InvestUn Archives | Page 8 of 16

Oct

2024

What Is Risk Tolerance and How to Determine Yours

By Michael Flannelly | Growing Wealth, invest, Investing | No Comments

Risk tolerance refers to the level of risk an investor is willing or able to assume as a part of their investment strategy. Knowing yourself and your risk tolerance is an essential part of investing. Of course, it’s good to have a diversified portfolio built with your financial goals in mind.

Still, the products and strategies you use should ideally fall within guidelines that make you feel comfortable — emotionally and financially — when things get rough. Otherwise, you might resort to knee-jerk decisions, such as selling at a loss or abandoning your plan to save, which could cost you even more.

Key Points

• Risk tolerance is the level of risk an investor is willing to assume to achieve financial goals.

• Factors that influence risk tolerance may include risk capacity, need, and emotional risk.

• Investors tend to fall within or between three main categories of risk tolerance: conservative, moderate, and aggressive.

• Someone with a conservative risk tolerance may focus on preserving capital, as opposed to maximizing potential returns.

• Diversifying investments into different risk buckets can align your risk tolerance with your personal goals and timelines.

What Is Risk Tolerance?

As noted, risk tolerance is the amount of risk an investor is willing to take to achieve their financial goals when investing — whether through online investing or any other type of investing. In a broad sense, an investor’s risk tolerance level comprises three different factors: risk capacity, need, and emotional risk.

Risk Capacity

Risk capacity is the ability to handle financial risk. While it’s similar to risk tolerance, and can certainly influence it, it’s not the same thing. Unlike your emotional attitude about risk, which might not change as long as you live, your risk capacity can vary based on your age, your personal financial goals, and your timeline for reaching those goals. To determine your risk capacity, you need to determine how much you can afford to lose without affecting your financial security.

For example, if you’re young and have plenty of time to recover from a significant market downturn, you may decide to be aggressive with your asset allocation; you may invest in riskier assets like stocks with high volatility or cryptocurrency. Your risk capacity might be larger than if you were older and close to retirement.

For an older investor nearing retirement, you might be more inclined to protect the assets that soon will become part of your retirement income. You would have a lower risk capacity.

Additionally, a person with a low risk capacity may have serious financial obligations (a mortgage, your own business, a wedding to pay for, or kids who will have college tuition). In that case, you may not be in a position to ride out a bear market with risky investments. As such, you may use less-risky investments, like bonds or dividend stocks, to balance your portfolio.

On the other hand, if you have additional assets (such as a home or inheritance) or another source of income (such as rental properties or a pension), you might be able to take on more risk because you have something else to fall back on.

Need

The next thing to look at is your need. When determining risk tolerance, it’s important to understand your financial and lifestyle goals and how much your investments will need to earn to get you where you want to be.

The balance in any investment strategy includes deciding an appropriate amount of risk to meet your goals. For example, if you have $100 million and expect that to support your goals comfortably, you may not feel the need to take huge risks. When looking at particular investments, it can be helpful to calculate the risk-reward ratio.

But there is rarely one correct answer. Following the example above, it may seem like a good idea to take risks with your $100 million because of opportunity costs — what might you lose out on by not choosing a particular investment.

Emotional Risk

Your feelings about the ups and downs of the market are probably the most important factor to look at in risk tolerance. This isn’t about what you can afford financially — it’s about your disposition and how you make choices between certainty and chance when it comes to your money.

Conventional wisdom may suggest “buy low, sell high,” but emotions aren’t necessarily rational. For some investors, the first time their investments take a hit, fear might make them act impulsively. They may lose sleep or be tempted to sell low and put all their remaining cash in a savings account or certificate of deposit (CD).

On the flip side, when the market is doing well, investors may get greedy and decide to buy high or move their less-risky investments to something much more aggressive. Whether it’s FOMO trading, fear, greed, or something else, emotions can cause any investor to make serious mistakes that can blow up their plan and forestall or destroy their objectives. A volatile market is a risk for investors, but so is abandoning a plan that aligns with your goals.

And here’s the hard part: it’s difficult to know how you’ll feel about a change in the market — especially a loss — until it happens.

The Levels of Risk Tolerance

Generally, it’s possible to silo investors’ risk tolerances into a few key categories: aggressive, moderate, and conservative. But those terms are subjective, and depending on the institution they can be broadened to include other levels of risk tolerance (for example, a moderate-aggressive level). But because risk tolerance is subjective, the percentages of different assets is hypothetical, and ultimately an investor’s portfolio allocation would be determined by the individual investor themselves.

Again: the hypothetical allocation or investment mix, as it relates to any individual investor’s risk tolerance or risk profile, is not set in stone. You can read more about conservative, moderate, and aggressive risk tolerances below, but first, to help you get an idea of what the investment mix or allocation might look like for a broader range of risk tolerance profiles, here’s a hypothetical rundown of how an investor from each category might allocate their portfolio:

Risk Tolerance Level and Hypothetical Investment Mix
	Bonds, Cash, Cash Equivalents	Stocks
Conservative	70%	30%
Moderately Conservative	55%	45%
Moderate	40%	60%
Moderately Aggressive	27%	73%
Aggressive	13%	87%

And, as promised, here’s a bit more about what the three main risk tolerance categories could entail for investors:

Conservative Risk Tolerance

A person with conservative risk tolerance is usually willing to accept a relatively small amount of risk, but they truly focus on preserving capital. Overall, the goal is to minimize risk and principal loss, with the person agreeable to receiving lower returns in exchange.

Moderate Risk Tolerance

An investor with a moderate risk tolerance balances the potential risk of investments with potential reward, wanting to reduce the former as much as possible while enhancing the latter. This investor is often comfortable with short-term principal losses if the long-term results are promising.

Aggressive Risk Tolerance

People with aggressive risk tolerance tend to focus on maximizing returns, believing that getting the largest long-term return is more important than limiting short-term market fluctuations. If you follow this philosophy, you will likely see periods of significant investment success that are, at some point, followed by substantial losses. In other words, you’re likely to ride the full rollercoaster of market volatility.

How to Determine Your Own Risk Tolerance

There are steps you can take and questions to ask yourself to determine your risk tolerance for investing. Once you know your risk preference, you should be able to open a retirement account with more confidence. Both low risk tolerance and high risk tolerance investors may want to walk through these steps to ensure they know what investment style is right. Matching your specific risk tolerance to your personality traits can help you stick to your strategy over the long haul.

Consider the following questions, especially as they relate to your post-retirement life – or, what your life might look like once you reach your financial goals (which, for many people, is retirement!).

1. What will your income be? If you expect your salary to ratchet higher over the coming years, then you may want to have a higher investment risk level, as time in the market can help you recover from any losses. If you are in your peak-earning years and will retire soon, then toning down your risk could be a prudent move, since you don’t want to risk your savings this close to retirement.

2. What will your expenses look like? If you anticipate higher expenses in retirement, that might warrant a lower risk level since a sharp drop in your assets could result in financial hardship. If your expenses will likely be low (and your savings rate is high), then perhaps you can afford to take on more retirement investing risk.

3. Do you get nervous about the stock market? Those who cannot rest easy when stocks are volatile are likely in a lower-risk, likely lower-return group. But if you don’t pay much attention to the swings of the market, you might be just fine owning higher-risk, (potentially) higher-return stocks.

4. When do you want to retire? Your time horizon is a major retirement investing factor. The more time you have to be in the market, the more you should consider owning an aggressive portfolio. Those in retirement and who draw income from a portfolio are likely in the low risk-tolerance bucket, since their time horizon is shorter.

The Takeaway

Risk tolerance refers to an investor’s comfort with varying levels of investment risk. Each investor may have a unique level of risk tolerance, though generally, the levels are broken down into conservative, moderate, and aggressive. The fact is, all investments come with some degree of risk — some greater than others. No matter your risk tolerance, it can be helpful to be clear about your investment goals and understand the degree of risk tolerance required to help meet those goals.

Investors may diversify their investments into buckets — some less-risky assets, some intermediate-term assets, and some for long-term growth — based on their personal goals and timelines.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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SOIN-Q324-048

Oct

2024

6 Examples of When to Use Your Emergency Fund

By Jacqueline DeMarco | Budgeting & Goals, Family Finances, money | Comments Off

There are times when urgent, vital expenses pop up that lead you to dip into your emergency fund. Maybe you were laid off and rent is due, or you get into an accident and wind up with a pile of medical bills.

But at other times, it can be hard to know what exactly qualifies as a rainy day and gives you license to dip into your emergency savings. What about a great deal on a used car, which you could really use? Or the opportunity to replace your old fridge at a steep discount? Do those qualify as reasons to dip into your savings? Learn more here.

What Are Things to Avoid Spending My Emergency Savings on?

If you’ve done a good job stashing cash in an emergency fund, you likely want to know what types of expenses are valid uses of the money sitting in your savings account. Here are examples of when not to withdraw funds:

• Fun purchases. If you want but don’t need something and it isn’t in your budget, don’t pull from your emergency fund. Entertainment, dining out, tech gadgets, and designer clothes (even if on final sale) are all examples of wants, not needs. Set aside some funds for such buys if you like, but don’t deplete your emergency fund savings. It’s always best to ask questions before making an impulse buy. Spend time thinking about a purchase carefully before making it. You may find that new bike you thought you desperately needed doesn’t seem so vital a day or two later.

• Vacations. It’s very tempting to get away for a little R&R when things get tough, but a vacation isn’t a worthwhile emergency fund expense. If you want to have that week at the beach, go ahead and create a savings plan and a separate savings account to make it a reality. But it’s not a wise spending strategy to pull the money out of your rainy day funds.

• Debt. Paying down debt is a great goal. It’s also a smart use of any extra money you may have, but not at the expense of draining an emergency fund completely. If you’re chipping away at debt, keep at it but continue to keep some emergency funds aside. If you lose your job or an unexpected expense hits and you don’t have emergency savings, you might end up turning to more expensive forms of credit as a result. This underscores the importance of having an emergency fund.

How to Know When an Expense Counts as an Emergency

Now, it’s time to consider when to go ahead and use that money you saved for a rainy day. If you’re on the fence about whether an expense counts as an emergency, ask yourself the following six questions to determine if you should tap your emergency funds.

1. Is This Absolutely Necessary?

There’s a difference between things you want and things you need. If you start a new job and have to buy a uniform for it, that’s a necessity. If, however, you begin a new job and simply want some new outfits, that isn’t a necessity. Similarly, pining for a new stove with a commercial-style cooktop is a want; replacing a stove that conked out is a necessity.

2. Is This the Only Way That I Can Pay for This?

Before pulling money from this account, consider if the emergency fund is the only source of money that can cover this expense. Would it be possible to wait a week until payday and use your income instead? Gift cards, coupons, and sale discount codes can make it easier to pay for purchases without draining your emergency fund.

Your goal here is to determine the lowest possible price for a purchase and then see if there’s another (non-emergency fund) way to pay for it.

3. Is This an Unexpected Event?

Emergency funds can be a great way to cover unexpected and necessary purchases, but they aren’t supposed to replace poor planning. If you know a major expense is coming your way (say, the hot-water heater is coming to the end of its lifespan), it’s best to save for it instead of reaching into your rainy day fund.

4. Is This Urgent or Can It Wait?

Even if an expense feels like something that must be dealt with at the moment, there’s a good chance it can be put off. Ask yourself if it can wait until you have saved enough money to pay for it without accessing emergency funds.

5. How Much of My Emergency Fund Will I Be Using?

An emergency fund exists as a safety valve when you unexpectedly need funds. However, before pulling money from an emergency fund, it can be helpful to consider just how much of the emergency fund the purchase will take up. If it’s going to drain the fund and the purchase can wait, it’s likely best to wait. Or maybe you can buy a less pricey version of the item in question.

6. How Long Will It Take To Rebuild My Savings?

If the purchase will take up a big chunk of the emergency savings fund, it can be a good idea to map out how long it will take to rebuild those savings. If it will take more than six months, then it may be best to hold off on making that purchase until the emergency fund is more substantial. It may be better to cut back on spending to cover this expense now without having to touch emergency savings.

Of course, sometimes an emergency is really an emergency, and you can’t hold off. If you are hit with, say, a major medical bill, you may have to use up that emergency fund and work hard to rebuild it later. But it will have done its job and seen you through a tough time.

Recommended: Emergency Fund Calculator

The Takeaway

Before pulling savings from an emergency fund, it’s important to determine if the purchase is truly urgent or simply something you really want. Sometimes, real emergencies do crop up, and you’ll be glad you have money saved. Other times, you may realize that the expense isn’t really so vital. Emergency savings can be a real lifesaver, so you want to protect those funds and make sure you use them properly.

One way to build up an emergency fund faster is to put your money in a savings account that earns a competitive interest rate.

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FAQ

What should you ask yourself before using your emergency fund?

Before you pull money from an emergency fund, ask yourself questions like, Is this expense absolutely necessary? Is this the only way I can pay for it? Is it urgent or can it wait? How much of my emergency savings will I be using up? The answers should guide you towards whether or not it’s worth tapping into your emergency fund.

What should you spend your emergency fund on?

What constitutes an emergency purchase for one person may look quite different for another. That being said, it’s usually best to only spend emergency fund savings on necessities, not wants. Financial emergencies are usually unexpected and may include home repairs, medical bills, and car repairs — or day-to-day expenses after, say, a job loss.

What should you not put in your emergency fund?

While it’s a good idea to put extra money towards an emergency fund instead of spending it frivolously, there are some types of savings it’s best to leave out of an emergency fund. For example, it’s not a good idea to use 401(k) contributions or other retirement savings to build an emergency fund. Saving for retirement is crucial, and employers may match 401(k) contributions, which is basically like getting free money. In this scenario, it may be wise to focus on maxing out retirement contributions before building an emergency fund.

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SOBNK-Q324-094

Oct

2024

What Are Index Funds, and How to Invest in Them

By Carla Tardi | Growing Wealth, invest, Investing | Comments Off

Index investing is a passive investment strategy in which you buy shares of an index fund that mirrors the composition and performance of a market index like the S&P 500.

Index investing is considered passive because index funds are formulated to follow the index and thus deliver market returns. There is no portfolio manager to oversee the fund or execute trades as there is with actively managed funds. Index funds can include mutual funds as well as exchange-traded funds (ETFs).

While index funds were once considered somewhat unsophisticated, a growing number of investors have come to embrace passive strategies in the last several years: In 2010, about 19% of total assets under management with U.S. investment firms were in passive funds. By 2023, passive strategies accounted for 48%.

Although index funds are considered passive, that doesn’t mean they are risk free; there are specific concerns for investors to bear in mind when considering index investing.

Key Points

• Index funds are mutual funds that try to replicate the benchmark index for a market segment or sector.

• Because index funds are passively managed and have low turnover, which helps keep costs lower than an actively managed fund.

• Indexes — and the index funds that track them — may be weighted by market cap, price, or fundamentals.

• Passive investing in index funds may help restrain investors’ emotional impulses and improve long-term returns.

• Index investing offers diversification and cost efficiency, but lacks downside protection and flexibility.

What Are Index Funds?

An index fund is a type of mutual fund or exchange-traded fund (ETF) that tracks the performance of a market segment — like large-cap companies — or a sector like technology, by following the benchmark index for that sector.

Index funds typically hold a portfolio of securities — e.g., stocks, bonds, or other assets — that are identical or nearly identical to those in the relevant index. The idea is to try to replicate the chosen benchmark’s performance as closely as possible.

Unlike actively managed funds, which employ a portfolio manager that seeks to outperform the benchmark by actively trading securities within the fund, index funds aim to provide returns based solely on the performance of that particular market or sector.

There is an ongoing debate about the merits of pursuing active vs. passive strategies. In 2023, passive investments tended to outperform their active counterparts, according to industry data analyzed by Morningstar. That said, active strategies outperformed under certain conditions, and for specific markets.

There are index funds for the U.S. bond market, the U.S. stock market, international markets, and countless others represented by various market indexes like the Russell 2000 index of small-cap companies, the Nasdaq 100 index of tech companies, and so on.

How Do Index Funds Work?

When you buy shares of an index fund — typically a mutual fund or ETF — your money is effectively invested in the many stocks or bonds that make up the particular index. This helps add some diversification to your portfolio, potentially more so than if you were buying individual securities.

In addition, index funds tend to be lower cost than active funds, because passive funds don’t require a live portfolio management team.

Passive investing comes with certain risks, however, chiefly the risk of being tied to the ups and downs of a specific market. Without an active manager at the helm, an index fund can only deliver market returns.

Why Index Funds Typically Cost Less

Because index funds are designed to track the securities in a given market index, an index fund’s portfolio is typically updated only when the constituents in the index itself change. Thus, there is typically low turnover in these funds, which helps keep overall costs low.

By contrast, actively managed funds typically employ a more frequent trading strategy in a quest for outperformance, which can add to the cost of the fund. In addition, active funds have a live portfolio manager and thus tend to charge higher fees.

Understanding the impact of investment fees is important to long-term performance, as many investors know.

How an Index Is Weighted

Some indexes give more weight to companies with a bigger market capitalization; these are market-cap-weighted indexes. This means index funds that track a weighted index, like the S&P 500, likewise allocate a higher percentage to those bigger companies — and those companies influence the performance of the index.

Indexes can also be weighted by price (with higher priced companies making up a higher proportion of the index) or by company fundamentals. While the weighting structure of the index may not matter to individual investors at first, it ultimately influences the holdings of any related index funds or ETFs, and may be something to bear in mind when selecting an index fund.

Well-Known Big Market Indexes

There are thousands of indexes in the U.S. alone, each one designed to reflect how a certain aspect of the market is doing. Some of the biggest indexes include:

• S&P 500 Index — Standard & Poor’s 500 tracks the 500 largest companies in the U.S. by market capitalization.

• Dow Jones Industrial Average (DIJA) — The Dow tracks 30 blue-chip companies; this is a price-weighted index.

• Nasdaq Composite Index — The Nasdaq Composite tracks all of the tech companies listed in the Nasdaq stock exchange (one of the major U.S. exchanges); this is a price-weighted index.

• Wilshire 5000 Index — The Wilshire 5000 is a market-cap-weighted index, and it’s considered a total market index because it tracks all publicly traded companies with headquarters in the United States.

• Bloomberg Barclays Aggregate Bond Index — Nicknamed the “Agg,” this index tracks over $50 trillion in fixed-income securities, and is often considered an indicator of the economy’s health.

Top 10 Equity Index Funds

While the above list reflects some of the larger market indexes, these don’t dictate what the most popular index funds may be. Some index funds are more cost efficient or do a better job of tracking their benchmark than others.

Following are the top 10 low-cost U.S. equity index mutual funds and ETFs in 2024, according to Morningstar, Inc., the industry ratings and research company.

1. DFA US Large Company (DFUSX)

2. Fidelity 500 Index (FXAIX)

3. Fidelity Mid Cap Index (FSMDX)

4. Fidelity Total Market Index (FSKAX)

5. Fidelity ZERO Large Cap Index (FNILX)

6. iShares Core S&P 500 ETF (IVV)

7. iShares Core S&P Total US Stock Market ETF (ITOT)

8. iShares S&P 500 Index (WFSPX)

9. Schwab US Mid-Cap Index (SWMCX)

10. Schwab Total Stock Market Index (SWTSX)

How to Invest in Index Funds: Step by Step

Investing in index funds requires as much due diligence as investing in any single security. Here’s how to start.

Step 1: Determine Your Goals, Time Horizon, and Risk Tolerance

You may want to consider some of the basic tenets of investing as you select your index fund or funds. Will you be adding an index fund to an existing portfolio? Are you starting a taxable account? Is this for retirement?

Knowing your goals, your time frame, and how much risk you feel comfortable with will inform the funds you choose.

Step 2: Choose an Index Fund

The name of a particular index fund may catch your eye, but it’s essential to examine what’s inside an index fund’s portfolio before investing in it. Some index funds track a larger market, such as the S&P 500 or Russell 3000. Others track a more narrow or even niche sector of the market.

Determine what your short- and long-term goals are, and what markets you are interested in. You may want to start with a broad market index fund focused on equities or bonds. Or you may want to target certain sectors like technology, sustainability, or health care.

Step 3: Open a Brokerage Account

Open and fund a brokerage account or online brokerage account, and explore the index fund options available. Be sure to check potential fees and trading costs, as well as account minimums and cost per share. The price per share can vary widely.

Step 4: Buy Shares of an Index Fund

Once you’ve selected the fund(s) you want, execute the trade. Decide whether to create an automatic investment (e.g. every month) to support your goals.

Step 5: Consider Your Index Strategy

While it’s possible to simply add one index fund to your portfolio, it’s also possible to populate your entire portfolio using only index funds. Again, bear in mind the pros and cons of index strategies in light of your current and long-term goals for this investment, as well as your risk tolerance.

Potential Advantages of Index Investing

Index investing has a number of merits to consider. As noted above, index investing tends to be cost efficient, and may offer some portfolio diversification. In addition, investors may benefit from other aspects of passive strategies.

Easier to Manage

It might seem as if active investors could have a better chance at seeing significant returns versus index investors, but this isn’t necessarily the case. Day trading and timing the market can be difficult, and may result in big losses or underperformance. After all, few individual investors have the time to master the ins and outs of financial markets.

Index investing offers a lower-cost, lower-maintenance alternative. Because index funds simply track different benchmarks, individual investors don’t have to concern themselves with the success or failure of an active portfolio manager. Also, index investing doesn’t necessarily require a wealth manager or advisor — you can assemble a portfolio of index funds on your own.

Behavioral Guardrails

Investors who pursue active strategies may succumb to emotional impulses, like timing the market, which can impact their portfolio’s performance. Investing in index funds, which takes a more hands-off approach, may help restrain investor behavior — which may help portfolio returns over time.

According to the 30th annual Quantitative Analysis of Investor Behavior (QAIB) report by DALBAR, the market research firm, equity investors typically underperform the S&P 500 over time.

The QAIB report is based on data from Bloomberg Barclays indices, the Investment Company Institute (ICI), and Standard and Poor’s, as well as proprietary sources. The study examined mutual fund sales, redemptions, and exchanges each month, from Jan. 1, 1985 to December 31, 2023, in order to measure investor behavior, and then compared investor returns to a relevant set of indices.

In 2023, the average equity investor earned 5.50% less than the return of the S&P 500 for that year — a common pattern, as DALBAR research shows.

Potential Disadvantages of Index Investing

The potential upsides of passive strategies have to be weighed against the potential risks.

No Downside Protection

Index funds track the market they’re based on, whether that’s small-cap stocks or corporate bonds. So, if the market drops, so does the index fund that’s trying to replicate that market’s performance. There is no live manager who can try to offset losses; index investors have to ride out any volatility on their own.

No Choice About Investments

Individual investors themselves typically can’t change the securities in any mutual fund or ETF, whether passive or active. But whereas active strategies are based on trading securities within the fund, index funds rarely change up their portfolios — unless the index itself changes constituents (which does happen).

Index Investing: a Long-Term Strategy

Some investors may try to time the market: meaning, they try to buy high and sell low. Investing in index funds tends to work when you hold your money in the fund for a longer period of time; or if you rely on dollar-cost averaging.

Dollar-cost averaging is a method of investing the same amount consistently over time to take advantage of both high and low points in market prices. Generally speaking, this strategy tends to lower the average cost of your investments over time, which may support returns. But dollar-cost averaging can be inflexible, and limit an investor’s ability to respond to certain market conditions.

The Takeaway

Index investing is considered a passive strategy because index funds track a benchmark that reflects a certain part of the market: e.g. large-cap stocks or tech stocks or green bonds. Indexing is considered a low-cost way to gain broad market exposure. But index funds are not without risks, and it’s wise to consider index funds in light of your long-term goals.

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

FAQ

What happens when you invest in an index?

You can’t invest in an index, per se, but you can invest in a fund that tracks a specific market index. When you invest in an index fund, you’re investing in not one stock, but in numerous stocks (or other securities, like bonds) that match that benchmark. A large-cap index fund would track big U.S. companies; an emerging market index fund would track emerging markets.

How much do index funds cost?

Index funds tend to have a lower annual expense ratio than actively managed funds, often under 0.05%. That said, investment fees can vary widely, and it’s essential to check a fund’s all-in costs.

Are index funds safe?

Investing in the capital markets always entails risk — no investment is 100% safe. That said, investing in an index fund may involve less risk than owning a single stock, because the range of securities in the fund’s portfolio provide some diversification. That doesn’t mean you can’t lose money. Index funds are only as stable as their underlying index.

Is it smart to put all your money in an index fund?

It’s possible to use an index investing strategy for your entire portfolio. Whether this makes sense for you is determined by your goals and risk tolerance. Index investing offers some potential advantages in terms of cost efficiency and broader market exposure, but comes with the risk of being tied to market returns, with no ability to adjust the portfolio allocation.

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

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

SoFi Invest®

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

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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.

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SOIN-Q324-042

Oct

2024

What Are Stocks? Types, Benefits, Risks, Explained

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

A stock represents a fraction of ownership in a company. Stockowners, also called shareholders, are entitled to a proportional cut of the company’s earnings and assets (and sometimes dividends).

That means that if you own stock in a company, as the company grows and expands you stand to earn a return on your investment as your shares gain value. But you also risk losing all or part of your investment if the company doesn’t prosper.

Key Points

• Stocks represent fractional ownership in a company, offering potential returns through appreciation and dividends.

• Stocks may be either common or preferred, with common stocks being the most common.

• Stock prices are typically determined by supply and demand, influenced by factors such as market conditions and company performance.

• Investing in stocks may help build wealth over time but also carries risks, including potential loss of investment.

• Diversifying a portfolio with various stocks and other assets can help mitigate investment risks.

What Are Stocks?

Stocks are shares of ownership in a company, and they are primarily bought and sold on publicly traded stock exchanges. That means you can open an online brokerage account and become a partial owner of whatever company you choose when you buy shares in that company.

How Do Stocks Work?

Stocks are a type of financial security, or asset, and they are traded on public exchanges. A stock is created when a company goes public, typically through an initial public offering (IPO), and issues shares that investors can buy and sell. Stocks are usually traded on exchanges, like the NYSE or Nasdaq.

Individual investors can open a brokerage account so they can buy and sell the stocks of their choosing on a given exchange. Exchanges list the purchase or bid price, as well as the selling or offer price.

The price of a stock is generally determined by supply and demand via an auction process, where buyers and sellers negotiate a price to make a trade. The buyer makes a bid price, while the seller has an ask price; when these two prices meet, a trade occurs.

The stock market consists of thousands or millions of trades daily, usually through online platforms and between investors and market makers. So, the auction process is not usually completed between investors directly. Rather, prices are determined through electronic trades, often conducted in fractions of a second.

When a stock’s prospects are high and it’s in high demand, the company’s share price could increase. In contrast, when investors sour on a company and want to sell en masse, the price of a stock will likely decline.

Types of Stocks

Stocks generally fit into two categories: common stock and preferred stock.

• Common stocks are the most common type of stock. Along with proportional ownership of the company, common stocks also give stockholders voting rights, allowing them to have voice when it comes to things like management elections or structural business changes. Most individual investors own common stock.

• Preferred stocks don’t come with voting rights, but they are given “preferred” status in that earnings are paid to preferred stockholders first. That makes this kind of stock a slightly less risky asset. If the company goes under and its assets are liquidated to repay investors, the preferred stockholders are less likely to lose everything, since they’ll be paid their share before common stockholders.
Most individual investors own common stock.

Benefits of Stocks

For investors, the primary benefit of owning stocks is that they present the opportunity to generate a return. While stocks do have risks, by and large, the stock market tends to rise over time, meaning that an investor owning a diversified stock portfolio could benefit from the market’s gains over time, too. Though there are no guarantees.

Further, stocks allow investors to diversify their portfolios to a good degree. Diversifying your portfolio — buying a variety of different stocks as well as other assets like bonds and cash equivalents — is one way to help mitigate the risks of investing.

Again, it’s important to understand that it is possible (and even likely) that you may lose money you have invested when a company’s stock or the market takes a downturn. It’s also important to remember that a certain amount of market fluctuation is absolutely normal — and, in fact, an indicator that the market is healthy and functioning.

Risks of Stocks

As discussed, owning or investing in stocks has its risks, too. Though buying stocks can sometimes result in a positive return, it’s also possible to see significant losses — or even to lose everything you’ve invested.

Stocks might lose value under the following circumstances (though there could be many others):

• The market as a whole experiences losses, due to wide-reaching occurrences like economic recessions, war, or political changes.

• The issuing company falters or goes under, in which case individual shares can drop in price and the company may forgo paying dividends. This is also known as “specific” or “unsystematic risk,” and may be slightly mitigated by having a diversified portfolio.

• A lackluster financial report, such as a quarterly earnings report showing declining sales, could lead to a stock’s value declining.

How to Buy Stocks

If you decide that investing in the stock market is the right move to help you reach your financial goals, you’ve got a variety of ways to get started. For most investors, there are two main account types through which they might buy stocks: tax-deferred retirement accounts and taxable brokerage accounts. There are also accounts that allow for automated investing.

Before you even sit down to choose your first stock (or learn to evaluate stocks in general), you’ll need to decide what kind of investment account you’ll use.

Tax-Deferred Accounts

These accounts are typically used for retirement-saving or planning purposes because they offer certain tax advantages to investors (along with some restrictions). Generally, investors contribute pre-tax money to these accounts — meaning contributions are tax deductible — and pay taxes when they withdraw funds in retirement.

• A 401(k): The 401(k) plan is commonly offered to W-2 employees as part of their benefits package. Contributions are taken directly from your paycheck, pre-tax, for this retirement account. In most cases, taxation is deferred until you take the funds out at retirement.

• IRAs: Individual retirement accounts, or IRAs, may be useful investment vehicles for the self-employed and others who don’t have access to an employer-sponsored retirement account. There are a number of different types of IRAs – two of the most common are the traditional and the Roth IRA, though typically only the traditional IRA is tax-deferred. Roth IRA account holders contribute after tax-dollars, which grow tax-free. Each type of IRA offers unique benefits and limitations.

Taxable Accounts

You can also open a brokerage account, which allows you to buy and sell assets pretty much at will. However, there are no tax deductions for investing through a brokerage account.

Also, the dividends you earn are subject to taxes in the year you earn them, and you may incur taxes when you sell an investment. Tax rates are usually lower for “long-term” assets, or those held for a year or longer; taxes on “short-term” capital gains (on securities held for less than a year) tend to be higher.

Different brokers assess different maintenance and trading fees, so it’s important to shop around for the most cost-effective option.

Automated Investment Options

If all that footwork sounds exhausting, that doesn’t necessarily mean investment isn’t right for you. You might consider an automated investing option (also known as a “robo-advisor”), which offer pre-built investment portfolios based on your goals and timelines. It’s similar to a pre-built house: there are some adjustments you can make, and different models to choose from, but your choices are limited.

That said, many investors choose automated options because the algorithm on the back-end takes care of most of the basic maintenance for your portfolio. Also, robo advisors can help you get started with a minimal amount of research and effort.

The programs may charge a small fee in exchange for creating, maintaining, and rebalancing a portfolio. Some may also allow you to choose specific stocks or themed ETFs, which can help you support companies or industries that share your values and vision.

Stock Terms to Get Familiar With

The stock market is chock full of unique jargon and terminology. As such, it can be helpful to learn some of the lingo so you better understand what’s going on, and what you’re doing.

Stocks and Shares

What is the difference between a stock vs. a share? A share of stock is the unit you purchase. “Stock” is a shorthand way of referring to the company that is selling its shares.

So: You might buy 100 shares of a company. If you owned 100 stocks, however, that means you own shares of 100 different companies.

Further, trading equities is the same as trading stocks. Equities or equity shares, is another way of talking about stocks as an asset class. You’re not likely to say you bought equity in a company. But your portfolio may have different asset classes that include equities, fixed income, commodities, and so on.

It’s also possible to own a fraction of a share of stock (called fractional shares), for those who can’t afford to buy a single share (which can happen with very large or popular companies).

Dividends

A dividend payment is a portion of a company’s earnings paid out to shareholders. For every share of stock an investor owns, they get paid an amount of the company’s profits. Companies can pay out dividends in cash, called a cash dividend, or additional stock, known as a stock dividend.

Growth stocks

Growth stocks are shares of companies that demonstrate a strong potential to increase revenue or earnings thereby ramping up their stock price

Market capitalization

To figure out a company’s market cap, multiply the number of outstanding shares by the current price per share. A company with 10 million outstanding shares of stock selling at $30 per share, has a market cap of $300 million.

Spread

Spread is the difference between two financial measurements; in finance there are a variety of different spreads. When talking specifically about a stock spread, it is the difference between the bid price and the ask price — or the bid-ask spread.

The bid price is the highest price a buyer will pay to purchase one or more shares of a specific stock. The ask price is the lowest price at which a seller will agree to sell shares of that stock. The spread represents the difference between the bid price and the ask price.

Stock split

A company usually initiates a stock split when its stock price gets too high. A stock split lowers the price per share, but maintains the company’s market cap.

A 10-for-1 stock split of a stock selling for $1,000 per share, for instance, would exchange 1 share worth $1,000 into 10 shares, each worth $100.

Value stock

Value stocks are shares of companies that have fallen out of favor and are valued less than their actual worth.

Volatility

Volatility in the stock market occurs when there are big swings in share prices, which is why volatility is often synonymous with risk for investors. While volatility usually describes significant declines in share prices, it can also describe price surges.

Thus, volatility in the equity market can also represent significant opportunities for investors. For instance, investors might take advantage of volatility to buy the dip, purchasing shares when prices are momentarily lower.

Should You Invest in Stocks?

When you consider the average return of the stock market over time, including boom and bust cycles, the stock market can offer investors the prospect of generating returns — but not a guarantee of such returns.

The difficulty with stocks is that they also come with a degree of risk; some are riskier than others. There are different ways to invest in stocks that can help mitigate some of that risk.

Ultimately, the choice to invest in stocks — and which specific stocks — will come down to the individual investor, their risk tolerance, and goals. It may be helpful to speak with a financial professional for guidance, too.

The Takeaway

Stocks, also known as “shares” or “equity investments,” are small pieces of ownership of a larger company. Stocks come in both common and preferred varieties, which offer stockholders different benefits and risks. Although relatively risky, stocks tend to offer better return-generating potential than other asset classes like bonds or long-term savings accounts.

Even taking major financial crises into consideration, the market’s overall trend over the last 100 years has been toward growth. But again, there are no guarantees, and you should always do your research before investing in a stock or other asset.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

How do stocks make money?

Stocks can earn investors returns primarily through appreciation — meaning that they gain value, and investors sell them for more than they purchased them for — or by paying out dividends.

How are stock prices determined?

Stock prices are mostly determined by supply and demand among traders and investors. When a specific stock is in demand, values might rise — conversely, when many investors are selling a stock, its value might fall.

What is shareholder ownership?

Shareholder ownership is specifically based on your ownership of shares in the company. If you own 20% of a company’s shares, you don’t own 20% of the company — you own 20% of the shares.

SoFi Invest®

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

SOIN-Q324-046

Oct

2024

How to Roll Over Your 401(k): Knowing Your Options

By MP Dunleavey | Budgeting & Goals, Building Your Career, Growing Wealth, invest, Investing, Life & Career | No Comments

It’s pretty easy to rollover your old 401(k) retirement savings to an individual retirement account (IRA), a new 401(k), or another option — yet millions of workers either forget to rollover their hard-won retirement savings, or they lose track of the accounts. Given that a 401(k) rollover typically takes minimal time and, these days, minimal paperwork, it makes sense to know the basics so you can rescue your 401(k), roll it over to a new account, and add to your future financial security.

Whether you’re starting a new job and need to roll over your 401(k), or are looking at what other options are available to you, here’s a rundown of what you need to know.

Key Points

• Rolling over a 401(k) to an IRA or new 401(k) is typically straightforward and your retirement funds will continue to have the opportunity to grow.

• Moving 401(k) funds to another 401(k) is often the simplest option and allows you to continue to have a higher contribution limit.

• Moving 401(k) funds to an IRA may provide more investment choices and control over those investments.

• Leaving a 401(k) with a former employer is an option but may involve additional fees and complications.

• Direct transfers are simpler and generally preferred over indirect transfers, which run the risk of incurring tax liabilities and penalties.

401(k) Rollover Options

For workers who have a 401(k) and are considering next steps for those retirement funds — such as rolling them to an IRA or another 401(k), here are some potential avenues.

1. Roll Over Money to a New 401(k) Plan

If your new job offers a 401(k) or similar plan, rolling your old 401(k) funds into your new 401(k) account may be both the simplest and best option — and the one least likely to lead to a tax headache.

That said, how you go about the rollover has a pretty major impact on how much effort and paperwork is involved, which is why it’s important to understand the difference between direct and indirect transfers.

Here are the two main options you’ll have if you’re moving your 401(k) funds from one company-sponsored retirement account to another.

Direct Rollover

A direct transfer, or direct rollover, is exactly what it sounds like: The money moves directly from your old account to the new one. In other words, you never have access to the money, which means you don’t have to worry about any tax withholdings or other liabilities.

Depending on your account custodian(s), this transfer may all be done digitally via ACH transfer, or you may receive a paper check made payable to the new account. Either way, this is considered the simplest option, and one that keeps your retirement fund intact and growing with the least possible interruption.

Indirect Rollover

Another viable, but more complex, option, is to do an indirect transfer or rollover, in which you cash out the account with the expressed intent of immediately reinvesting it into another retirement fund, whether that’s your new company’s 401(k) or an IRA (see above).

But here’s the tricky part: Since you’ll actually have the cash in hand, the government requires your account custodian to withhold a mandatory 20% tax. And although you’ll get that 20% back in the form of a tax exemption later, you do have to make up the 20% out of pocket and deposit the full amount into your new retirement account within 60 days.

For example, say you have $50,000 in your old 401(k). If you elected to do an indirect transfer, your custodian would cut you a check for only $40,000, thanks to the mandatory 20% tax withholding.

But in order to avoid fees and penalties, you’d still need to deposit the full $50,000 into your new retirement account, including $10,000 out of your own pocket. In addition, if you retain any funds from the rollover, they may be subject to an additional 10% penalty for early withdrawal.

Pros and Cons of Rolling Over to a New 401(k)

With all of that in mind, rolling over your money into a new 401(k) has some pros and cons:

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Pros:

• Often the simplest, easiest rollover option when available.

• Should not typically result in any tax liabilities or withholdings.

• Allows your investments to continue to grow (hopefully!), uninterrupted.

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Cons:

• New employer may change certain aspects of your 401(k) plan.

• There may be higher associated fees or costs with your new plan.

• Indirect transfers may tie up some of your funds for tax purposes.

¹Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

2. Roll Over Your 401(k) to an IRA

If your new job doesn’t offer a 401(k) or other company-sponsored account like a 403(b), you still have options that’ll keep you from bearing a heavy tax burden. Namely, you can roll your 401(k) into an IRA.

The entire procedure essentially boils down to three steps:

1. Open a new IRA that will accept rollover funds.

2. Contact the company that currently holds your 401(k) funds and fill out their transfer forms using the account information of your newly opened IRA. You should receive essential information about your benefits when you leave your current position. If you’ve lost track of that information, you can contact the plan sponsor or the company HR department.

3. Once your money is transferred, you can reinvest the money as you see fit. Or you can hire an advisor to help you set up your new portfolio. It also may be possible to resume making deposits/contributions to your rollover IRA.

Pros and Cons of Rolling Over to an IRA

This option also has its pros and cons, however.

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Pros:

• IRAs may have more investment options available.

• You’ll have more control over how you allocate your investments.

• You could potentially reduce related expenses, depending on your specifications.

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Cons:

• May require you to liquidate your holdings and reinvest them.

• Lower contribution limit compared to 401(k).

• May involve different or higher fees and additional costs.

• IRAs may provide less protection from creditor judgments.

• You’ll be subject to new distribution rules – namely, you’ll need to be 59 1/2 before withdrawing funds to avoid incurring penalties.

3. Leave Your 401(k) With Your Former Employer

Leaving your 401(k) be – or, with your former employer – is also an option.

If you’re happy with your portfolio mix and you have a substantial amount of cash stashed in there already, it might behoove you to leave your 401(k) where it is.

You’ll also want to dig into the details and determine how much control you’ll have over the account, and how much your former employer might.

You might also consider any additional fees you might end up paying if you leave your 401(k) where it is. Plus, racking up multiple 401(k)s as you change jobs could lead to a more complicated withdrawal schedule at retirement.

Pros and Cons of Leaving Your 401(k) Alone

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Pros:

• It’s convenient – you don’t do anything at all, and your investments will remain where they are.

• You’ll have the same protections and fees that you previously had, and won’t need to get up to speed on the ins and outs of a new 401(k) plan.

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Cons:

• If you have a new 401(k) at a new employer, you could end up with multiple accounts to juggle.

• You’ll no longer be able to contribute to the 401(k), and may not get regular updates about it.

4. Cash Out Your Old 401(k)

Cashing out, or liquidating your old 401(k) is another option. But there are some stipulations investors should be aware of.

Because a 401(k) is an investment account designed specifically for retirement, and comes with certain tax benefits — e.g. you don’t pay any tax on the money you contribute to your 401(k), depending on the specific type — the account is also subject to strict rules regarding when you can actually access the money, and the tax you’d owe when you did.

Specifically, if you take out or borrow money from your 401(k) before age 59 ½, you’ll likely be subject to an additional 10% tax penalty on the full amount of your withdrawal — and that’s on top of the regular income taxes you’ll also be obligated to pay on the money.

Depending on your income tax bracket, that means an early withdrawal from your 401(k) could really cost you, not to mention possibly leaving you without a nest egg to help secure your future.

This is why most financial professionals generally recommend one of the next two options: rolling your account over into a new 401(k), or an IRA if your new job doesn’t offer a 401(k) plan.

Pros and Cons of Cashing Out Your 401(k)

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Pros:

• You’ll have immediate access to your funds to use as you like.

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Cons:

• Early withdrawal penalties may apply, and there will likely be income tax liabilities.

• Liquidating your retirement account may hurt your chances of reaching your financial goals.

When Is a Good Time to Roll Over a 401(k)?

If there’s a good time to roll over your 401(k), it’s when you change jobs and have the chance to enroll in your new employer’s plan. But you can generally do a rollover any time.

That said, if you have a low balance in your 401(k) account — for example, less than $5,000 — your employer might require you to do a rollover. And if you have a balance lower than $1,000, your employer may have the right to cash it out without your approval. Be sure to check the exact terms with your employer.

When you receive funds from a 401(k) or IRA account, such as with an indirect transfer, you’ll only have 60 days from the date you receive them to then roll them over into a new qualified plan. If you wait longer than 60 days to deposit the money, it will trigger tax consequences, and possibly a penalty. In addition, only one rollover to or from the same IRA plan is allowed per year.

The Takeaway

Rolling over your 401(k) — to a new employer’s plan, or to an IRA — gives you more control over your retirement funds, and could also give you more investment choices. It’s not difficult to rollover your 401(k), and doing so can offer you a number of advantages. First of all, when you leave a job you may lose certain benefits and terms that applied to your 401(k) while you were an employee. Once you move on, you may pay more in account fees for that account, and you will likely lose the ability to keep contributing to your account.

There are some instances where you may not want to do a rollover, for instance when you own a lot of your old company’s stock, so be sure to think through your options.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

How can you roll over a 401(k)?

It’s fairly easy to roll over a 401(k). First decide where you want to open your rollover account, then contact your old plan’s administrator, or your former HR department. They typically send funds to the new institution directly via an ACH transfer or a check.

What options are available for rolling over a 401(k)?

There are several options for rolling over a 401(k), including transferring your savings to a traditional IRA, or to the 401(k) at your new job. You can also leave the account where it is, although this may incur additional fees. It’s generally not advisable to cash out a 401(k), as replacing that retirement money could be challenging.

SoFi Invest®

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

SOIN-Q324-044

What Is Risk Tolerance and How to Determine Yours

What Is Risk Tolerance?

Risk Capacity

Need

Emotional Risk

The Levels of Risk Tolerance

Conservative Risk Tolerance

Moderate Risk Tolerance

Aggressive Risk Tolerance

How to Determine Your Own Risk Tolerance

Risk Tolerance Quiz

The Takeaway

6 Examples of When to Use Your Emergency Fund

What Are Things to Avoid Spending My Emergency Savings on?

Earn up to 3.80% APY with a high-yield savings account from SoFi.

How to Know When an Expense Counts as an Emergency

1. Is This Absolutely Necessary?

2. Is This the Only Way That I Can Pay for This?

3. Is This an Unexpected Event?

4. Is This Urgent or Can It Wait?

5. How Much of My Emergency Fund Will I Be Using?

6. How Long Will It Take To Rebuild My Savings?

The Takeaway

FAQ

What should you ask yourself before using your emergency fund?

What should you spend your emergency fund on?

What should you not put in your emergency fund?

What Are Index Funds, and How to Invest in Them

What Are Index Funds?

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

How Do Index Funds Work?

Why Index Funds Typically Cost Less

How an Index Is Weighted

Well-Known Big Market Indexes

Top 10 Equity Index Funds

How to Invest in Index Funds: Step by Step

Step 1: Determine Your Goals, Time Horizon, and Risk Tolerance

Step 2: Choose an Index Fund

Step 3: Open a Brokerage Account

Step 4: Buy Shares of an Index Fund

Step 5: Consider Your Index Strategy

Potential Advantages of Index Investing

Easier to Manage

Behavioral Guardrails

Potential Disadvantages of Index Investing

No Downside Protection

No Choice About Investments

Index Investing: a Long-Term Strategy

The Takeaway

FAQ

What happens when you invest in an index?

How much do index funds cost?

Are index funds safe?

Is it smart to put all your money in an index fund?

What Are Stocks? Types, Benefits, Risks, Explained

What Are Stocks?

How Do Stocks Work?

Types of Stocks

Get up to $1,000 in stock when you fund a new Active Invest account.*

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Benefits of Stocks

Risks of Stocks

How to Buy Stocks

Tax-Deferred Accounts

Taxable Accounts

Automated Investment Options

Stock Terms to Get Familiar With

Stocks and Shares

Dividends

Growth stocks

Market capitalization

Spread

Stock split

Value stock

Volatility

Should You Invest in Stocks?

The Takeaway

FAQ

How do stocks make money?

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