May
18
2024
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The Strategic Guide to Early Retirement

By | Budgeting & Goals, invest, Life & Career, Preparing for Retirement | No Comments

An early retirement used to be considered a bit of a dream, but for many people it’s a reality — especially those who are willing to budget, save, and invest with this goal in mind.

If you’d like to retire early, there are concrete steps you can take to help reach your goal. Here’s what you need to know about how to retire early.

Key Points

•   Early retirement requires significant savings, often guided by the Rule of 25, which suggests saving 25 times annual expenses.

•   The FIRE movement encourages saving 50-75% of income to retire early.

•   Effective budgeting and reducing expenses are crucial for accumulating necessary retirement funds.

•   Investment strategies should balance growth and risk, adjusting as retirement nears.

•   Health insurance planning is essential when retiring before qualifying for Medicare at age 65.

Understanding Early Retirement

Early retirement typically refers to retiring before the age of 65, which is when eligibility for Medicare benefits begins. Some people may want to retire just a few years earlier, at age 60, for instance. But others dream of retiring in their 40s or 50s or even younger.

Clarifying Early Retirement Age and Goals

You’re probably wondering, how can I retire early? That’s an important question to ask. First, though, you have to decide at what age to retire.

Schedule a few check-ins with yourself, and/or a partner or loved ones, to discuss what “early retirement” means. Is it age 50? Age 55? And what might your early retirement look like? Will you stop working completely? Work part-time? Or maybe you want to switch to a different field or start a business? Perhaps you dream of going back to school, volunteering, or traveling.

Early retirement is different for everyone. So the clearer you can get about the details now, the smarter you can be about how much money you need to make your plan work.

Also, consider why you want to retire at a specific age. Is it because you’re financially prepared to take that step? Or are you feeling ready to spend more time with family and friends? Determining what’s motivating you can help you better prepare and plan for your retirement.

Reasons for Retiring

In a recent SoFi survey, respondents cite the following as the top factors influencing their reasons to retire:

•   Financial readiness: 54%

•   Enjoying more time with family and friends and pursuing hobbies: 50%

•   Health considerations: 46%

•   More travel and leisure: 43%

•   Eligibility for Social Security benefits: 41%

Source: SoFi Retirement Survey, April 2024

Insights into the Financial Independence, Retire Early (FIRE) Movement

There’s a movement of people who want to retire early. It’s called the FIRE movement, which stands for “financially independent, retire early.” FIRE has become a worldwide trend that’s inspiring people to work toward retiring in their 50s, 40s, and even their 30s. In the 2024 SoFi Retirement Survey, 12% of respondents say the retirement age they’re aiming for is 49 or younger.

Here’s how FIRE works: In order to retire at a young age, people who follow the movement allocate 50% to 75% of their income to savings. However, that can be challenging because it means they have to sacrifice certain lifestyle pleasures such as eating out or traveling. Of the SoFi survey respondents who said they want to retire at age 49, 18% are not using any strategies that might help them retire early.

Once they retire, FIRE proponents tend to use investments that pay dividends as passive income sources to help support themselves. However, dividend payments depend on company performance and they’re not guaranteed. So a FIRE adherent would likely need other sources of income in retirement as well.

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Financial Planning for Early Retirement

In order to start planning to retire early, first ask yourself how confident you are about pulling it off. In the SoFi Retirement Survey, 68% of respondents say they are very or somewhat confident in their ability to retire at their target age, while 15% are very or somewhat doubtful they can do it.

Once you’ve assessed your confidence level, the next step is to calculate how much money you’ll need to live on once you stop working. How much would you have to save and invest to arrive at an amount that would allow you to retire early? Here’s how to help figure that out.

Many people wonder: How much do I need to retire early? There isn’t one answer to that question. The right answer for you is one that you must arrive at based on your unique needs and circumstances. That said, to learn whether you’re on track for retirement it helps to begin somewhere, and the Rule of 25 may provide a good ballpark estimate.

The Rule of 25 recommends saving 25 times your annual expenses in order to retire. Why? Because according to one rule of thumb, you should only spend 4% of your total nest egg every year. By limiting your spending to a small percentage of your savings, the logic goes, your money is more likely to last.

Here’s an example: if you spend $75,000 a year, you’ll need a nest egg of $1,875,000 in order to retire.

$75,000 x 25 = $1,875,000

With that amount saved, and assuming an annual withdrawal rate of 4%, you would have $75,000 per year in income.

Obviously, this is just an example. You might need less income in retirement or more — perhaps a lot less or a lot more, depending on your situation. If your desired income is $50,000, for example, you’d need to save $1,250,000.

The Benefits of Social Security

Once you reach the age of 62, which some consider a traditional retirement age, you are then able to claim Social Security benefits. (Age 67 is considered “full retirement” age for those born in 1960 and later, and you can wait to claim benefits until age 70.)

The longer you wait to claim Social Security, the higher your monthly payments will be. You could add those Social Security benefits to your income or consider reinvesting the money, depending on your circumstances as you get older.

Recommended: Typical Retirement Expenses to Prepare For

Effective Savings Strategies

How do you save the amount of money you’d need for your early retirement plan?

Having a budget you can live with is critical to making this plan a success. The essential word here isn’t budget, it’s the whole phrase: a budget you can live with.

There are countless ways to manage how you budget. There’s the 50-30-20 plan, the envelope method, the zero-based budget, and so on. You could test a couple of them for a couple of months each in order to find one you can live with.

Another strategy for saving more is to get a side hustle to bring in some extra income. You can put that money toward your early retirement goal.

Adjusting Your Financial Habits

As you consider how to retire early, one of the first things you’ll need to do is cut your expenses now so that you can save more money. These strategies can help you get started.

Lifestyle Changes to Accelerate Savings

Take a look at your current spending and expenses and determine where you could cut back. Maybe instead of a $4,000 vacation, you plan a $2,000 trip instead, and then save or invest the other $2,000 for retirement.

You may be able to live more of a minimalist lifestyle overall. Rather than buying new clothes, for instance, search through your closets for items you can wear. Eat out less and cook at home more. Cut back on some of the streaming services you use. Scrutinize all areas of your spending to see what you can eliminate or pare back.

Debt Management Before Retirement

Obviously, it’s very difficult to achieve a big goal like saving for an early retirement if you’re also trying to pay down debt. It’s wise to work to pay off any and all debts you might have (credit card, student loan, personal loan, car loan, etc.).

That’s not only because being debt-free feels better — it also saves you money. For example, the interest rate you’re paying on credit card or store cards can be quite high, often above 15% or even 20%. If you owe $6,000 on a credit card at 17% interest, for example, when you pay that off, you’re essentially saving the interest that debt was costing you each year.

Health Care Planning: A Critical Component of Early Retirement

When you retire early, you need to think about health insurance since you’ll no longer be getting it through your employer. Medicare doesn’t begin until age 65, so start researching the private insurance market now to understand the different plans available and what you might need.

It’s critical to have the right health insurance in place, so make sure you devote proper time and attention to this task.

Investment Management for Future Retirees

Next up, you’ll need to decide what to invest in and how much to invest in order to grow your savings without putting it at risk.

Understanding Your Investment Options

How do you invest to retire early? You can invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), target date funds, and more.

One major factor to consider is how aggressively you want to invest. That means: Are you ready to invest more in equities, say, taking on the potential for greater risk in order to possibly reap potential gains? Or would you feel more at ease if you invested using a more conservative strategy, with less exposure to risk (but potentially less reward)?

Whichever strategy you choose, you may want to invest on a regular cadence. This approach, called dollar-cost averaging, is one way to maximize potential market returns and mitigate the risk of loss.

Balancing Growth and Risk in Your Investment Portfolio

Because you have less time to save for retirement, you will likely want your investments to grow. But you also need to consider your risk tolerance, as mentioned above. Think about a balanced, diversified portfolio that has the potential to give you long-term growth without taking on more risk than you are comfortable with.

As you get closer to your early retirement date, you can move some of your savings into safer, more liquid assets so that you have enough money on hand for your living, housing, and healthcare expenses.

Retirement Accounts: 401(k)s, IRAs, and HSAs

If your employer offers a retirement plan like a 401(k) or 403(b), that’s the first thing you want to take advantage of — especially if your employer matches a percentage of your savings.

The other reason to save and invest in an employer-sponsored plan is that in most cases the money you save the plan reduces your taxable income. These accounts are considered tax deferred because the amount you save is deducted from your gross income. So the more you save, the less you might pay in taxes. You do pay ordinary income tax on the withdrawals in retirement, however.

The caveat here is that you can’t access those funds before you’re 59½ without paying a penalty. So if you plan to retire early at 50, you will need to tap other savings for roughly the first decade to avoid the withdrawal penalties you’d incur if you tapped your 401(k) or Individual Retirement Account (IRA) early.

Be sure to find out from HR if there are any other employee benefits you might qualify for, such as stock options or a pension, for instance.

Additionally, if your employer offers a Health Savings Account as part of your employee benefits, you might consider opening one.

A Health Savings Account allows you to save additional money: For tax year 2024, the HSA contribution caps are $4,150 for individuals and $8,300 for family coverage.

Your contributions are considered pre-tax, similar to 401(k) or IRA contributions, and the money you withdraw for qualified medical expenses is tax free (although you’ll pay taxes on money spent on non-medical expenses).

Finally, consider opening a Roth IRA. The advantage of saving in a Roth IRA vs. a regular IRA is that you’re contributing after-tax money that can be withdrawn penalty- and tax-free at any time.

To withdraw your earnings without paying taxes or a penalty, though, you must have had the account for at least five years (as per the Roth IRA 5-Year Rule), and you must be over 59 ½.

Recommended: How to Open an IRA in 5 Steps

The Pillars of Early Retirement

Retiring early means you’ll need to have income coming in to help support you. You may have a pension, which can also help. Once you’ve identified the income you’ll be generating, you’ll need to withdraw it in a manner that will help it last over the years of your retirement.

Establishing Multiple Income Streams

Having different streams of income is important so that you’re not just relying on one type of money coming in. For instance, your investments can be a source of potential income and growth, as mentioned. In addition, you may want to get a second job now in addition to your full-time job — perhaps a side hustle on evenings and weekends — to generate more money that you can put toward your retirement savings.

The Role of Social Security and Pensions in Early Retirement

Social Security can help supplement your retirement income. However, as covered above, the earliest you can collect it is at age 62. And if you take your benefits that early they will be reduced by as much as 30%. On the other hand, if you wait until full retirement age to collect them, you’ll receive full benefits. If you were born in 1960 or later, your full retirement age is 67. You can find out more information at ssa.gov.

If your employer offers a pension, you should be able to collect that as another income stream for your retirement years. Generally, you need to be fully vested in the plan to collect the entire pension. The amount you are eligible for is typically based on what you earned, how long you worked for the company, and when you stop working there. Check with your HR department to learn more.

The Significance of Withdrawal Strategies: Rules of 55 and 4%

When it comes to withdrawing money from your investments after retirement, there are some rules and guidelines to be aware of. According to the Rule of 55, the IRS allows certain workers who leave their jobs to take penalty-free distributions from their current employer’s workplace retirement account, such as a 401(k) or 403(b), the year they turn 55.

The 4% rule is a general rule of thumb that recommends that you take 4% of your total retirement savings per year to cover your expenses.

To figure out what you would need, start with your desired yearly retirement income, subtract the annual amount of any pension or additional revenue stream you might have, and divide that number by 0.4. The resulting amount will be 4%, and you can aim to withdraw no more than that amount every year. The rest of your money would stay in your retirement portfolio.

Monitoring Your Progress Towards Early Retirement

To stay on course to reach your goal of early retirement, keep tabs on your progress at regular intervals. For instance, you may want to do a monthly or bi-monthly financial check-in to see where you’re at. Are you saving as much as you planned? If not, what could you do to save more?

Using an online retirement calculator can help you keep track of your goals. From there you can make any adjustments as needed to help make your dreams of early retirement come true.

How to Manage Early Retirement When You Get There

The budget you make in order to save for an early retirement is probably a good blueprint for how you should think about your spending habits after you retire. Unless your expenses will drop significantly after you retire (for instance, if you move or need one car instead of two, etc.), you can expect your spending to be about the same.

That said, you may be spending on different things. Whatever your retirement looks like, though, it’s wise to keep your spending as steady as you can, to keep your nest egg intact.

The Takeaway

An early retirement may appeal to many people, but it takes a real commitment to actually embrace it as your goal. These days, many people are using movements like FIRE (financial independence, retire early) to help them take the steps necessary to retire in their 30s, 40s, and 50s.

You can also make progress toward an early retirement by determining how much money you’ll need for post-work life, budgeting, and cutting back on expenses . And by saving and investing wisely, you may be able to make your goal a reality.

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.

FAQs

How much do you need to save for early retirement?

There isn’t one right answer to the question of how much you need to save for early retirement. It depends on your specific needs and circumstances. However, as a starting point, the Rule of 25 may give you an estimate. This guideline recommends saving 25 times your annual expenses in order to retire, and then following the 4% rule, and withdrawing no more than 4% a year in retirement to cover your expenses.

Is early retirement a practical goal?

For some people, early retirement can be a practical goal if they plan properly. You’ll need to decide at what age you want to retire, and how much money you’ll need for your retirement years. Then, you will need to map out a budget and a concrete strategy to save enough. It will likely require adjusting your lifestyle now to cut back on spending and expenses to help save for the future, which can be challenging.

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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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

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May
18
2024
What is a Secondary Offering?

An Introduction to Secondary Offerings

By | Financial Independence, Growing Wealth, invest, Investing | Comments Off on An Introduction to Secondary Offerings

You may be familiar with the phrase “initial public offering,” or IPO, when a new company makes its shares available on a public exchange. The term secondary offering can refer to a couple of things: One is when investors sell their IPO shares on the secondary market to other investors. Another is when companies seek to raise more cash in a follow-on offering some time after the IPO.

When companies seek to raise additional capital after an IPO through a secondary offering, there are two types: dilutive and non-dilutive. Secondary offerings can have a significant impact on stock prices, so it’s beneficial for investors to understand how they work. Let’s dive into the details.

Key Points

•   Secondary offerings occur when a company or its shareholders sell additional shares after an initial public offering (IPO).

•   These offerings can be dilutive, issuing new shares, or non-dilutive, selling existing shares.

•   Dilutive offerings decrease existing shareholders’ ownership percentage, potentially lowering the stock’s value.

•   Non-dilutive offerings involve shareholders selling their shares, not affecting the company’s share count.

•   Understanding the type of secondary offering is crucial for investors assessing potential impacts on stock value.

What Are Offerings In Stock?

When a company begins selling shares of stocks, bonds, or other securities to the public, it’s called an offering.

Usually people talk about buying stocks during initial public offerings, or IPOs, but there are other types of offerings companies can make to raise cash.

A company may have later offerings, post-IPO, which are called seasoned offerings or follow-on public offerings (FPO) in which the company sells new shares on the market or by issuing a convertible note offering. These are low-interest notes that can be converted into shares, often within five to 10 years.

Any of these can also be called a secondary offering or secondary stock offering.

Companies may make these offerings if they need cash, are looking to expand their business, want to acquire another company — or their stock is performing well and they want to stoke investor demand with a limited additional supply of new shares.

Primary vs Secondary Offerings

The difference between primary and secondary offerings is pretty straightforward, but there are different types of secondary offerings.

A primary offering is to raise capital. Companies issue new shares to investors in exchange for cash that’s used to fund business operations, make acquisitions, and other corporate aims.

In a secondary stock offering, investors who own those IPO shares can buy and sell their shares directly from and to each other. Or a company may decide to issue new shares. Here’s what that can look like.

Recommended: Shares vs. Stocks: What’s the Difference?

What Is a Secondary Offering, What Are the Different Types?

There are a couple of different types of secondary offerings, so it’s important to distinguish between them.

The main definition of a secondary offering refers to investors who buy and sell IPO shares amongst each other. In this case, the cash is exchanged between investors, as noted above.

Sometimes a company needs to raise more capital and may hold what’s known as a follow-on, or seasoned equity offering. This is referred to as a type of secondary offering as well.

Sometimes, in this type of secondary offering, shareholders such as the CEO and founders sell a portion of their shares on the secondary market for private or personal reasons. If the shares are sold by individuals, the money goes to those sellers.

If the shares come from the company, the money raised from the sale goes to the company. There are two types of shares that can be offered here: dilutive and non-dilutive.

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

Types of Secondary Offerings

It’s important for investors to understand the difference between dilutive and non-dilutive shares as they can have different impacts on the value of the stock.

Dilutive Secondary Offerings

A dilutive offering involves the creation of additional shares by the company, which in turn reduces the amount of ownership that preexisting shareholders have. As the name implies, the offering has a dilutive effect. Investors often have a negative sentiment toward dilutive offerings.

The company’s board of directors must approve of the increase in floating stock shares. The float of a stock is the number of shares available for trade.

Non-Dilutive Secondary Offerings

With non-dilutive offerings, no additional shares are created. A non-dilutive offering is often made by major shareholders selling their existing shares. This doesn’t have any effect on the company itself, except perhaps the investor’s perception about why the shareholders are selling.

This type of offering can also be beneficial because it allows more individuals and institutions to invest, which can increase the stock’s liquidity since there are more people buying and selling.

Examples of Secondary Offerings

Many companies make secondary offerings following their IPOs.

Google made a secondary offering in 2005 after its IPO in 2004. During the IPO, the company had a share price of $85 and raised $2 billion. During the secondary offering, the share price was $295 and the company raised $4 billion.

Then there’s Rocket Fuel, a company that made a secondary offering of 5 million shares in 2013. Existing shareholders sold 3 million shares and the company sold 2 million, all at a price of $34 per share. Just one month after the secondary offering, the value of the shares had gone up nearly 30%, to $44.

Why Make a Secondary Offering?

Similar to an IPO, a secondary offering helps companies raise money so they can expand their operations. This can be a quick way for companies to raise significant funds fairly efficiently.

Companies may also hold a second offering between their IPO and the end of their stock’s lock-up period, which is a time when large shareholders are not allowed to sell shares. After the lock-up period, a stock’s price often falls when these shareholders sell off some of their shares. By holding a secondary offering before the end of the lock-up period, additional investors can benefit from the success of an IPO.

It’s important for investors to look into why a company is making a secondary offering before deciding whether to invest, as this can affect the price of the stock in both the short and long term.

How to Trade Secondary Offerings

Most companies that file secondary offerings choose to do so soon after the end of the lock-up period after their IPO. When a company wants to make a secondary offering, they file it for approval with the SEC.

Investors can find out about the latest secondary offerings in a few ways. The SEC has a database of secondary offerings called the EDGAR database, where investors can find out about them. Investors can also look to the NASDAQ list of secondary offerings made by companies listed on the NASDAQ stock exchange. Companies filing secondary offerings tend to get covered in the media and also put out press releases with details about the offering.

How Do Stock Prices React to a Secondary Offering?

The basic concept of supply and demand dictates that if there is more of something available, its price will likely decrease. This is sometimes what occurs during a secondary offering, but not always.

If more shares are created, the price of the shares may fall — especially with dilutive offerings because they can decrease the earnings per share of the stock.

The price of stocks can also decrease during a secondary offering because the company issues the offered shares at a discounted price to incentivize investors to buy. The decrease in value can last a while because any investors who buy-in at the discounted price can sell at a slight increase and make a profit.

If a company creates new shares and sells them at market value with a discount to account for the amount of dilution, this generally results in the least amount of price volatility.

Although a secondary offering often results in a decline in stock price, that isn’t always the case. Non-dilutive offerings are viewed more positively, as they don’t affect the stock’s earnings per share or shareholders’ amount of ownership. Also, it can be seen as a good sign for the long-term value of the stock if a company is investing in growth and acquisitions.

Many secondary offerings don’t have any restrictions, but some may require a lock-up period similar to an IPO, during which investors aren’t allowed to sell their shares.

For Investors, Green or Experienced

Now the difference between a primary offering and the different types of secondary offerings makes more sense. A primary offering is when a new company goes public and makes its shares available on a public exchange — this is part of how companies raise capital.

A secondary offering is when IPO investors subsequently sell their shares on the secondary market to other investors. In this case the company doesn’t issue new shares, and they don’t raise more cash from this type of secondary stock offering. However, companies can seek to raise more cash in a follow-on offering some time after the IPO — which is also called a secondary offering. There are two types, dilutive and non-dilutive secondary offerings, which can impact the stock price overall.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

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.

Need help getting an account set up? SoFi has a team of professional advisors available to help at any time.

FAQ

Is a secondary offering good for stock?

A secondary stock offering can be good for the stock price, particularly if the shares offered are non-dilutive. Dilutive shares, which reduce the value of existing shares, may not be good for the stock price in the short-term — although prices may recover.

What is the difference between a primary and secondary offering?

A primary offering is to raise capital, typically during an IPO. In a secondary offering, investors with IPO shares can trade their shares directly with each other. Or a company may decide to issue new shares in a follow-on offering to raise more cash.

Can you sell a secondary offering stock?

Yes, you can sell stock from a secondary offering, whether you’ve bought it from an IPO investor selling their shares, or from the company during a follow-on offering.

How do you sell on secondary?

To sell stock on a secondary market, shareholders need to find a buyer through whatever method they deem most efficient (there are platforms that can facilitate this), come to an agreement regarding price, and execute a trade.

What is the purpose of a secondary listing?

In general, the purpose of a secondary listing is to raise more capital, and to expand a customer’s investor base.

What are the risks of buying from a secondary market?

Buying from a secondary market means that an investor is purchasing securities from any public stock exchange. As such, the risks of buying on the secondary market are the same as buying any stock – there’s market risks, credit risks, and numerous other risks baked into the securities.

What are the benefits of secondary markets to investors?

Secondary markets give investors access to publicly traded securities, and for shareholders, open up liquidity for their holdings, as there’s a market full of potential buyers. Overall, secondary markets facilitate trading and thus, create liquidity.

SoFi Invest®

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

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

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

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

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

Claw Promotion: Customer must fund their Active Invest account with at least $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
18
2024
Everything You Need to Know About Taxes on Investment Income

Everything You Need to Know About Taxes on Investment Income

By | Growing Wealth, invest, Investing | Comments Off on Everything You Need to Know About Taxes on Investment Income

There are several ways investment income is taxed: You may be familiar with capital gains taxes — the taxes imposed when one sells an asset that has gained value — but it’s important to also understand the tax implications of dividends, interest, retirement account withdrawals, and more.

In some cases, for certain types of accounts, taxes are deferred until the money is withdrawn, but in general, tax rules apply to most investments in one way or another.

Being well aware of all the tax liabilities your investments hold can minimize headaches and help you avoid a surprise bill from the IRS. Being tax savvy can also help you plan ahead for different income streams in retirement, or for your estate.

Key Points

•   Investment income is taxed through various forms including capital gains, dividends, and interest.

•   Capital gains tax applies when assets are sold for a profit, with rates depending on the holding period.

•   Dividends received from stocks are taxed either at ordinary income rates or qualified rates.

•   Interest income from investments like bonds and savings accounts is taxed at ordinary income rates.

•   The Net Investment Income Tax adds a 3.8% tax on investment income for high earners.

Types of Investment Income Tax

There are several types of investment income that can be taxed. These include:

•   Dividends

•   Capital Gains

•   Interest Income

•   Net Investment Income Tax (NIIT)

Taking a deeper look at each category can help you assess whether — and what — you may owe.

Tax on Dividends

Dividends are distributions that are sometimes paid to investors who hold a certain type of dividend-paying stock. Dividends are generally paid in cash, out of profits and earnings from a corporation.

•   Most dividends are considered ordinary (or non-qualified) dividends by default, and these payouts are taxed at the investor’s income tax rate.

•   Others, called qualified dividends because they meet certain IRS criteria, are typically taxed at a lower capital gains rate (more on that in the next section).

Generally, an investor should expect to receive form 1099-DIV from the corporation that paid them dividends, if the dividends amounted to more than $10 in a given tax year.

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

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.

*Probability of Member receiving $1,000 is a probability of 0.028%.

More About Capital Gains Tax

Capital gains are the profit an investor sees when an investment they hold gains value when they sell it. Capital gains taxes are the taxes levied on the net gain between purchase price and sell price.

For example, if you buy 100 shares of stock at $10 ($1,000 total) and the stock increases to $12 ($1,200), if you sell the stock and realize the $200 gain, you would owe taxes on that stock’s gain.

There are two types of capital gains taxes: Long-term capital gains and short-term capital gains. Short-term capital gains apply to investments held less than a year, and are taxed as ordinary income; long-term capital gains are held for longer than a year and are taxed at the capital-gains rate.

For 2023 and 2024, the long-term capital gains tax rates are typically no higher than 15% for most individuals. Some individuals may qualify for a 0% tax rate on capital gain — but only if their taxable income for the 2023 tax year is $89,250 or less (married filing jointly), or $44,625 or less for single filers and those who are married filing separately.

For the 2024 tax year, individuals may qualify for a 0% tax rate on long-term capital gains if their taxable income is $94,050 or less for those married and filing jointly, and $47,025 or less for single filers and those who are married and filing separately.

The opposite of capital gains are capital losses — when an asset loses value between purchase and sale. Sometimes, investors use losses as a way to offset tax on capital gains, a strategy known as tax-loss harvesting.

Recommended: Is Automated Tax-Loss Harvesting a Good Idea?

Capital losses can also be carried forward to future years, which is another strategy that can help lower an overall capital gains tax.

Capital gains and capital losses only become taxable once an investor has actually sold an asset. Until you actually trigger a sale, any movement in your portfolio is called unrealized gains and losses. Seeing unrealized gains in your portfolio may lead you to question when the right time is to sell, and what tax implications that sale might have. Talking through scenarios with a tax advisor may help spotlight potential avenues to mitigate tax burdens.

▶️ Watch the video: Unrealized Gains: Explained

Taxable Interest Income

Interest income on investments is taxable at an investor’s ordinary income level. This may be money generated as interest in brokerage accounts, or interest from assets such as CDs, bonds, Treasuries, and savings accounts.

One exception are investments in municipal (muni) bonds, which are exempted from federal taxes and may be exempt from state taxes if they are issued within the state you reside.

Interest income (including interest from your bank accounts) is reported on form 1099-INT from the IRS.

Tax-exempt accounts, such as a Roth IRA or 529 plan, and tax-deferred accounts, such as a 401(k) or traditional IRA, are not subject to interest taxes.

Net Investment Income Tax (NIIT)

The Net Investment Income Tax (NIIT), also sometimes referred to as the Medicare tax, is a 3.8% flat tax rate on investment income for taxpayers whose modified adjusted gross income (MAGI) is above a certain level — $200,000 for single filers; $250,000 for filers filing jointly. Per the IRS, this tax applies to investment income including, but not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities.

For taxpayers with a MAGI above the required thresholds, the tax is paid on the lesser of the taxpayer’s net investment income or the amount the taxpayer’s MAGI exceeds the MAGI threshold.

For example, if a taxpayer makes $150,000 in wages and earns $100,000 in investment income, including income from rental properties, their MAGI would be $250,000. This is $50,000 above the threshold, which means they would owe NIIT on $50,000. To calculate the exact amount the taxpayer would owe, one would take 3.8% of $50,000, or $1,900.

💡 Quick Tip: How long should you hold onto your investments? It can make a difference with your taxes. Profits from securities that you sell after a year or more are taxed at a lower capital gains rate. Learn more about investment taxes.

Tax-Efficient Investing

One way to mitigate the effects of investment income is to create a set of tax efficient investing strategies. These are strategies that may minimize the tax hit that you may experience from investments and may help you build your wealth. These strategies can include:

•   Diversifying investments to include investments in both tax-deferred and tax-exempt accounts. An example of a tax-deferred account is a 401(k); an example of a tax-exempt account is a Roth IRA. Investing in both these vehicles may be a strategy for long-term growth as well as a way to ensure that you have taxable and non-taxable income in retirement.

   Remember that accounts like traditional, SEP, and SIMPLE IRAs, as well as 401(k) plans and some other employer-sponsored accounts, are tax-deferred — meaning that you don’t pay taxes on your contributions the year you make them, but you almost always owe taxes whenever you withdraw these funds.

•   Exploring tax-efficient investments. Some examples are municipal bonds, exchange-traded funds (ETFs), Treasury bonds, and stocks that don’t pay dividends.

•   Considering tax implications of investment decisions. When selling assets, it can be helpful to keep taxes in mind. Some investors may choose to work with a tax professional to help offset taxes in the case of major capital gains or to assess different strategies that may have a lower tax hit.

The Takeaway

Investment gains, interest, dividends — almost any money you make from securities you sell — may be subject to tax. But the tax rules for different types of investment income vary, and you also need to consider the type of account the investments are in.

Underreporting or ignoring investment income can lead to tax headaches and may result in you underpaying your tax bill. That’s why it’s a good idea to keep track of your investment income, and be mindful of any profits, dividends, and interest that may need to be reported even if you didn’t sell any assets over the course of the year.

Some investors may find it helpful to work with a tax professional, who may help them see the full scope of their liabilities and become aware of potential investment strategies that might help them minimize their tax burden, especially in retirement. A tax professional should also be aware of any specific state tax rules regarding investment taxes.

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

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

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

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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.

SoFi Invest®

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

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


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

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.

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May
18
2024

What Is Stock Volatility and How Do You Measure It?

By | Growing Wealth, invest, Investing | Comments Off on What Is Stock Volatility and How Do You Measure It?

Key Points

•   Stock volatility refers to the variation in a stock’s price from its mean, and it can provide opportunities for investors.

•   Standard deviation, beta, VIX, and maximum drawdown are common measures used to gauge stock volatility.

•   Standard deviation measures how far a stock’s performance deviates from its average, while beta compares a stock’s volatility to the overall market.

•   Factors such as company performance, investor behavior, global events, seasonality, and market cycles can contribute to stock market volatility.

•   Balancing risk and reward, diversifying your portfolio, sticking to long-term investing strategies, avoiding timing the market, and considering dollar-cost averaging are effective ways to manage volatility when investing.

What Is Stock Volatility?

Stock volatility is often defined as big swings in price, but technically the volatility of a stock refers to how much its price tends to vary from the mean. The same is true of stock market volatility; when an index tends to perform a certain percentage above or below the mean, it’s a signal of volatility.

Generally, the higher the volatility of a stock, the more risk an investor incurs when they purchase or hold it. But volatility can also provide opportunities for some investors.

How to Measure Stock Volatility

There are a handful of ways to measure stock volatility. Each metric gives investors different information, and a different view of stock market fluctuations.

Standard Deviation

Standard deviation is a common stock volatility measure; it refers to how far a stock’s performance varies from its average. Investors often measure an investment’s volatility by the standard deviation of returns compared with a broader market index or past returns. Standard deviation measures the extent to which a data point deviates from an expected value, i.e. the mean return.

Beta

Beta is another way to measure volatility; it captures systematic risk, which refers to the volatility of a security (or of a portfolio) versus the market as a whole.

For example, beta can measure the volatility of a stock versus its benchmark (e.g. the S&P 500 or another relevant index). If a stock or mutual fund has a beta of 1.0, its inherent volatility is no different than the market at large. If the beta of a stock is higher or lower than its benchmark, that indicates higher or lower volatility.

Recommended: How to Find Portfolio Beta

VIX

The Cboe Global Markets Volatility Index, known as the VIX for short, is a tool used to measure implied volatility in the market. In simple terms, the VIX index tells investors how professional investors feel about the market at any given time.

The VIX Index is a real-time calculation that measures expected volatility in the stock market. One of the most recognized barometers of fluctuations in financial markets, the VIX measures how much volatility investing experts expect to see in the market over the next 30 days. This measurement reflects real-time quotes of S&P 500 Index (SPX) call option and put option prices.

Maximum Drawdown

Maximum drawdown, or MDD, is another stock volatility measure, and can give investors a sense of how much downside risk exists for a given stock (though not the risks of the stock market overall). It basically measures the maximum fall in value that a stock has seen in the past, and is reflected in the difference between that maximum trough, and the highest peak in value before its value fell.

You may recognize the terms peak and trough when discussing the business cycle and bull markets, too. MDD is a peak-to-trough calculation, in other words. It’s a simpler calculation than standard deviation, too:

MDD= Trough Value−Peak Value / Peak Value​

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

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.

*Probability of Member receiving $1,000 is a probability of 0.028%.

Using Standard Deviation to Calculate Volatility

You can use the standard deviation and variance of returns to create a basic measure of stock volatility. This measure captures variance in price changes over a certain period of time, so you can gauge how far from the mean the stock price tends to go (i.e. how volatile it is).

Formula: σ √T = volatility, where:

σ = standard deviation of returns

T = number of time periods

1. To arrive at the variance, imagine a stock that starts in January with a monthly closing price of $10, and adds $1 per month. Month 1 = $10. Month 2 = $11. Month 3 = $12 … and so on, for all 12 months (or whatever time period you choose).

2. Add the stock price for each month, to arrive at a total of $186.

3. Divide $186 by the number of time periods (12 months in this case) to get an average stock price of $15.50 for the year.

4. Subtract the mean ($15.50) from each monthly value; include results that are negative numbers.

5. Square all the deviations (which will also remove negative numbers), and add them together to get the sum ($50.50); divide the sum by the number of time periods (in this case 12) to get a variance of $4.21.

6. Take the square root of $4.21 to get $2.05 = which is the standard deviation for this particular stock. Knowing this provides an important point of comparison for investors, because it indicates whether a stock’s price fluctuations could be within ‘normal’ ranges or too volatile.

Recommended: What Is a Stock?

Types of Stock Volatility

types of stock volatility

There are two common types of stock volatility that investors use to measure the riskiness of an investment: implied volatility and historical volatility. These two types of volatility are often used by options traders, who make trades based on the potential volatility of the options contract’s underlying asset.

Historical Volatility

Historical volatility (HV), also known as statistical volatility, is a measurement of the price dispersion of a financial security or index over a period of time. Investors calculate this by determining the average deviation from an average price. Historical volatility typically looks at daily returns, but some investors use it to look at intraday price changes.

As the name implies, historical volatility used past performance to assess present volatility. When a stock sees large daily price swings compared to its history, it will typically have a historical volatility reading. Historical volatility does not measure direction; it simply indicates the deviation from an average.

Implied Volatility

Implied volatility (IV) is a metric that captures the market’s expectation of future movements in the price of a security. Implied volatility employs a set of predictive factors to forecast the future changes of a security’s price.

Implied volatility doesn’t anticipate which way prices might move, up or down, only how likely the volatility will be.

What Causes Market Volatility?

what causes stock market volatility

The stock market is known for having boom-and-bust cycles, which is another way of describing stock market volatility. And there are numerous factors that can influence market volatility. Here are just a few:

•   Company Performance: Regarding individual stocks, events tied to the company’s performance can drive volatility in its shares. This can include countless factors including: earnings reports, a product announcement, a merger, a change in management, and much more.

•   Investor Behavior: Long periods of rising share prices tend to drive investors to take on more risk. They enter into more speculative positions and buy assets like high-risk stocks.

In doing so, investors may disregard their own risk tolerance, and make themselves more vulnerable to market shocks. This pattern can lead to market busts when investors need to sell their holdings en masse when the market is shaky.

•   Global Events: For instance, the early stages of the COVID pandemic in February and March 2020 created shockwaves in the markets. As economies across the globe shut down, investors began to sell off risky assets, bringing about high levels of volatility in the financial markets.

Governments enacted extraordinary fiscal and monetary stimulus programs to calm this volatility and bring stability to the markets.

But even as these efforts took effect, other global factors — the war in Ukraine impacting energy prices — also took a toll. And federal reserve interest rate increases during 2022 — instituted at the fastest rate in history in an effort to tamper inflation — likewise roiled the markets, causing stock volatility.

•   Seasonality: You’ve heard the old saying, “Sell in May and go away.” That’s a reflection of a phenomenon called market seasonality, which means that year in and year out there are certain patterns that tend to occur around the same times.

While seasonality certainly doesn’t guarantee any investment outcomes, some sectors do see more demand and greater production during specific times of year. Summer months tend to impact the travel sector; the fall might see an uptick in school-related consumer goods, and so on.

Depending on the year, this rise and fall of demand can impact volatility for some stocks.

•   Market Cycles: In a similar way, markets also have their cycles; these cycles emerge thanks to trends generated by what’s going on in different business sectors. For example, the rapid evolution of AI in 2023 and early 2024 may have sparked a bit of a market cycle in the tech sector, as the demand for certain products and technologies jumped.

That said, it’s difficult to spot a market cycle until it’s over. Sometimes what appears to be a cycle is simply a normal set of fluctuations. But the anticipation or perception of a cycle can drive volatility.

•   Liquidity: Other factors that can drive volatility include liquidity and the derivatives market. Stock liquidity is the ease with which an asset can be bought and sold without affecting prices. If an asset is tough to unload and gets sold at a significantly lower price, that could inject fear into the market and cause other investors to sell, ramping up volatility.

Separately, there’s sometimes a debate as to whether equity derivatives — contracts that are based on an underlying asset (e.g. futures and options) — can cause volatility. For instance, in 2020, investors debated whether large volumes of stock options trading caused sellers of the options, typically banks, to hedge themselves by buying stocks, exposing the market to sudden ups and downs when the banks had to purchase or sell shares quickly.

What Causes Stock Prices to Go Up?

As noted, any number of things can cause a stock’s price to go up — be it good or bad news. For instance, geopolitical events can cause certain stocks to appreciate in price, while others may fall. When there’s political instability, some investors seek safer investments and may pile into consumer staple stocks, or investments that track the price of precious metals.

When the economy is faring well, earnings season can be another time during which stock prices go up as companies report positive news to investors, who may, in turn, feel better about the economy overall, which can affect their investing decisions.

What Causes Stock Prices to Go Down?

Just as nearly anything and everything can drive stock prices up, there are countless factors that can likewise drive values down. That can include bad earnings reports from companies, or earnings data that doesn’t live up to expectations. Political or regulatory changes can also spook investors, who may sell certain stocks and drive prices down.

Again: Stock prices can go down for any and every reason, or no reason at all. This is as good a time as any to remind you that there really is no such thing as a completely safe investment.

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

How to Manage Volatility When Investing

Let’s imagine that it’s 2007, and an individual has money invested in the U.S. stock market. Unfortunately, this investor is about to face one of the largest stock market crashes in history: The S&P 500 fell by 48% during the crash of 2008-2009.

This sort of dramatic drop in the stock market isn’t typical, and it can be traumatic even for the savviest and most experienced investor. So, the first step to handling stock market volatility is understanding that there will always be some price fluctuation.

The second step is to know one’s risk tolerance and financial goals, then invest, readjust, and rebalance your portfolio accordingly.

Balance Risk and Reward

Generally speaking, higher rewards sometimes come with higher risks. For example, younger investors in their 20s might want to target higher growth options and be open to more volatile stocks. They may have enough time to weather the gains and losses and, possibly, come out ahead over time.

The reverse is true for someone approaching retirement who wants stable portfolio returns. With a shorter time horizon there’s less time to recover from volatility, so investing in lower-risk securities may make more sense.
Some strategies offer ways that more cautious investors might take to mitigate volatility in their portfolios. One way is diversification.

Portfolio diversification involves investing your money across a range of different asset classes — such as stocks, bonds, and real estate — rather than concentrating all of it in one area. Studies have shown that by diversifying the assets in your portfolio, you may offset a certain amount of investment risk and thereby improve returns.

For example: Lower volatility stocks, such as utility or consumer staple companies, can add stability to a stock portfolio. Meanwhile, energy, technology, and consumer discretionary shares tend to be more turbulent because their businesses are more cyclical, or tied to the broader economy.

Another way to diversify one’s portfolio is to add bonds, alternative investments, or even cash. When deciding to add bonds or stocks to a portfolio, it’s helpful to know that the former is generally a less volatile asset class.

This is useful to know if you’re managing your own portfolio, or if you want to try automated investing, where a sophisticated algorithm provides different asset allocation options in pre-set portfolios.

There are a few other things to take into consideration when managing volatility in your portfolio.

Assess Risk Tolerance

A big part of effectively managing stock volatility as it relates to your portfolio is knowing your limits, or, as discussed, your risk tolerance. How much risk can you actually handle when it comes down to it?

Every investor will need to give that question some thought when deciding how to deploy their money.

While bigger risks often come with bigger rewards, when the market does experience a downturn, there’s the outstanding question of whether you’ll stick to your investing strategy or cut and run. Each investor’s risk tolerance will be different, but it’s important to think about how you can actually handle the risk you take on when investing.

Stick to Long-Term Investing Strategies

One way to manage market volatility is to stick to a long-term investing strategy, such as a buy-and-hold strategy. If you stick to long-term investments rather than derivatives or other short-term assets or tools, you can somewhat ignore the day-to-day ups and downs of stock prices, and in doing so you may be able to better weather market volatility.

Avoid Timing the Market

Timing the market, as it relates to trading and investing, means waiting for ideal market conditions, and then making a move to try and capitalize on the best market outcome. But nobody can predict the future, and this is a high-risk strategy.

When seeing stock market charts and business news headlines, it can be tempting to imagine you can strike it rich by timing your investments perfectly. In reality, figuring out when to buy or sell securities is extremely difficult. Both professional and at-home investors make serious mistakes when trying to time the market.

Consider Dollar-Cost Averaging

Dollar cost averaging is essentially a way to manage volatility as you continue to save and build wealth. It’s a basic investment strategy where you buy a fixed dollar amount of an investment on a regular cadence (e.g. weekly or monthly). The goal is not to invest when prices are high or low, but rather to keep your investment steady, and thereby avoid the temptation to time the market.

That’s because with dollar cost averaging (DCA) you invest the same dollar amount each time. When prices are lower, you buy more; when prices are higher, you buy less. Otherwise, you might be tempted to follow your emotions and buy less when prices drop, and more when prices are increasing (a common tendency among investors).

How Much Stock Volatility Is Normal?

The average stock market return in the U.S. is roughly 10% annualized over time, or about 6% or 7% taking inflation into account.

When looking at nearly 100 years of data, as of the end of July 26 2023, the yearly average stock market return was between 8% and 12% only eight times. In reality, stock market returns are typically much higher or much lower.

It’s also important to remember that past market performance is not indicative of future returns. But looking at history can help an investor gauge how much volatility and market fluctuation might be considered normal. Since the end of World War II, the S&P 500 has posted 14 drops of more than 20%, including the most recent in 2022 — a dip precipitated by the rapid rise in interest rates.

These prolonged downturns of 20% or more are considered bear markets. While bear markets have a bad name, they don’t always lead to recession, and on average bear markets are shorter than bull markets.

Investing in Stocks With SoFi

Stock volatility is the pace at which the price of a company’s shares move up or down during a certain period of time. Volatility is a complex topic, and it often sparks debate among investors, traders, and academics about what causes it.

While equities are considered an important part of any investment portfolio, they are also known for being volatile, and some degree of turbulence is something most stock investors have to live with.

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


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

FAQ

Is volatility the same as risk?

In a sense, yes. Volatility is an indicator of risk. So a stock that is highly volatile, with big price changes, is considered riskier than a stock that is less volatile and maintains a more stable price.

Who should buy stocks when volatility strikes?

Certain types of investors, e.g. day traders and options traders, may have strategies that enable them to profit from volatile securities (although there are no guarantees). In some cases, ordinary investors with a very high risk tolerance may want to invest in a volatile stock — but they have to be willing to face the possibility of steep losses.

What is the best stock volatility indicator?

Perhaps the most common or popular one is the VIX. Depending on which way the VIX is trending, it may throw off buy or sell signals to investors. The VIX can be helpful for assessing risk in order to capitalize on anticipated market movements.

What is good volatility for a stock?

Deciding whether the volatility of a certain stock is “good” is a matter of your personal investing style and goals. Some investors may seek out volatile equities if they believe they have a strategy that can capitalize on price fluctuations. Other investors with a long-term view may not mind volatility if they believe the outcome over time will be favorable — while others may opt for as little volatility in their portfolios as possible.

What causes volatility in a stock?

Just about anything can cause stock volatility. Some of the more common causes of volatility are earnings reports or other company news; geopolitical news and developments; or broader economic changes, such as interest rate hikes or inflation.

Photo credit: iStock/FluxFactory

SoFi Invest®

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

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


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

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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May
18
2024
How taxes and fees impact return on investment

Taxes, Fees, Commissions, and Your Investments

By | Growing Wealth, invest, Investing | Comments Off on Taxes, Fees, Commissions, and Your Investments

Earning returns can be exhilarating. But it’s important to remember that they don’t necessarily represent the money that goes in the bank. Commissions, taxes, and other fees impact the returns any investor makes on their investment.

Just how big a bite these investment expenses take out of an investor’s assets isn’t always instantly clear. But by understanding the fees they pay, and the taxes they’re likely to owe, investors can better plan for the money they’ll actually receive from their investments. And they can also take concrete steps to minimize the effects of fees and taxes.

Key Points

•   Taxes, fees, and commissions significantly reduce the actual returns from investments.

•   Understanding and planning for these costs can help investors manage their net earnings more effectively.

•   Mutual funds and advisors charge various fees, which can diminish investment gains.

•   Income tax and capital gains tax are the primary taxes affecting investment profits, with different rates applied based on the investment duration and investor’s income.

•   Employing strategies like investing through tax-advantaged accounts can minimize the tax impact on returns.

Investment Expenses 101

There are a few different types of investment expenses an investor may come across as they buy and sell assets. Here are the most common ones.

Fund Fees

Mutual funds are a very popular way for investors to get into the market. They’re the vehicles that most 401(k), 403(b), and IRAs offer investors to save for retirement. But these funds charge fees, starting with a management fee, which pays the fund’s staff to buy and trade investments.

Investors pay this fee as a portion of their assets, whether the investments go up or down. (With employer-sponsored retirement accounts, the employer may cover the fees as long as the account holder is employed by the company.) Management fees vary widely, with some index funds charging as little as .10% of an investor’s assets. But other mutual funds may charge more than 2%.

In addition to the management fee, the fund may also charge for advertising and promotion expenses, known as the 12b-1 fee. Plus, mutual fund investors may have to pay sales charges, especially if they buy funds through a financial planner, or an investment advisor. While the maximum legal sales charge for a mutual fund is 8.5%, the common range is between 3% and 6%.

One way to understand how much of a bite these mutual fund fees take out of an investment on an annual basis is to look at the expense ratio.

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

Advisor Fees

Investors may also face fees when they hire a professional to help manage their money. Some advisors charge a percentage of invested assets per year. More recently, some advisors have simplified the cost by simply charging an hourly fee.

Broker Fees and Commissions

Even investors who want to manage their own portfolios typically pay a broker for their services in the form of fees and commissions. These fees and commissions may be based on a percentage of the transaction’s value, or they may be rolled into a flat fee. Another factor that may influence the fee: whether an investor uses a full-service broker or a discount broker.

How to Minimize the Cost of Investing

No matter how an investor approaches the market, they can expect to pay some fees. It’s up to each individual to decide whether or not those fees are worth it. For some, paying a professional for hands-on advice is worth the extra annual 1% fee (or more) of their invested assets. For others, minimizing costs may be a priority. Among many options, there are a few investing opportunities that stand out as relatively low-cost.

Index Funds

When investing in mutual funds, one type of fund has established itself as the least expensive in terms of fees: Index funds. That’s because these funds track an index instead of paying analysts and managers to research and trade securities. When it comes to index funds vs. managed funds, proponents typically cite the lower fees.

Automated Investing Platforms

People seeking investing advice or guidance who don’t want to pay typical fees might want to explore automated investing platforms, also known as “robo-advisors.” Some of these platforms charge annual advisory fees as low as .25%. That said, these platforms often use mutual funds, which charge their own fees on top of the platform fees.

Discount Brokerage

Investors who manage their own portfolio may opt for a discount or online brokerage. These brokers tend to charge flat fees per trade as low as $5, with account maintenance fees also often as low as $0 to $50 per account.

How Taxes Eat into Investing Profits

There are typically two kinds of taxes that investors have to worry about. The first is income tax, and the second is capital gains tax. In general, income taxes apply to investment earnings in the form of interest payments, dividends, or bond yields. Capital gains, on the other hand, apply to the returns an investor realizes when they sell a stock, bond, or other investment. (The exception: The IRS taxes short-term investments, which an investor has held for less than a year, at that investor’s marginal income tax rate.)

By and large, capital gains tax rates are lower than income tax rates. Income tax rates for high-earners can be as high as 37%, plus a 3.8% net investment income tax (NIIT). That means the taxes on those quick gains can be as high as 40.8%—and that’s not including any state or local taxes.

The taxes on long-term capital gains are lower across the board. For tax year 2023, for investors who are married filing jointly and earning less than $89,250, the capital gains tax rate is 0%. It goes up depending on income, with couples making between $89,250 and $553,850 paying 15%, and those with income above that level paying 20%.

For tax year 2024, those who are married and filing jointly with taxable income up to $94,050 have a capital gains tax rate of 0%. Couples making between $94,050 and $583,750 have a rate of 15%, and those with income above that have a tax rate of 20%.

💡 Quick Tip: Automated investing can be a smart choice for those who want to invest but may not have the knowledge or time to do so. An automated investing platform can offer portfolio options that may suit your risk tolerance and goals (but investors have little or no say over the individual securities in the portfolio).

Strategies to Minimize Taxes

There are a few ways an investor can minimize the impact of taxes on their investments. One popular way to take advantage of the tax code is by investing through a retirement plan, such as a 401(k), 403(b), or IRA. All of these plans encourage people to save for retirement by offering attractive tax breaks.

For tax-deferred accounts like a 401(k) or traditional IRA, the tax break comes on the front end. Retirees will have to pay income taxes on their withdrawals in retirement. On the other hand, retirement accounts like a Roth 401(k) or Roth IRA are funded with after-tax dollars, and money is not taxed upon withdrawal in retirement.

Another approach some investors may want to consider is tax-loss harvesting. This strategy allows investors to take advantage of investments that lost money by selling them and taking a capital loss (as opposed to a capital gain). That capital loss can help investors reduce their annual tax bill. It may be used to offset as much as $3,000 in non-investment income.

The Takeaway

Fees and taxes typically do have an impact on an investor’s returns on investments. How much they eat into profit varies, and is largely dependent on what the investments are, how they are being managed, and how long an investor has had them. Other factors include the investor’s income level, and whether they’ve also lost money on other investments.

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

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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

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