InvestZ Archives | Page 8 of 163

Nov

2024

When Should You Start Saving for Retirement?

By Melanie Mannarino | Budgeting & Goals, Growing Wealth, invest, Preparing for Retirement | No Comments

If you ask any financial advisor when you should start saving for retirement, their answer would likely be simple: Now, or in your 20s if possible.

It’s not always easy to prioritize investing for retirement. If you’re in your 20s or 30s, you might have student loans or other goals that seem more “immediate,” such as a down payment on a house or your child’s tuition. But starting early is important because it can allow you to save much more. In fact, setting aside a little every year starting in your 20s could mean an additional hundreds of thousands of dollars of accumulated investment earnings by retirement age.

No matter what age you are, putting away money for the future is a good idea. Read on to learn more about when to start saving for retirement and how to do it.

Key Points

• Starting to save for retirement in your 20s is ideal, as it gives your money more time to potentially grow and benefit from compounding. Compounding occurs when any earnings received are added to your principal balance, so future earnings are calculated on this updated, larger amount.

• Assessing personal financial situations and retirement goals is crucial when determining how much to save for retirement, regardless of age.

• Individuals in their 30s, 40s, 50s, or 60s can still successfully start saving for retirement, with different strategies tailored to each age group.

• Regular contributions and taking advantage of employer-sponsored plans are key steps in building a solid retirement savings strategy at any age.

This article is part of SoFi’s Retirement Planning Guide, our coverage of all the steps you need to create a successful retirement plan.

What Is the Ideal Age to Start Saving for Retirement?

Ideally, you should start saving for retirement in your 20s, if possible. By getting started early, you could reap the benefits of compound interest. That’s when money in savings accounts earns interest, that interest is added to the principal amount in the account, and then interest is earned on the new higher amount.

Starting to save for retirement in your 20s can allow you to save much more. In fact, setting aside a little every year starting in your 20s could mean an additional hundreds of thousands of dollars of accumulated investment earnings by retirement age.

That said, if you are older than your 20s, it’s not too late to start saving for retirement. The important thing is to get started, no matter what your age.

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.

The #1 Reason to Start Early: Compound Interest

If you start saving early, you could reap the benefits of compound interest.

CFP^®, Brian Walsh says, “Time can either be your best friend or your worst enemy. If you start saving early, you make it a habit, and you start building now, time becomes your best friend because of compounded growth. If you delay — say 5, 10, 15 years to save — then time becomes your worst enemy because you don’t have enough time to make up for the money that you didn’t save.”

Here’s how compound interest works and why it can be so valuable: The money in a savings account, money market account, or CD (certificate of deposit) earns interest. That interest is added to the balance or principle in the account, and then interest is earned on the new higher amount.

Depending on the type of account you have, interest might accrue daily, weekly, monthly, quarterly, twice a year, or annually. The more frequently interest compounds on your savings, the greater the benefit for you.

Investments — including investments in retirement plans, such as an employee-sponsored 401(k) plan or a traditional or Roth IRA — likewise benefit from compounding returns. Over time, you can see returns on both the principal as well as the returns on your contributions. Essentially, your money can work for you and potentially grow through the years, just through the power of compound returns.

The sooner you start saving and investing, the more time compounding has to do its work.

💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Saving Early vs Saving Later

To understand the power of compound returns, consider this:

If you start investing $7,000 a year at age 25, by the time you reach age 67, you’d have a total of $2,129,704.66. However, if you waited until age 35 to start investing the same amount, and got the same annual return, you’d have $939,494.76.

Age	Annual Return	Savings
25	8%	$2,129,704.66
35	8%	$939,494.76

As you can see, starting in your 20s means you may save double the amount you would have if you waited until your 30s.

Starting Retirement Savings During Different Life Stages

Retirement is often considered the single biggest expense in many peoples’ lives. Think about it: You may be living for 20 or more years with no active income.

Plus, while your parents or grandparents likely had a pension plan that kicked off right at the age of 65, that may not be the case for many workers in younger generations. Instead, the 401(k) model of retirement that’s more common these days requires employees to do their own saving.

As you get started on your savings journey, do a quick assessment of your current financial situation and goals. Be sure to factor in such considerations as:

• Age you are now

• Age you’d like to retire

• Your income

• Your expenses

• Where you’d like to live after retirement (location and type of home)

• The kind of lifestyle you envision in retirement (hobbies, travel, etc.)

To see where you’re heading with your savings you could use a retirement savings calculator. But here are more basics on how to get started on your retirement savings strategy, at any age.

Starting in Your 20s

Starting to save for retirement in your 20s is something you’ll later be thanking yourself for.

As discussed, the earlier you start investing, the better off you’re likely to be. No matter how much or little you start with, having a longer time horizon till retirement means you’ll be able to handle the typical ups and downs of the markets.

Plus, the sooner you start saving, the more time you’ll be able to benefit from compound returns, as noted.

Start by setting a goal: At what age would you like to retire? Based on current life expectancy, how many years do you expect to be retired? What do you imagine your retirement lifestyle will look like, and what might that cost?

Then, create a budget, if you haven’t already. Document your income, expenses, and debt. Once you do that, determine how much you can save for retirement, and start saving that amount right now.

💡 Learn more: Savings for Retirement in Your 20s

Starting in Your 30s

If your 20s have come and gone and you haven’t started investing in your retirement, your 30s is the next-best time to start. While there may be other expenses competing for your budget right now — saving for a house, planning for kids or their college educations — the truth remains that the sooner you start retirement savings, the more time they’ll have to grow.

If you’re employed full-time, one easy way to start is to open an employer-sponsored retirement savings plan, like a 401(k). We’ll get into details on that below, but one benefit to note is that your savings will come out of your paycheck each month before you get taxed on that money. Not only does this automate retirement savings, but it means after a while you won’t even miss that part of your paycheck that you never really “had” to begin with. (And yes, Future You will thank you.)

💡 Learn more: Savings for Retirement in Your 30s

Starting in Your 40s

When it comes to how much you should have saved for retirement by 40, one general guideline is to have the equivalent of your two to three times your annual salary saved in retirement money.

Once you have high-interest debt (like debt from credit cards) paid off, and have a good chunk of emergency savings set aside, take a good look at your monthly budget and figure out how to reallocate some money to start building a retirement savings fund.

Not only will regular contributions get you on a good path to savings, but one-off sources of money (from a bonus, an inheritance, or the sale of a car or other big-ticket item) are another way to help catch up on retirement savings faster.

Starting in Your 50s

In your 50s, a good ballpark goal is to have six times your annual salary in your retirement savings by the end of the decade. But don’t panic if you’re not there yet — there are a few ways you can catch up.

Specifically, the government allows individuals over age 50 to make “catch-up contributions” to 401(k), traditional IRA, and Roth IRA plans. That’s an additional $7,500 in 401(k) savings, and an additional $1,000 in IRA savings for 2024 and 2023.

The opportunity is there, but only you can manage your budget to make it happen. Once you’ve earmarked regular contributions to a retirement savings account, make sure to review your asset allocation on your own or with a professional. A general rule of thumb is, the closer you get to retirement age, the larger the ratio of less risky investments (like bonds or bond funds) to more volatile ones (like stocks, mutual funds, and ETFs) you should have.

Starting in Your 60s

It’s never too late to start investing, especially if you’re still working and can contribute to an employer-sponsored retirement plan that may have matching contributions. If you’re contributing to a 401(k), or a Roth or traditional IRA, don’t forget about catch-up contributions (see the information above).

In general, when you’re this close to retirement it makes sense for your investments to be largely made up of bonds, cash, or cash equivalents. Having more fixed-income securities in your portfolio helps lower the odds of suffering losses as you get closer to your target retirement date.

💡 Learn more: Savings for Retirement in Your 60s

The Takeaway

Investing in retirement and wealth accounts is a great way to jump-start saving and investing for your golden years, whether you invest $10,000 or just $100 to get started.

The first step is to open an account or use the one that’s already open. You could also increase your contribution. If you’re opening an account, you may want to consider one without fees, to help maximize your bottom line.

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).

Easily manage your retirement savings with a SoFi IRA.

FAQ

Is 20 years enough to save for retirement?

It’s never too late to start investing for retirement. If you’re just starting in your 40s, consider contributing to an employer-sponsored plan if you can, so that you can take advantage of any employer matching contributions. In addition to regular bi-weekly or monthly contributions, make every effort to deposit any “windfall” lump sums (like a bonus, inheritance, or proceeds from the sale of a car or house) into a retirement savings vehicle in an effort to catch up faster.

Is 25 too late to start saving for retirement?

It’s not too late to start saving for retirement at 25. Take a look at your budget and determine the max you can contribute on a regular basis — whether through an employer-sponsored plan, an IRA, or a combination of them. Then start making contributions, and consider them as non-negotiable as rent, mortgage, or a utility bill.

Is 30 too old to start investing?

No age is too old to start investing for retirement, because the best time to start is today. The sooner you start investing, the more advantage you can take of compound returns, and potentially employer matching contributions if you open an employer-sponsored retirement plan.

Should I prioritize paying off debt over saving for retirement?

Whether you should prioritize paying off debt over saving for retirement depends on your personal situation and the type of debt you have. If your debt is the high-interest kind, such as credit card debt, for instance, it could make sense to pay off that debt first because the high interest is costing you extra money. The less you owe, the more you’ll be able to put into retirement savings.

And consider this: You may be able to pay off your debt and save simultaneously. For instance, if your employer offers a 401(k) with a match, enroll in the plan and contribute enough so that the employer match kicks in. Otherwise, you are essentially forfeiting free money. At the same time, put a dedicated amount each week or month to repaying your debt so that you continue to chip away at it. That way you will be reducing your debt and working toward saving for your retirement.

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SOIN0623043

Nov

2024

How Are IPO Prices Set?

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

Before listing a stock for sale on a public exchange, companies undergo a rigorous process of preparation and compliance — which includes a suggested starting price for the shares they plan to sell in their initial public offering (IPO).

This price then creates an IPO valuation for the company.

Companies and their bankers use a variety of factors and steps to determine the IPO price. Here’s a closer look at the IPO valuation process.

Key Points

• The IPO process involves a rigorous preparation phase, where companies set a suggested starting price for shares before going public.

• Investment banks analyze various factors like market conditions and growth potential to establish the IPO price, which is aimed at attracting investors.

• Companies typically go public to raise capital, enhance visibility, and provide liquidity for early investors, though they may face new challenges post-IPO.

• The initial public offering price is distinct from the opening price; the latter may fluctuate based on market demand once trading begins.

• Investing in IPOs can be risky due to potential volatility, making it crucial for investors to assess their financial goals and risk tolerance before participating.

What Is IPO Price?

An IPO price is the price at which a company’s stock is sold to accredited and institutional investors right before the stock trades on a public exchange. The purpose of the public offering price is to attract investors to buy the shares.

IPO stocks are considered high-risk investments, and while some companies may present an opportunity for growth, there are no guarantees. Like investing in any other type of stock, it’s essential for investors to do their due diligence.

The investment banks that underwrite a company’s public offering set the IPO price, using several variables including an analysis of the company’s growth potential, a comparison to related firms, and a determination of market demand conditions.

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

Initial Public Offerings 101

When privately owned companies, such as unicorn companies, begin to sell shares of stock to the public, they hold an initial public offering, or IPO. Before an IPO, companies are usually owned by the founders, employees, and early investors, such as venture capital firms and angel investors. The process of selling shares to investors is called going public. Typically the initial offering is limited, and there are a number of people eligible for those shares first.

For this reason, it can be difficult for individual investors to buy IPO stock when it’s first issued. In most cases, individuals can trade IPO shares on the secondary market through their brokerage. In some cases, a brokerage may set certain requirements in order for individual investors to buy shares.

An IPO can help a company raise significant capital. It can also be a source of publicity. However, the IPO process is also time-consuming and expensive. Once a company has gone public, it faces new challenges such as regulatory scrutiny and an increased need to please shareholders.

Recommended: What Is an IPO and How Does it Work?

Why Do Companies Go Public?

The main reason companies choose to go public is to raise money. Holding an IPO can create significant value for a company and its management. In some cases, IPOs raise millions and even billions of dollars for the company, but some companies also face losses after an IPO.

Bringing in public investment benefits the business, but it also benefits early investors. These initial investors, who have invested time and money in a company, can sell their shares following an IPO, unlocking shareholder value.

An IPO can also benefit employees of the company. That’s because when an individual joins a company, sometimes they are granted employee stock options. Companies will often give early employees the options over several months or years — a process called vesting. Usually, employees must wait to sell their vested stock until the end of a lock-up period — a period after an IPO during which employees have to wait before selling their shares.

Other reasons companies go public are to gain media attention, grow a broad base of financial supporters, and create a windfall for venture capital firms that helped fund the company in its early stages.

The number of publicly traded, exchange-listed companies in the U.S. has decreased from the peak in the mid-to-late 1990s when it reached about 8,000. In 2021, the figure was closer to 6,000 companies that traded on different stock exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq.

Steps in IPO Valuation

When a company decides to hold an IPO, they work with an investment bank to determine the company’s IPO valuation. The process of investment bankers handling an IPO is called underwriting.

How Underwriting Works in IPOs

Each underwriting process can be slightly different, but investment bankers’ factors in determining IPO prices and valuations are essentially the same. Some questions include:

• Why has the company decided to go public?

• What is the current status of the market?

• Who are the company’s competitors?

• What are the company’s assets?

• How much has been invested in the company and by whom?

• What is the history of the company and its team?

• What are the company’s prospects for growth?

Recommended: What Is IPO Due Diligence?

Process of Determining IPO Prices

The rules of supply and demand apply to how the company and its underwriters will set an IPO price. Essentially, the underwriters must determine the demand for the shares based on the supply of shares that will be offered and sold to investors. These underwriters try to figure out what investors are willing to pay for each share of a company when it decides to go public.

To create a balance in this tradeoff that makes both existing and new investors happy, the company must decide how many new shares to issue and the estimated IPO price they plan to sell each share. The company’s executives and their investment bank determine the number of new shares by deciding how much money they hope to raise and how much ownership they are willing to give up.

Institutional Investors in IPO Process

Once executives and bankers decide on the number of new shares to issue, they reach out to institutional investors to start asking them how many shares they are interested in buying. Institutional investors include hedge funds, mutual funds, high net worth individuals, and pension funds in good standing with the investment bank.

Days before the IPO, the institutional investors place requests for how many shares they actually want to purchase. The company and its investment bankers then set the price for the IPO, and they know how much money they will raise.

The underwriting investment bank goes through the complex process of selling and allocating all the newly public shares to the institutional investors. They want to create a balance of different types of investors.

Retail Investors in IPO Process

Unfortunately for the at-home retail investor, it can be difficult to buy a stock at its IPO price. However, some brokerage platforms, like SoFi, have started to offer IPO Investing services that allow individuals to buy closer to the IPO price.

Determining Opening Price Point

Before the first day of trading, the stock exchanges on which the company decides to list look at all the incoming orders for the newly issued stock, which may be either buy or sell orders, and report the predominant price.

They then go through a process of price discovery to determine what the opening price will be. The goal is to have the maximum number of trades be executed from all the placed orders. At Nasdaq, this is done electronically, while human traders are involved at the NYSE.

Following this price discovery period, the opening price point is set, and the trading day continues. The stock is open for public trading.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

Post-IPO Trading

In an ideal situation for the company and the underwriters, the stock’s closing price is relatively close to the opening price on opening day. This means the shares were priced accurately for what investors are willing to pay and the company had an appropriate valuation.

However, the IPO price isn’t necessarily a good indicator of the value of a stock. Broader market interest in the stock is impossible to plan for, and IPO conditions differ from the company’s long-term presence in the market.

IPO Price vs Opening Price: Similarities & Differences

Many analysts use the terms IPO price and opening price interchangeably when discussing a newly public company. However, there is a distinction between the two price points.

The IPO price is the price at which a company’s shares are first offered to institutional and accredited investors. The underwriters of the IPO sell the newly issued public share to these investors and clients at the initial public offering price.

In contrast, the opening price is the price at which the stock trades when it first begins trading on the stock market. The two prices are usually very close, but the opening price may be higher or lower than the IPO price.

Do IPO Stocks Always Rise?

IPO stocks don’t always rise in price once they are available for public trading. Many highly talked-about IPOs have disappointed in their opening weeks. This may be because investors feel these companies are overvalued and don’t want to risk putting money into them when they haven’t yet shown a profit.

It can take time for a stock to increase following an IPO, so the initial sale isn’t necessarily an indicator of long-term success or failure. The initial stock offering doesn’t always result in an immediate rise, but the influx of new capital can allow the company to grow.

Many stocks experienced tumultuous action for months before seeing a steadier climb. As an investor, looking for companies with a solid team and business plan, rather than just hype and a high valuation, can result in long-term portfolio growth.

How to Invest in IPOs

You can expose yourself to IPO stocks through an exchange-traded fund (ETF). Certain ETFs offer a weighted balance of newly public stocks and are adjusted over time. By diversifying your portfolio, you benefit from any gains while avoiding steep losses.

Also, some online brokerages, like SoFi, offer IPO investing for retail investors.

But, as mentioned above, IPOs can be very volatile. Although there is potential for significant returns, investors can also see severe losses in the weeks and months after a company goes public.

Rather than investing immediately, you can wait a quarter or six months to see how a company’s stock fluctuates following the IPO and then decide whether to invest. Stocks can often fall to form a base price before beginning to rise again.

The Takeaway

It’s exciting when a company opens up to public investment. Although the IPO price is set as part of the lengthy IPO process, once the stock goes public all bets are off. Now the market determines the stock price, and the valuation of the company itself.

That’s one reason it can be challenging for most investors to know when and how to add new IPO stocks to their portfolios. Ultimately, investing in newly public stocks can be risky; the decision should be based on financial goals, time horizon, and risk tolerance.

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.

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

FAQ

Is it good to buy at IPO price?

Like all investments, there is risk in buying a stock when it goes public. IPOs can be suitable investments if the stock price increases after the IPO, but there is also a risk that the stock price could decrease. When buying a stock at an IPO price, investors don’t have the benefit of history to help analyze the stock.

How is an IPO price determined?

The IPO price is the initial public offering price of a stock. The IPO price is the price the underwriters will sell stock to institutional and accredited investors. The investment bank that works with the company going public determines the IPO price.

Can you lose money on an IPO?

Yes. An investor can lose money on an IPO if the company’s stock price falls below the price at which the investor bought the shares.

SoFi Invest®

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

SOIN0623083

Nov

2024

What Is the Average Stock Market Return?

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

Wondering how much you’ll gain by investing in stocks? It helps to look at the average stock market return for the last 10, 20, and 30 years.

Nov

2024

What Is a Stock Market Crash?

By Michael Flannelly | Growing Wealth, invest, Investing, Terminology | Comments Off

Table of Contents

What Happens When the Stock Market Crashes?
What Causes the Market to Crash?
Examples of Past Stock Market Crashes
What Are the Effects of a Crash?
Preventing Stock Market Crashes
Investment Tips During a Market Crash

The specter of a stock market crash weighs on the mind of many investors. After all, stock market crashes have played a substantial role in the United States during the 20th and 21st centuries. But knowing what is a stock market crash as well as the history and effects of stock market crashes can help investors weather the storm when the next one occurs.

Key Points

• A stock market crash occurs when major indices experience significant declines, usually driven by panic selling rather than specific company issues.

• Key factors that can trigger a crash include economic crises, natural disasters, and investor behavior, often exacerbated by rapid declines in stock prices.

• Historical crashes, such as those in 1929, 1987, 2000, 2008, and 2020, illustrate the profound impact of bubbles and external shocks on the market.

• Crashes can lead to bear markets and recessions, as declining stock values negatively affect corporate growth and consumer spending.

• Strategies for navigating crashes include maintaining long-term focus, diversifying investments, and considering opportunities to buy undervalued stocks during downturns.

What Happens When the Stock Market Crashes?

A stock market crash occurs when broad-based stock indices like the S&P 500, Dow Jones Industrial Average, or the Nasdaq Composite experience double-digit declines over a single or several days. This means that the stocks of a wide range of companies sell off rapidly, generally because of investor panic and macroeconomic factors rather than company-specific fundamentals.

While no specific percentage decline defines a stock market crash, investors generally know one is occurring while it’s happening.

💡 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.

What Causes the Market to Crash?

Stock market crashes are usually unexpected and occur without warning. Often, crashes are caused by investor dynamics; when stocks start to sell off, investors’ fear takes over and causes them to panic sell shares en masse.

Though stock market crashes are usually unexpected, there are often signs that one could be on the horizon because a stock market bubble is inflating. A bubble occurs when stock prices rise quickly during a bull market, outpacing the value of the underlying companies. The bubble forms as investors buy certain stocks, driving prices up. Other investors may see the stocks doing well and jump on board, further raising prices and initiating a self-sustaining growth cycle.

The stock price growth continues until some unexpected event makes investors wary of stocks. This unexpected event causes investors to unload shares as quickly as possible, with the herd mentality of panic selling resulting in a stock market crash.

Catastrophic events such as economic crises, natural disasters, pandemics, and wars can also trigger stock market crashes. During these events, investors sell off risky assets like stocks for relatively safe investments like bonds.

Stock markets can also experience flash crashes, where the stock market plummets and rebounds within minutes. Computer trading algorithms can make these crashes worse by automatically reacting and selling stocks to head off losses. For example, on May 6, 2010, the Dow Jones Industrial Average fell 1,000 points in 10 minutes but recovered 70% of its losses by the end of the day.

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Examples of Past Stock Market Crashes

There have been several crashes in the stock market history, the most recent being the crash associated with the coronavirus pandemic in early 2020. The following are some of the most well-known crashes during the past 100 years.

Stock Market Crash of 1929

The most devastating stock market crash in the history of the United States occurred in October 1929. The crash occurred following a period of relative prosperity during the Roaring Twenties, when new investors poured money into the stock market.

The crash began on Thursday, October 24, when the Dow Jones Industrial Average declined about 11%, followed by a 13% decline on Monday, October 28, and a 12% drop on Tuesday, October 29. These losses started a downward trend that would continue until 1932, ushering in the Great Depression.

Black Monday Crash of 1987

On Monday, October 19, 1987, the Dow Jones Industrial Average plummeted nearly 23% in a single day. Known as Black Monday, this selloff occurred for various reasons, including the rise of computerized trading that made it easier for panicked investors to offload stocks quickly, and stock markets around the world crashed.

Dotcom Crash of 2000

The Dotcom crash between 2000 and 2002 occurred as investors started to pull money away from internet-based companies. The Nasdaq Composite index declined about 77% from March 2000 to October 2002.

In the mid to late 1990s, the internet was widely available to consumers worldwide. Investors turned their eyes to internet-based companies, leading to rampant speculation as they snapped up stocks of newly public internet companies. Eventually, startups that enthusiastic investors had fueled began to run out of money as they failed to turn a profit. The bubble eventually burst.

Recommended: Lessons From the Dotcom Bubble

Financial Crisis of 2008

The stock market crash of 2008 was fueled by rising housing prices, which came on the heels of the dot-com crash recovery. At the time, banks were issuing more and more subprime mortgages, which financial institutions would bundle and sell as mortgage-backed securities.

As the Federal Reserve increased interest rates, homeowners, who often had been given mortgages they couldn’t afford, began to default on their loans. The defaults had a ripple effect throughout the economy. The value of mortgage-backed securities plummeted, causing major financial institutions to fail or approach the brink of failure. This financial crisis spilled over into the stock market, and the S&P 500 fell nearly 60% from a peak in October 2007 to a low in March 2009.

Coronavirus Crash of 2020

As the coronavirus pandemic swept the United States in February 2020, the government responded with stay-at-home orders that shut down businesses and curtailed travel. The U.S. economy entered a recession, and the stock market plunged. The S&P 500 fell 30% into bear market territory in just one month, including a one day decline of 12% on March 16, 2020.

What Are the Effects of a Crash?

Stock market crashes can lead to bear markets, when the market falls by 20% or more from a previous peak. If the crash leads to an extended period of economic decline, the economy may enter a recession.

A market crash could lead to a recession because companies rely heavily on stocks as a way to grow. Falling stock prices curtail a company’s ability to grow, which can have all sorts of ramifications. Companies that aren’t able to earn as much as they need may lay off workers. Workers without jobs aren’t able to spend as much. As consumers start spending less, corporate profits begin to shrink. This pattern can lead to a cycle of overall economic contraction.

A recession is usually declared when U.S. gross domestic product, or GDP, shrinks for two consecutive quarters. There may be other criteria for declaring a recession, such as a decline in economic activity reflected in real incomes, employment, production, and sales.

💡 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.

Preventing Stock Market Crashes

Major stock exchanges like the New York Stock Exchange (NYSE) have instituted circuit breaker measures to protect against crashes. These measures halt trading after markets drop a certain percentage to curb panic selling and prevent the markets from going into a freefall.

The NYSE’s circuit breakers kick in when three different thresholds are met. A drop of 7% or 13% in the S&P 500 shuts down trading for 15 minutes when the drop occurs between 9 am and 3:25 pm. A market decline of 20% during the day will shut down trading for the rest of the day.

Suppose a crash does occur, and it threatens to weaken the economy. In that case, the federal government may step in to ease the situation through monetary and fiscal policy stimulus measures. Monetary policy stimulus is a set of tools the Federal Reserve can use to stimulate economic growth, such as lowering interest rates. Fiscal stimulus is generally infusions of cash through direct spending or tax policy.

Investment Tips During a Market Crash

A stock market crash can be alarming, especially when it comes to an investor’s portfolio. Here are some investment tips to consider for navigating a market downturn.

Don’t Panic and Focus on the Long-Term

It will help if you remain calm when the stock market is plummeting. That’s often easier said than done, especially when your portfolio’s value declines by more than 10% in a short period. It’s tempting to join the panic selling, to make sure stock losses are minimized.

But remember, investing is a long game. In general, making decisions based on something happening now when your investing time horizon might be 30 years, may not be the best choice. If you don’t need access to your money right away, it may be better to hold on to your investments and give them time to recover.

Diversify Your Portfolio

Stocks and the stock market get most of the media’s attention, especially when the stock market is crashing, but there are other potential ways to help you realize your financial goals. Other assets like bonds, commodities, or emerging market stocks may be attractive investment opportunities to consider during a crash.

Consider Buying The Dip

While it depends on an individual’s specific situation and risk tolerance, a stock market crash might present opportunities to purchase stocks at a lower, more attractive share price that some investors may want to consider.

The Takeaway

The stock market tends to recover following a stock market crash; it took the S&P 500 six months to recover the losses experienced during the coronavirus crash. So any rash moves investors make during a stock market crash may prevent them from seeing gains in the long term.

A stock market crash can be scary, causing you to panic and fret over your savings and investments. But often, with investing, the best advice is not to make rash decisions. Even during a stock market crash, there may still be some opportunities and strategies to help build wealth over time.

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

When was the last market crash?

The last stock market crash was in 2020, at the onset of the coronavirus pandemic, when business shut down and the stock market plunged. The S&P 500 fell 30% in just one month. Within six months, however, the S&P 500 had recovered its losses.

What goes up when the stock market crashes?

Bonds generally tend to go up when the stock market crashes, although not always. Government bonds such as U.S. Treasuries typically do best during a market crash, though again, there are no guarantees.

Do stocks recover after a crash?

Historically, the stock market has recovered after a crash, although it’s impossible to say how long a recovery might take. Some stock market recoveries have taken a year or less, some have taken much longer.

Photo credit: iStock/Prostock-Studio

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

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

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Nov

2024

What Are Futures? A Guide to Futures Trading

Exploring Futures in Financial Markets: A Comprehensive Guide

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

Some investors may trade futures contracts in order to hedge against risk, or to speculate on the price movements of a given asset or security — or because their business will benefit if they lock in a commodity at a certain price. Trading futures can provide opportunities for a range of investors.

A futures contract requires both parties to honor the terms, no matter what the price is in the market when the contract expires. If you want to trade futures, there are various ways they can fit into your portfolio or plan.

Key Points

• Trading futures contracts allows investors to hedge against risks or speculate on price movements of various assets, including commodities and financial instruments.

• Futures contracts are standardized agreements that obligate parties to buy or sell an asset at a predetermined price on a future date.

• Investors can utilize leverage when trading futures, which can amplify both potential gains and losses due to margin trading practices.

• Hedging with futures helps businesses secure prices for commodities, mitigating the impact of unexpected price fluctuations in the market.

• Understanding the risks and benefits of futures trading is crucial, as it involves leveraged positions that can lead to significant financial consequences.

What are Futures?

Futures are derivatives that take the form of a contract in which two traders agree to buy or sell an asset for a specified price at a future date. Popular underlying assets for futures may include physical commodities like gold, corn, or oil, as well as currencies, or financial instruments like stocks.

The most commonly traded futures contracts use standardized terms, and are traded on a futures exchange. For example, if you want to buy or sell corn futures, one contract would equal 5,000 bushels and be traded via the Chicago Board of Trade (CBOT). Oil is traded on the Chicago Mercantile Exchange (CME), and one oil futures contract equals 1,000 barrels of oil.

Traders buy and sell in increments specified by the contract. To buy 50,000 bushels of corn or 10,000 barrels of oil, you’d buy 10 contracts of each. Given the quantities and dollar amounts of these trades, investors often use leverage, thereby paying only a fraction of the total cost of the position.

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

Understanding How Futures Work

Futures work by obligating a buyer or seller to purchase or offload an asset — it’s a contract.

Mechanism of Futures Trading

A futures contract obliges the buyer to buy a certain asset, or the seller to sell an asset, at an agreed-upon price, by a certain date. Each party must fulfill the terms of the contract, no matter what the market price or spot price is when the contract expires (or trade the contract before the expiration).

Futures contracts are standardized, as noted above, and each contract also spells out the contract terms, which includes among other things:

• The unit of the trade (e.g., tons, gallons, bushels, etc.).

• The grade or quality of the commodity, where relevant. For example, there are different types of corn, oil, soy, etc.

• Terms of settlement (e.g., physical delivery or a cash settlement).

• Quantity of goods covered by the contract.

• Currency in which the contract is priced.

Recommended: How Does a Margin Account Work?

The Role of Futures in Markets

A futures contract allows investors to speculate on the direction of the underlying asset, either long or short, using leverage. (Leverage means the trader doesn’t have to put up the full amount of the contract. Instead, futures traders use a margin account.) As such, they’re a tool that allows investors to use leverage and speculation.

Types of Futures Contracts

There are numerous types of futures contracts, including those tied to underlying assets such as equities and commodities. They can even be tied to other futures.

Equity, Commodity, and Other Futures

Futures contracts allow investors to make bets on the prices of a wide array of assets:

• Commodity futures, which allow investors to buy or sell physical goods like crude oil, pork bellies, natural gas, orange juice, corn, wheat, and more.

• Financial futures, including index contracts and interest rate or debt contracts.

• Precious metal futures allow investors to bet on the future prices of gold, platinum, and silver.

• Currency futures for fiat currencies like the euro, yen, the British pound, and more.

• U.S. Treasury futures allow investors to make bets on the future value of government bonds.

What are stock futures? Like futures contracts where the underlying is a physical commodity, some futures are tied to shares of a single stock or ETF. Stock index futures, however, are tied to the price movements of an index like the S&P 500 index.

Trading and Speculating with Futures

There are two key aspects to futures trading, which are hedging and speculating. Both play an important role in the markets, and determining whether futures are actually traded or not. There are also trading strategies to keep in mind, too.

Strategies for Futures Trading

There are many strategies for trading futures contracts, just as there are many strategies for trading almost any other type of security or derivative. To name a few of the basic strategies, investors can look at strategizing around price pullbacks, breakout trading, or even spread trading — each requires its own gameplan, and some background research to get started.

Futures as Speculation and Hedging Tools

Hedging is a big reason why investors buy futures contracts: It’s a way to protect against losses resulting from price changes in commodities.

Among the businesses that hedge using futures, the goal is to reduce the risk they face from unexpected price movements, and to guarantee the price they pay or receive for a particular asset.

If a large food manufacturer wants to lock in the price of corn, for example, they might enter into a contract for $10 a bushel. Since corn contracts are typically standardized at 5,000 bushels per contract, the total amount of the futures contract would be $50,000 ($10 x 5,000), to be delivered in six months. Entering into this futures contract would offer the buyer some protection against the possibility of rising corn prices in the future.

Let’s say the price of corn does rise to $12/bushel by the time the contract expires. In that case, the buyer still only pays the agreed-upon price of $10/bushel, even though the spot price is now $12/bushel.

For the corn producer in this scenario, even though it turned out that the futures contract terms weren’t quite as favorable as the actual market price — the contract guaranteed they would get at least $10/bushel, which provided a hedge against a potentially bigger loss.

Although it’s possible to settle a futures contract for the physical asset specified in the contract, most futures contracts are cash-settled. That’s because speculation on price movements is one of the main reasons that investors purchase futures contracts. A futures contract gives traders the opportunity to speculate whether a commodity will go up or down and potentially profit from the price change.

If the underlying asset of the futures contract — such as gold, oil, or corn — is above the price specified in the futures contract, then the investor can sell that contract for a profit before it expires. In that case, the contract would sell for the difference between the market price of the underlying commodity and the purchase price as specified in the contract.

In such a transaction, the underlying commodities don’t change hands between the counterparties of the contract. Instead, the trade would be cash-settled in the brokerage account of the investor.

Alternatively, an investor using futures for speculation could lose money if the price of the commodity is lower than the purchase price specified in the futures contract.

Risks and Benefits of Trading Futures

Futures trading has some significant risks and potential rewards — investors would be wise to know what they’re getting into, accordingly.

Understanding the Risks

Owing to the nature of futures trading, i.e., the binding nature of the contracts and the use of leverage, there are some obvious risks to bear in mind.

In a speculative trade, a futures contract allows you to bet on a commodity’s price movement. If you bought a futures contract, and at expiration the price of the commodity was trading above the original contract price, you’d see a profit. However, you could also lose if the commodity’s price was lower than the purchase price specified in the futures contract.

The potential risks here can be greater than they seem, because trading on margin permits a much larger position than the actual amount held by the brokerage. As a result, margin investing can amplify gains, but it can also magnify losses.

Imagine a trader who has $5,000 in their brokerage account and is in a trade for a $50,000 position in crude oil. If the price of oil moves against the trade, the losses could far exceed the account’s $5,000 initial margin amount. In this case, the broker would make a margin call requiring additional funds to be deposited to cover the market losses.

Speculators can also take a short position if they believe the price of the underlying asset will decline. An investor would realize a gain if the underlying asset’s price was below the contract price, and a loss if the current price was above the contract price. Again, using leverage to place these bets, long or short, can potentially expose investors to more risk than they intended.

Potential Benefits and Rewards

Some of the potential benefits of trading futures include the fact that investors can use leverage to try and generate outsized returns, the markets are liquid (meaning there’s plenty of trading action) and it offers up a chance to make some relatively quick (and potentially large) returns. That should, of course, be weighed against the aforementioned risks.

Futures vs Other Derivative Instruments

There are other financial derivatives with similar characteristics to futures contracts, such as options and forwards.

Comparing Futures with Options and Forwards

American-style options grant the buyer the right, but not the obligation, to buy or sell the contract’s underlying asset at any time until the contract expires.

Unlike a futures contract, however, option contracts don’t require the investor to purchase or sell the underlying asset. The investor can simply let the option expire. A futures contract, on the other hand, obligates the buyer to purchase the underlying asset, or to pay the seller of the futures contract the cash equivalent of that asset at the time of the contract’s expiration.

Similarly, a forward contract looks and functions a lot like a futures contract, with the primary difference being that forward contracts are only settled once — on their expiration date. Forwards are also often settled in the underlying asset (as opposed to cash), and the forwards market tends to be less liquid.

💡 Quick Tip: In order to profit from purchasing a stock, the price has to rise. But an options account offers more flexibility, and an options trader might gain if the price rises or falls. This is a high-risk strategy, and investors can lose money if the trade moves in the wrong direction.

Opening and Managing Futures Positions

Opening and managing futures positions can be relatively simple, granted you’re using a platform that allows for futures trading, and can follow a few steps.

Steps to Start Trading Futures

It’s common for some brokerages to have their own futures-trading capabilities, as well as their own rules about what an investor needs in terms of assets in order to trade futures contracts. Be sure to verify what those requirements are before selecting a broker.

Once you’re eligible to open a margin account and trade futures, those contracts trade on different exchanges, such as the Chicago Mercantile Exchange (CME), ICE Futures U.S. (Intercontinental Exchange), and the CBOE Futures Exchange (CFE).

From there, depending on the brokerage or platform being used, investors should be able to open and swap futures positions.

Managing Futures Contracts Effectively

Most investors in futures contracts have no interest in either receiving or having to deliver the physical commodities that underlie these contracts. Rather, they’re interested in the cash profit. The means of doing so is to trade the futures contract before its expiration date.

The standardized nature of most futures makes it so that a great many (but not all) futures contracts will expire on the third Friday of each month. Some commodities are seasonal, and only trade during specific months. High-grade corn trades on the CBOT in March, May, July, September, and December, for example.

As with any type of trading or investing, making sure you know what you’re dealing with when it comes to futures — and paying attention to the market — is going to be paramount to finding success as a trader. There are risks at play, and there’s no guarantee that the chips will fall your way. But for some, futures trading has proven fruitful.

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

Photo credit: iStock/hopeist

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Examples of Past Stock Market Crashes

Stock Market Crash of 1929

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Preventing Stock Market Crashes

Investment Tips During a Market Crash

Don’t Panic and Focus on the Long-Term

Diversify Your Portfolio

Consider Buying The Dip

The Takeaway

FAQ

When was the last market crash?

What goes up when the stock market crashes?

Do stocks recover after a crash?

Exploring Futures in Financial Markets: A Comprehensive Guide

What are Futures?

Understanding How Futures Work

Mechanism of Futures Trading

The Role of Futures in Markets

Types of Futures Contracts

Equity, Commodity, and Other Futures

Trading and Speculating with Futures

Strategies for Futures Trading

Futures as Speculation and Hedging Tools

Risks and Benefits of Trading Futures

Understanding the Risks

Potential Benefits and Rewards

Futures vs Other Derivative Instruments

Comparing Futures with Options and Forwards

Opening and Managing Futures Positions

Steps to Start Trading Futures

Managing Futures Contracts Effectively

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