or price-to-earnings ratio. Active traders who are interested in benefiting from market momentum, may consider technical analysis indicators instead.

Drawbacks of EBIT vs EBITDA

While EBIT and EBITDA can be useful, there are some potential issues to be aware of. Chiefly, neither formula is considered part of Generally Accepted Account Principles (GAAP). This is a uniform set of standards that’s designed to encourage transparency and accuracy in accounting for corporations, governments and other entities.

In other words, EBIT and EBITDA don’t have any official seal of approval from an accounting authority. That means companies can manipulate the numbers in their favor, if they choose to.

Here’s why: The better a company looks on paper, the easier it may be to attract investors or qualify for financing. Companies that are struggling behind the scenes may use inflated numbers or leave out critical information when calculating EBIT or EBITDA to appear more financially stable than they are.

That could potentially lead to losses for investors who choose to put money into a company because they accepted EBIT or EBITDA calculations at face value. So it’s important to dig deeper when deciding where to invest, as these numbers may not provide a full picture of a company’s financial situation.

The Takeaway

EBIT, or earnings before interest and tax, and EBITDA, or earnings before interest, tax, depreciation and amortization, are two ways to assess the financial health of a company. To recap, EBIT measures operating income, and EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.”

But note that these figures can be manipulated by companies looking to present a rosy outlook to investors, so as always, it’s a good idea to research a company from a variety of different angles before investing in it.

Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), 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/Vertigo3d

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

May

2023

Diamond Hands? Tendies? A Guide to Day Trading Terminology

A User’s Guide to New Day Trading Lingo

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

A new interest in trading and investing in recent years has sparked new nicknames, jargon, and day trading lingo. For most, the jargon used on Wall Street and in other facets of the financial industry was largely unknown outside of the markets. But with more and more people trading and investing, it can be helpful to know what certain terms and phrases actually mean.

Note, of course, that language is always evolving, and that there may be even newer phrases out there that we’ve yet to include!

Popular Day Trading Lingo in 2023

Tendies

This term is short for chicken tenders, which is a way of saying gains or profits or money. The phrase originated with self-deprecating jokes by 4Chan users making fun of themselves as living with their mothers, who rewarded them with chicken tenders, or tendies.

STONKS

This is a playful way of saying stocks, or of referring more broadly to the world of finance. The obvious misspelling is a way of making fun of the market, and to mock people who lose money in the market. It became a popular meme — of a character called Meme Man in front of a blue board full of numbers — used as a quick reaction to someone who made poor investing or financial decisions.

Diamond Hands

This is an investor who holds onto their investments despite short-term losses and potential risks. The diamond refers to both the strength of their hands in holding on to an investment, as well as the perceived value of staying with their investments.

Paper Hands

This is the opposite of diamond hands. It refers to an investor who sells out of an investment too soon in response to the pressure of high financial risks. In another age, they would have been called panic sellers.

YOLO

When used in the context of day trading or investing, the popular acronym for the phrase “you only live once” is usually used in reference to a stock a user has taken a substantial and possibly risky position in.

Bagholder or Bag Holder

This is a term for someone who has been left “holding the bag.” They’re someone who buys a stock at the top of a speculative runup, and is stuck with it when the stock peaks and rolls back.

To the Moon

This term is often accompanied by a rocket emoji. Especially on certain online stock market forums, it’s a way of expressing the belief that a given stock will rise significantly.

GUH

This is similar to the term “ugh,” and people use it as an exclamation when they’ve experienced a major loss. It came from a popular video of one investor on Reddit who made the sound when they lost $45,000 in two minutes of trading.

JPOW

This is shorthand for Jerome Hayden “Jay” Powell, the current Federal Reserve Chair, also popular on online forums as the character on the meme “Money Printer Go Brrr.” Both refer to Federal Reserve injections of capital in response to the COVID-19 pandemic, as well as “quantitative easing” policies.

Position or Ban

This is a demand made by users on the WallStreetBets (WSB) subreddit to check the veracity of another user’s investment suggestions. It means that a user has to deliver a screenshot of their brokerage account to prove the gain or loss that the user is referencing. It’s a way of eliminating posters who are trying to manipulate the board. Users who can’t or won’t show the investments, and the gain or loss, can face a ban from the community.

Roaring Kitty

This is the social media handle of Keith Gill, the Massachusetts-based financial adviser who’s widely credited with driving the 2021 GameStop and meme stock rally with his Reddit posts and YouTube video streams.

Apes Together Strong

This refers to the idea that retail investors, working together, can shape the markets. It is sometimes represented, in extreme shorthand, by a gorilla emoji. And the phrase comes from an earlier meme, which references the movie Rise of Planet of the Apes, in which downtrodden apes take over the world. In the analogy, the apes are retail investors. And the idea is that when they band together to invest in heavily-shorted stocks like GameStop, they can outlast the investors shorting those stocks, and make a lot of money at the expense of professional traders, such as hedge funds.

Hold the Line

This is an exhortation to fellow investors on WSB. It is based on an old infantry battle cry. But in the context of day traders, it’s used to inspire fellow board members not to sell out of stocks that the forum believes in, but which have started to drop in value.

DD

This refers to the term “Due Diligence,” and is used to indicate a deeply researched or highly technical post.

HODL

“HODL” is an abbreviation of the phrase “Hold On For Dear Life.” It’s used in two ways. Some investors use it to show that they don’t plan to sell their holdings. And it’s also used as a recommendation for investors not to sell out of their position — to maintain their investment, even if the value is dropping dramatically. HODL (which is also used in crypto circles) is often used by investors who are facing short-term losses, but not selling.

KYS

This is short for “Keep Yourself Safe,” and it is a rare bearish statement on WSB and other boards. It’s a way of advising investors to sell out of a given stock.

The Takeaway

Many retail traders have found a new home on message boards — and created a new language in the process. Some of the phrases are based on pop culture and memes, others are appropriated from terms used for decades. No matter the origins, it’s clear that the investors using these phrases are evolving the way retail investors talk about investing online and maybe IRL as well.

Learning to speak the language of the markets can be helpful, too, so that you don’t miss anything important when researching investment opportunities. That doesn’t mean it’s absolutely necessary, but it may help decipher some of the messages on online forums.

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/FG Trade

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

May

2023

The Pros & Cons of Thematic ETFs

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

Thematic ETfs are a subset of funds that allow investors to make targeted bets on a specific trend. ETF providers have used them to cover a wide range of themes in recent years, allowing investors to use them to gain exposure to themes as wide-ranging as the gig economy, renewable energy, gender equality, and even pet care.

But some market observers warn that thematic ETFs tend to be too narrow in their focus and have a history of underperforming the broader market. Here’s a deeper dive into thematic ETFs and the pros and cons of including them in an investor’s portfolio.

What’s a Thematic ETF?

ETFs, or exchange-traded funds, bundle many assets into one product, so when an investor purchases a share of an ETF, it gives them exposure to all the holdings in that fund. They’re similar to mutual funds, but ETFs are listed on an exchange so they can be bought or sold at any time of day. Thematic ETFs, then, invest in securities that focus on a single theme, concept, or industry.

Over the years, interest in thematic ETFs has increased as more retail investors have entered the stock market and gravitated towards niche sectors that represent technological or societal shifts.

This flexibility is one of the benefits of ETFs, along with the ability to diversify at a low cost. Traditional ETFs tend to be inexpensive and track some of the broadest, well-known benchmarks in the world, like the S&P 500.

In contrast, thematic ETF tend to group stocks in a much more targeted way, grouping similar companies together, for example, to give investors exposure to a more narrow subset of the overall market.

Why Invest in Thematic ETFs?

Thematic ETFs allow an investor to gain exposure to emerging technologies, like cloud computing, electric vehicles, artificial intelligence, blockchain tech, or even robotics. It’s perhaps the wide range of options that makes thematic ETFs attractive to some investors.

But the basic vehicle of an ETF can also have some big advantages for investors. That is, ETFs have a built-in degree of diversification, which can help many investors get an out-of-the-box element of risk mitigation in their portfolios — though ETFs are far from a risk-free or safe investment. ETFs are also relatively easy to trade, and can be purchased or sold on the stock market similar to shares of a company.

With that in mind, there are still pros and cons to thematic ETFs for investors to consider.

Pros of Investing In Thematic ETFs

There can be benefits to investing in thematic ETFs:

• Buying a thematic ETF can make it convenient to invest in a specific sector or trend an investor is interested in. For instance, instead of buying a number of companies in a niche space that appears to be growing, an investor can simply buy an ETF.

• Thematic ETFs can capture interesting societal or technological trends, giving investors quick access to a group of companies representing such changes.

Cons of Investing In Thematic ETFs

However, there can be downsides of thematic ETFs too:

• Thematic ETFs can be very narrow and small in assets. And many may be relatively new to the market, meaning they don’t have much of a track record. This makes it more likely that they could close as well.

• Part of the reason many of these thematic ETFs end up performing poorly is because sometimes by the time the ETF hits the market, the theme has already experienced its 15 minutes of fame.

• There’s evidence that thematic ETFs tend to underperform the broader market.

• Costs for thematic ETFs may also be higher, so investors might pay higher fees.

How to Choose a Thematic ETF

It can be very helpful to users to read the ETF prospectuses to make sure they understand the products they are putting money into. Investors can also do more research into the specific companies the ETF is invested in.

Timely themes, which might tap into current market movements, often start out strong but may drop off (and fast). Typically, the ETF that lands on the market first can have a big first-mover advantage — and end up being the go-to ETF for that theme.

Investors often consider the costs of the fund and what kinds of returns it’s had. Past performance is not necessarily a good predictor of future returns, but it may still provide a sense of its volatility.

The Takeaway

Thematic ETFs move away from the original tenets of index investing, which focused on providing very broad exposure to an asset class or sector. Instead, thematic funds instead allow investors to wager on niche, trendy market sectors. They’ve been popular because they allow for very targeted wagers on technological or societal trends people see around them.

They do have risks, though. Trends can lose steam, for instance, and these funds also tend to be more expensive than traditional ETFs and have a history of underperforming the broader market. They can, however, make for an additional option for investors building a portfolio.

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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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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May

2023

Why Index Fund Returns Vary from Fund to Fund

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

The performance of index funds can vary based on which index the fund tracks and how the stock market performs as a whole. Index funds can offer a simplified approach to portfolio building when the primary goal is to meet, rather than beat, the market’s performance.

In simple terms, these mutual funds or exchange-traded funds (ETFs) seek to track the performance of a particular stock market index or benchmark. While these funds can offer some insulation against volatility, it’s important to understand which factors drive index funds returns.

What are Index Funds, Exactly?

An index fund is a type of mutual fund that’s designed to track the performance of a stock market index, by investing in some or all of the securities tracked by that particular index.

An index represents a collection of securities, which may include stocks, bonds, and other assets. Stock indexes can cover one particular sector of the market or a select grouping of companies. Examples of well-known stock indices include the S&P 500 Index and the Russell 2000 Index.

What Determines Index Fund Returns?

Even though they tend to have a similar purpose and function inside a portfolio, the return on index funds isn’t identical from one fund to the next. Some index funds can lose money, too. Factors that can influence index funds’ returns include:

• Which specific index they track

• Whether that index is:

◦ Cap-weighted, in which each security is weighted by the total market value of their shares.

◦ Price-weighted, in which the per share price of each security in the index determines its value.

◦ Equal-weighted, in which all of the securities being tracked are assigned an equal weight for determining value.

• Number of securities held by the fund

• Geographic classification of fund securities

• Expense ratio and fees

• Overall market conditions

• Tracking error

Together, these factors can influence how well one index fund performs versus another.

Index Tracking

First, consider which benchmark an index fund tracks. There can be significant differences in the makeup of various indexes. For instance, the S&P 500 covers the 500 largest publicly traded companies while the Russell 2000 Index includes 2000 small-cap U.S. companies.

Large-cap stocks can perform very differently from small-cap stocks, which translates to differences in index fund returns. Between the two, large-cap companies tend to be viewed as more stable while smaller-cap companies are seen as riskier. Large-cap companies may fare better during periods of increased market volatility but in an extended downturn, small-cap companies may outperform their larger counterparts.

Index Weighting

Cap-weighted, price-weighted, and equal-weighted indexes all have the potential to perform differently, because each company’s stock may have different weight in each of these types of funds. For example, if a stock in an equal-weighted index filled with 500 stocks performs poorly, those shares represent 1/500th of performance. On the other hand, if the same stock performs poorly in a cap-weighted fund and it happens to have a very high market cap, it may represent a larger percentage of performance.

For these reasons, it’s also important to know how many securities are held by the fund. The more financial securities in a given fund, the greater the likelihood that a poorly performing one will be balanced by others.

Geographic Classification

Even when two index funds both follow the same formula with regard to market capitalization, returns can still differ if each fund offers a different geographic exposure. For example, a fund that tracks a global market index and includes a mix of international and domestic stocks may not yield the same results as an index fund that focuses exclusively on U.S. companies.

Funds that track global indexes can also differ when it comes to how they characterize certain markets. For instance, what one fund considers to be a developed country may be another index fund’s emerging market. That in turn can influence index fund returns.

Expense Ratio and Fees

Index funds are generally passive, rather than active, since the turnover of assets inside the fund is typically low. This allows for lower expense ratios, which represent the annual cost of owning a mutual fund or ETF each year, expressed as a percentage of fund assets. Generally, index funds carry lower expense ratios compared to actively managed funds but they aren’t all the same in terms of where they land on the pricing spectrum.

The industry average expense ratio for index funds tends to be a bit more than 0.5%, though it’s possible to find index funds with expense ratios well below that mark. The higher the expense ratio, the more you’ll hand back in various fees to own that index fund each year, reducing your overall returns.

In terms of fees, some of the costs you might pay include:

• Sales loads

• Redemption fees

• Exchange fees

• Account fees

• Purchase fees

When comparing index fund costs, it’s important to keep the expense ratio, fees, and historical performance in mind. Finding an index fund with an exceptionally low expense ratio, for instance, may not be that much of a bargain if it comes with high sales load fees. But a fund that charges a higher expense ratio may be justifiable if it’s consistently outperformed similar index funds year over year.

Tracking Error

Tracking errors can significantly impact your return on index funds. This occurs when an index fund doesn’t accurately track the performance of its underlying index or benchmark.

Tracking errors are often tied to issues with the fund, rather than its index. For example, if a fund’s composition doesn’t accurately reflect the composition of the index it tracks then performance results are more likely to be skewed. Excessive fees or a too-high expense ratio can also throw a fund’s tracking off.

What Are Good Index Fund Returns?

What is a good return on investment for an index fund? Given that the return on index funds can vary, the simplest answer may be to look at the stock market’s historical performance as a whole.

The S&P 500 Index is often used as a primary market benchmark for measuring returns year over year. The average annualized return for the S&P 500 Index since its inception — including dividends and adjusted for inflation — is 8.7%. Following that logic, a good return on investment for an index fund would be around the same.

You could also use the fund’s individual index as a means of measuring its performance. Comparing the fund’s performance to the index’s performance month to month or year over year can give you an idea of whether it’s living up to its expected return potential.

Are Index Funds a Good Investment?

Index funds may appeal to one type of investor more than another, which is why it’s always important to do your research before determining what will be a good fit for your portfolio.

Investors who prefer a low-cost, passive approach may lean toward index investing for growing potential for wealth long-term. Index funds can offer several advantages, including simplified diversification and consistent returns over time.

For example, if your investment goals include keeping costs low while producing consistent returns with lower fees, then index investing maybe a good choice. You may also appreciate how easy it is to buy index funds or ETFs and use them to create a diversified portfolio.

Index funds can help with pursuing a goals-based investing approach, which focuses on investing to meet specific goals rather than attempting to beat the market. When comparing index funds, pay attention to the fund makeup, its costs, historical performance, turnover ratio and the potential for tracking errors.

The Takeaway

A number of factors helps explain why different index funds have different returns — including, but not limited to, which index they track and how it’s weighted, the geographic classification of the fund securities, expense ratios, and overall market conditions.

But keep in mind: Unless you have a crystal ball, there’s no way to predict exactly how an index fund will perform. But getting to know what differentiates one index fund or ETF from the next can help with making more informed decisions about which ones to buy.

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.

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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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May

2023

Trade vs Settlement Date: What’s the Difference?

By Inyoung Hwang | Growing Wealth, invest, Investing, Terminology | Comments Off

The day that an investor or trader’s buy or sell order for a security is confirmed is called the trade date. But the day that the security actually changes hands is called the settlement date.

Both the trade date and the settlement critical to understand for investors who may not realize that there are things taking place behind the scenes when they’re buying or selling investments.

What Is a Settlement Date in Investing?

As mentioned, the settlement date in investing refers to the date that a security which is purchased or sold exchanges hands between the buyer and seller. It’s the day that a transaction or trade is final, in other words. It’s like buying a car or house — the transaction process may take some time, but it’s not really final until the keys are handed over.

Generally, the settlement date for a transaction is two business days after the trade date. So, if you make a trade, you should anticipate that it won’t be settled for at least a couple of business days.

Types of Settlement Dates

Depending on the specific security involved in a trade or transaction, settlement dates may vary. You can read further below for more detail, but typically you can expect a settlement date to be two business days following the sale or purchase of a stock, bond, or exchange-traded fund (ETF). This is sometimes referred to as “T+2,” meaning “trade date, plus two days” to settle.

Further, some types of securities, like government securities or options, may only require one business day to settle (T+1). Others, like mutual funds, may require between one and three business days.

Trade and Settlement Dates Explained

To recap, the trade date is the day that an investor actually executes a trade from their brokerage account — they decide to buy or sell a security, and go through the necessary steps to make the transaction. That day, say it’s a Tuesday, is the trade date.

The settlement date comes after that. Again, if you’re buying stock, it’ll take two business days for everything to settle, and if you made the trade on Tuesday, the settlement date will probably be on Thursday (two business days later).

These built-in delays between the trade date and settlement date aren’t due to you doing anything wrong, and there’s not much you can do to speed it up — it’s more or less how stock exchanges work.

Why Is There a Delay Between Trade and Settlement Dates?

Given modern technology, it seems reasonable to assume that everything should happen instantaneously. But the current settlement rules go back decades, way back to the creation of the Securities and Exchange Commission (SEC) in 1934, when all trading happened in person, and on paper.

Back then, a piece of paper representing shares of a security had to be in the possession of traders in order to prove they actually owned the shares of stock. Moving this paper around sometimes took as long as five business days after the trade date, or T+5.

💡 Recommended: A Brief History of the Stock Market

What Is the T+2 Rule?

As discussed, the T+2 rule refers to the fact that it takes two days beyond a trade date for a trade to settle. For example, if a trade is executed on Tuesday, the settlement date will be Thursday, which is the trade date plus two business days.

Note that weekends and holidays are excluded from the T+2 rule. That’s because in the U.S., stock exchanges are open from 9:30am to 4:00pm Eastern time Monday through Friday.

The T+2 rule has been enforced by the SEC since 2017. Before then, the T+3 rule was in place.

What Investors Need to Know About T+2

This delay in settling applies to trading of almost all securities. An exception is Treasury bills, which can settle on the same day they are transacted.

Investors who plan on engaging in cash account trading need to know about trade vs. settlement date. Cash accounts are those in which investors trade stocks and exchange-traded funds (ETFs) only with money they actually have today. Meanwhile, margin trading accounts allow investors to trade using borrowed money or trade “on margin.”

An investor may notice two different numbers describing the cash balance in his or her brokerage account: the “settled” balance, and the “unsettled” balance. Settled cash refers to cash that currently sits in an account. Unsettled refers to cash that an investor is owed but won’t be available for a few days.

Are T+1, T+0, or Real-Time Settlement Possible?

Market observers have called for the T+2 rule to be reevaluated, as the settlement process may be able to be sped up and improve trading conditions.

Clearinghouses — which serve as middlemen in financial markets that ensure the transfer of a security goes through — have previously said that the settlement process should be changed from two days to one. But in recent years, market volatility has actually prompted greater scrutiny and interest in regulations surrounding clearing and settlement. That included a lot of trading during the “meme stock” frenzies in 2020 and 2021.

Moving to T+1, T+0 or real-time settlement would need the approval of the SEC and collaboration of dozens of stakeholders across Wall Street. But the real-time transactions made possible in the cryptocurrency market by blockchain technology have escalated chatter for modernizing securities markets.

Potential Violations of the Trade Date vs Settlement Date

Knowing the difference between trade date vs. settlement date can allow investors to avoid costly potential trading violations.

The consequences of these violations could differ according to which brokerage an investor uses, but the general concept still applies. Violations all have one thing in common: They involve the attempted use of cash or shares that have yet to come under ownership in an investor’s account.

Cash Liquidation Violation

To buy a security, most brokerages require investors to have enough settled cash in an account to cover the cost. Trying to buy securities with unsettled cash can lead to a cash liquidation violation, as liquidating a security to pay for another requires settlement of the first transaction before the other can happen.

Let’s look at a hypothetical example: Say Sally wants to buy $1,000 worth of ABC stock. Sally doesn’t have any settled cash in her account, so she raises more than enough by selling $1,200 worth of XYZ stock she has. The next day, she buys the $1,000 worth of ABC she had wanted.

Because the sale of XYZ stock hadn’t settled yet and Sally didn’t have the cash to cover the buy for ABC stock, a cash liquidation violation occurred. Investors who face this kind of violation three times in one year can have their accounts restricted for up to 90 days.

Free Riding Violation

Free riding violations occur when an investor buys stock using funds from a sale of the same stock.

For example, say Sally buys $1,000 of ABC stock on Tuesday. Sally doesn’t pay her brokerage the required amount to cover this order within the two-day settlement period. But then, on Friday, after the trade should have settled, she tries to sell her shares of ABC stock, since they are now worth $1,100.

This would be a free riding violation — Sally can’t sell shares she doesn’t yet own in order to purchase those same shares.

Incurring just one free riding violation in a 12-month period can lead to an investor’s account being restricted.

Good-Faith Violation

Good-faith violations happen when an investor buys a security and sells it before the initial purchase has been paid for with settled funds. Only cash or proceeds from the sale of fully paid-for securities can be called “settled funds.”

Selling a position before having paid for it is called a “good-faith violation” because no good-faith effort was made on the part of the investor to deposit funds into the account before the settlement date.

For example, if Sally sells $1,000 worth of ABC stock on Tuesday morning, then buys $1,000 worth of XYZ stock on Tuesday afternoon, she would incur a good-faith violation (unless she had an additional $1,000 in her account that did not come from the unsettled sale of ABC).

With these examples in mind, it’s not hard for active traders to run into problems if they don’t understand cash account trading rules, all of which derive from trade date vs. settlement date. Having adequate settled cash in an account can help avoid issues like these.

Settlement Date Risks

Given that a lag exists between the trade date and settlement date, there are risks for traders and investors to be aware of — namely, settlement risk, and credit risk.

Settlement Risk

Settlement risk has to do with one of the two parties in a transaction failing to come through on their end of the deal. For example, if someone agrees to buy a stock, but then does not pay for it after ownership has been transferred. In this case, the seller assumes the risk of losing their property and not receiving payment.

This tends to happen when trading on foreign exchanges, where time zones and differing regulations can come into play.

Credit Risk

Credit risk involves potential losses suffered due to a buyer failing to hold up their end of a deal. If a transaction is executed and the buyer’s funds are not transferred before the settlement date, there could be an interruption in the transaction, or it could be canceled altogether.

History of Settlement Dates

The SEC makes the rules regarding how stock markets operate, including trades, and even what a broker does in regard to retail investing. As such, the SEC is tasked with creating the clearance and settlement system — a power it was granted back in the mid-1970s.

Prior to the SEC’s involvement, exchanges and transfers of security ownership were left up to participants, with sellers delivering stock certificates through the mail or even by hand in exchange for payment. That could take a long time, and prices could move a lot, so the SEC came in and set the settlement date at five business days following the trade date.

But as technology has progressed, transactions have been able to execute much faster. In 1993, the SEC changed the settlement date to three business days, and in 2017, it was changed to two days.

The Takeaway

The trade date is the day an investor or trader books an order to buy or sell a security, and the settlement date is when the exchange of ownership actually happens. For many securities in financial markets, the T+2 rule applies, meaning the settlement date is usually two business days after the trade date — so, not including weekends or holidays. An investor therefore will not legally own the security until the settlement date.

While there’s been chatter that the settlement process needs to speed up to either T+1 or real-time settlement, it’s still important for investors and traders to know these rules so they don’t make violations that lead to restricted trading or other penalties, and so they can properly gauge the risks of trading.

While you can’t make trades settle faster, you can start trading online using SoFi Invest®. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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FAQ

What’s the difference between trade date and settlement date?

The trade date is when an investor initiates a buy or sell order, and the settlement date is when ownership of the underlying security is actually transferred. That generally happens two business days after the trade date (also called T+2).

Is the settlement date the issue date?

Typically, the settlement date and issue date are the same, as the settlement date is when a security actually exchanges hands. But there are times when the two can be different, concerning specific types of securities.

Why does it take two days to settle a trade?

The two-day lag between the trade date and settlement is designed to give a security’s seller time to gather and transfer documentation , and to give a buyer time to clear funds needed for settlement.

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What Is the T+2 Rule?

What Investors Need to Know About T+2

Are T+1, T+0, or Real-Time Settlement Possible?

Potential Violations of the Trade Date vs Settlement Date

Cash Liquidation Violation

Free Riding Violation

Good-Faith Violation

Settlement Date Risks

Settlement Risk

Credit Risk

History of Settlement Dates

The Takeaway

FAQ

What’s the difference between trade date and settlement date?

Is the settlement date the issue date?

Why does it take two days to settle a trade?

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