Nov
22
2023
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Capital Appreciation on Investments

By | Growing Wealth, invest, Investing | Comments Off on Capital Appreciation on Investments

The term capital appreciation refers to an investment’s value rising over time. Theoretically, capital, meaning money or funds, appreciates, or goes up (as opposed to depreciates) after an investor initially purchases it, and that rise in value is what’s referred to as capital appreciation.

Of course, capital can also depreciate, but investors aren’t usually looking for negative returns. This is an important concept for investors to grasp, too, as capital appreciation is likely the main goal of most investors’ overall strategies.

Key Points

•   Capital appreciation refers to the increase in an investment’s value over time.

•   Calculating capital appreciation involves comparing the current market price of an asset to its original purchase price.

•   Factors such as company performance, economic conditions, and monetary policy can influence capital appreciation.

•   Assets like stocks, real estate, mutual funds, ETFs, and commodities are commonly associated with capital appreciation.

•   Capital appreciation is an important component of long-term wealth-building strategies, along with income from dividends and interest.

What Is Capital Appreciation?

As noted, capital appreciation refers to a rise in the price of an investment. Essentially, it is how much the value of an asset has increased since an investor purchased it. Analysts calculate capital appreciation by comparing the asset’s current market price and the original purchase price, also called the cost basis.

Example of Capital Appreciation

Capital appreciation can be understood by analyzing an example from stock market investing.

If an investor purchases 100 shares of Company A for $10 a share, they are buying $1,000 worth of stock. If the price of this investment increases to $12 per share, the initial 100 share investment is now worth $1,200. In this example, the capital appreciation would be $200, or a 20% increase above the initial investment.


💡 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.

What Causes Capital Appreciation?

The value of assets can rise and fall for various reasons. These include factors specific to individual investments and those affecting the economy and financial world as a whole.

Asset Fundamentals

In the most traditional sense, the price of an asset will increase because of a rise in the fundamental value of the underlying investment. When investors see that a company is doing well and expect it to keep doing well, they will invest in the company’s stock. This activity pushes the stock price up, resulting in capital appreciation if an investor holds shares in the company.

For a real estate asset, the value of a property could go up after a homeowner or landlord renovates a structure. This capital improvement increases the property’s market value.

Macroeconomic Factors

When the economy is booming, it can buoy all kinds of financial assets. In a strong economy, people typically have good jobs and can afford to spend money. This helps many companies’ bottom lines, which causes investors to put money into shares of the company. The opposite of this scenario is also true. When the economy endures a downturn, asset prices may fall.

Recommended: Understanding Economic Indicators

Monetary Policy

Central banks like the Federal Reserve play a significant role in how the financial markets operate. Because of this, the monetary policy set by central banks can play a prominent role in capital appreciation.

For example, when a central bank cuts interest rates, corporations can usually borrow money at a lower cost. Businesses often use this injection of cheap money to invest in and grow their business, which may cause investors to pour into the stock market and push share prices higher. Additionally, companies may take advantage of lower interest loans to borrow money to buy shares of their stock, known as a stock buyback. These moves may push share prices higher, further leading to capital appreciation.

Another monetary policy tool is quantitative easing (QE), which refers to a method of central bank intervention where central banks purchase long-term securities to increase the supply of money and encourage investment and lending. Like a low interest rate policy, this method can lead to rising asset prices because more money is being added to the economy — money that flows into assets, bidding their prices higher.

Speculation

Another potential cause of capital appreciation is speculation. Speculation occurs when many investors perceive the value of a particular asset as being higher than it is and start buying the asset in anticipation of a higher price. This activity may lead to the price of an asset being pushed higher. After a frenzy, the price of the asset eventually drops as investors sell in a panic when they realize there’s no fundamental reason to keep holding the asset. This type of speculation is fueled by investors’ emotions, rather than financial fundamentals.

Assets Designed for Capital Appreciation

There are several categories of assets that are designed for returns through price appreciation. Investors generally hold these investments for the long term hoping that prices will rise. This isn’t an exhaustive list, but it provides a good overview.

Stocks

Stocks are a type of financial security that represents equity ownership in a corporation. They can be thought of as little pieces of a publicly-traded company that investors can purchase on an exchange, with hopes that the price of the shares will go up.

Real Estate

Real estate is a piece of land and anything attached to that land. Many people build wealth through homeownership and capital appreciation, buying a house at a specific price with an expectation that it will appreciate in value by the time they are ready to sell.

Residential real estate is just one area of real estate investment. Investors may also look to put money into commercial, industrial, and agricultural real estate activities. Investors can invest in various real estate investment trusts (REITs) to get exposure to returns on real estate.

Mutual Funds

A mutual fund consists of a pool of money from many investors. The fund might invest in various assets, including stocks, bonds, commodities, or anything else. In the context of a mutual fund, capital appreciation occurs when the value of the assets in the fund rises.

ETFs

Similar to mutual funds, exchange-traded funds (ETFs) are investment vehicles that contain a group of different stocks, bonds, or commodities. ETFs can track stocks in one particular industry, e.g., gold mining stocks, or track all the stocks in an entire index such as the S&P 500. As the name suggests, ETFs are bought and sold on exchanges just like stocks.

Commodities

Commodities are an investment that has a tangible economic value. This means that the market values these raw materials because of their different use cases. For example, commodities like oil and wheat are desired because they can power automobiles and be used for food, respectively. Commodities markets can be highly volatile, but many investors take advantage of the volatility to see the capital appreciation on both a short-term and long-term time horizon.


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

Capital Appreciation Bonds

Capital appreciation bonds are municipal securities backed by local government agencies. With these bonds, investors hope to receive a significant return in the future by investing a small amount upfront.

Like all bonds, capital appreciation bonds yield interest, which is a primary reason that investors buy them. But instead of paying out interest annually, the interest gets compounded regularly until maturity. This gives the investor one lump sum payout at the end of the bond’s lifetime.

Unlike other assets that experience capital appreciation, the price of the capital appreciation bond does not rise. Instead, capital appreciation refers to the compounded interest paid out to the bondholder at maturity.

Capital Appreciation vs Capital Gains

Though the terms are sometimes used interchangeably, there is a difference between capital appreciation and capital gains.

Capital appreciation occurs when the value of an investment rises above the purchase price while the investor owns the asset. In contrast, capital gains are the profit made once an investment is sold. Appreciation is, in effect, an “unrealized” gain. It becomes “realized” once the investment is sold for a profit.

Capital appreciation alone does not have tax implications; an investor doesn’t have to pay taxes on the price growth of an investment when they own it. But when an investor sells an investment and realizes a profit, they must pay capital gains taxes on the windfall.

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Capital Appreciation vs Income

Capital appreciation is one piece of the puzzle in an investment strategy. Another critical component to build wealth is investing in assets that pay out dividends, interest, and other income sources.

A dividend is a portion of a company’s earnings paid out to the shareholders. For every share of stock an investor owns, they get paid a portion of the company’s profits.

Interest income is typically earned by investing in bonds, otherwise known as fixed-income investments. The interest payment is determined by the bond’s yield or interest rate. Investors can also be paid interest by putting money into savings accounts or certificates of deposit (CDs).

For real estate investors, rents paid by tenants can also act as a regular income payout.

Investing in assets that pay out regular income can supplement capital appreciation. The combination of capital appreciation with income returns is the total return of an investment.

Risks Associated With This Type of Investment

Assets intended for capital appreciation tend to be riskier than those intended for capital preservation, like many types of bonds.

Investing in stocks for capital appreciation alone is also known as growth investing. This strategy is typically focused on investing in young or small companies that are expected to increase at an above-average rate compared to the overall market.

The returns with a growth investing strategy can be high, but the risk involved is also high. Because they don’t have a long track record, these small and young companies can struggle to grow their business and lead to bankruptcy.

The Takeaway

Capital appreciation refers to the rise in value, or price, of an investment in an investor’s portfolio. It’s paramount to the whole concept of investing, as most investors invest in an effort to generate returns, or appreciation, on their money.

Capital appreciation is one part of a long-term wealth-building strategy. Along with income from dividends, interest, and rent, capital appreciation is part of the total return of an investment that investors need to consider.

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.

Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹

FAQ

What is the difference between capital growth and capital appreciation?

The difference between the terms capital growth and capital appreciation is merely semantics. Both terms refer to an increase in value of an investment over time, and effectively mean the same thing.

How much tax do you pay on capital appreciation?

Investors do not pay taxes on capital appreciation, as an investment gaining value does not trigger a taxable event. They do pay taxes on capital gains, which are realized when an investor sells an asset.

What is the difference between dividend and capital appreciation?

A dividend is a payout to shareholders from a company’s profits. Capital appreciation is the rise in market value of an investment or asset, so they are two completely different things.

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.


¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

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Nov
10
2023
What Is a Margin Loan? Definition & Examples

Margin Loans: Definition, Examples, Pros & Cons

By | Growing Wealth, invest, Investing | Comments Off on Margin Loans: Definition, Examples, Pros & Cons

Margin loans are a type of loan that an investor takes out from a brokerage to buy investments. An investor typically borrows from a brokerage if they don’t have the cash balance in their trading account to cover the cost of a trade or investment – so, they use credit from their brokerage to cover the costs.

While there are risks associated with using margin and margin loans, they can also increase an investor’s purchasing power and bolster potential returns.

What Is a Margin Loan?

A margin loan is a loan from your brokerage to pay for securities that you can’t cover with cash. Similar to any other loan, you must apply for the account and be approved before you can borrow funds; and your brokerage will charge interest on any funds you borrow.

Having a margin account by definition enables you to take out a margin loan (the two are synonymous in many ways). Having the flexibility to buy securities on margin gives many traders the ability to take positions they might not have been able to afford otherwise. In fact, margin loans are a cornerstone to putting together effective day trading strategies, for advanced investors.


💡 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.

Understanding Margin Loans

Understanding margin trading can be tricky, but for the average investor, all you really need to know is that a margin loan is essentially a short-term financing solution. If you want to buy securities, but don’t have the cash in your account, your brokerage may allow you to buy those securities using credit. It’s similar to a line of credit, in that way.

So, that’s what margin debt is: The result of a margin loan, in which a trader borrows money to buy securities.

How Margin Loans Work

While we’ve mostly been discussing margin loans in terms of trading and investing, they could be used for any purpose. But almost always, a margin loan is used to buy securities.

As for the process of how they actually work: A margin loan is more or less like any other loan. To get one, you’ll need to apply and qualify for margin on your brokerage account (typically called a “margin account”).

Margin Accounts and How They Work

Like other forms of lending, margin loans have strict criteria. In addition, these accounts are governed by industry regulations as well as the policies of individual institutions, so be sure to understand how your desired margin account works. Each brokerage has different rules and eligibility requirements, and FINRA, for example, also requires you to deposit a minimum of $2,000 or 100% of the security’s purchase price, whichever is less. This is the “minimum margin.” Some firms may require you to deposit more than $2,000.

If you’re approved for a margin account, you’re able to trade using a margin loan — up to a certain amount. According to Regulation T of the Federal Reserve Board, you may borrow up to 50% of the purchase price of securities that can be purchased on margin.

This is known as the “initial margin.” Some firms require you to deposit more than 50 percent of the purchase price. (Also be aware that not all securities can be purchased on margin. Only those deemed “marginable” can be traded on margin.)

If you have $5,000 in your brokerage account, and you want to buy stock X, which is valued at $50 per share, with a 50% margin you could buy 50% more than your cash balance: 200 shares instead of 100. But half of those (100 shares) would’ve been purchased on margin — so, you’d need to settle up your account at some point, if or when you decide to sell your shares (hopefully for a profit).

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 4.75% to 9.50%* and start margin trading.

*For full margin details, see terms.

How Margin Interest Works

The other important thing to remember about margin loans is that they are, like pretty much all loans, subject to interest charges. Your brokerage is going to charge you for the money you borrow.

Margin interest is a big topic unto itself, but the key takeaway is to know that you’ll be on the hook for paying your brokerage back for the money you borrow, plus interest charges.

You’re probably thinking: “Can I avoid paying margin interest?” The answer is that it depends on how fast you can pay your margin balance back. Most brokerages will charge interest by the day and add the charges to your account monthly. So, if you have cash or can sell securities and pay your balance off before interest accrues, it’s possible.


💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

Margin Loan Pros and Cons

Marginal loans can be highly useful for traders and investors. But like almost any financial instrument, margin loans have their pros and cons.

The biggest upside of margin is that it can open up a new swath of investing choices for traders. That means increasing their buying power, and allowing them to buy securities that may have otherwise been too expensive. This can increase potential profitability, too.

Conversely, traders who aren’t careful can’t quickly find themselves in debt if one of their trades backfires.

There are also interest charges to consider, as discussed. And if things really go sideways, some traders may experience a “margin call,” which is when your brokerage sells your assets without warning to settle up or get your account balance back within its requirements.

Here’s a quick rundown:

Margin Loans: Pros & Cons

Pros

 Cons
Increased trading capacity Traders can accumulate debt
Traders can buy pricier securities Interest charges
Increased potential gains Potential margin calls

Typical Margin Loan Rates

Margin loan rates, or, the interest rate charged by a brokerage for using margin, vary. Brokerages make the information available to traders and investors, so finding what types of margin loan rates you’re subjected to usually just requires a little research (or a call to your broker).

As mentioned, a brokerage will probably charge different interest rates depending on your overall margin balance, and how much you’ve borrowed. Lower balances are typically charged higher interest rates.

Here are some hypothetical examples: Let’s say Brokerage ABC’s margin interest rates vary between 4% and 8%, depending on the trader’s balance. Traders using up to $24,999 in margin will be subject to the highest interest rate (8%), whereas traders with more than $1 million in margin debit are subject to the 4% rate.

Brokerage B, however, has a different scale, with traders in margin debt up to $24,999 subject to 8.5% interest, and those with balances between $500,000 and $999,999 subject to 6.5%.

So, while brokerages do vary in what they charge for margin loan rates, they tend to be similar. To know your exact rate, contact your brokerage, or look up the current rate schedule on the company’s website.

The Takeaway

Margin loans are similar to any other type of loan, but are typically used for the purpose of buying stocks or other securities. Once you’ve applied for and been approved for a margin account, which is akin to adding a line of credit to your existing brokerage account, you’ll have the flexibility to buy more investments than if you were relying only on cash.

That said, you’re on the hook for repaying the money you’ve borrowed, with interest. If you’ve made a profitable investment, this shouldn’t be a problem. But if you invest in stock X on margin, say, and the price drops, you would still owe the full amount you’d borrowed to buy the stock, plus interest.

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.

Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹

FAQ

Can you withdraw a margin loan?

Yes, it’s possible to withdraw a margin loan, although the specifics will depend on an individual brokerage, as will any applicable interest charges.

Are margin loans a good idea?

Margin loans can be useful for many investors and traders, and whether or not they’re a good idea will depend on the specific individual considering taking one out. They do have risks, but upsides, too.

How do I pay back my margin loan?

The simplest ways to pay back margin loans are to either deposit cash into your brokerage account to get the balance back to zero, or to sell holdings that will result in a positive or neutral balance.

How much collateral is required for a margin loan?

The collateral required to take out a margin loan depends on a specific brokerage, but it’s not uncommon for brokerages to require somewhere between 30%, 40%, or 50%.

What happens if you can’t pay back a margin loan?

If you can’t pay back a margin loan, the brokerage will likely reach out to see what can be done, or lock you out of your account. Further, it could end up liquidating securities in your portfolio in order to cover the debt.

Photo credit: iStock/Sergey Nazarov

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.


¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

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Sep
11
2023
IPO Pop & IPO Trends

What Is an IPO Pop?

By | Growing Wealth, invest, Investing | Comments Off on What Is an IPO Pop?

An IPO pop occurs after a company goes public, when its stock price jumps higher on the first day of trading.

No matter how much preparation they’ve done, company executives and shareholders never really know how a stock will perform once it hits the market through its initial public offering (IPO).

While they of course hope to see some increase in price, a big spike — or IPO pop — could indicate that the underwriters underpriced the IPO.

Key Points

•   An IPO pop occurs when a company’s stock spikes on its first day of trading and may indicate that underwriters didn’t properly price retail investor demand into the IPO price.

•   In 2021, IPOs saw increases of 40% on average on the first trading day, but in the second quarter, companies were pricing below their expected ranges.

•   Direct listings are an alternative to IPOs that may help avoid an IPO pop, but they aren’t as efficient at raising capital.

•   Buying IPO stocks can be profitable, but it’s important to research the company before investing and to consider broad market trends.

•   IPO pops are relatively common, and larger companies tend to have larger pops since they are in high demand.

IPO Pop Defined

An IPO pop occurs when a company’s stock spikes on its first day of trading. An IPO pop may be a sign that underwriters did not properly price retail investor demand into the IPO price.

For instance, if a company prices its shares at $47 in its IPO and the price goes to $48 or $50, that would be considered a normal and positive IPO increase. But if the stock jumped to $60, both the company and its early investors might believe an error occurred in the IPO pricing.

This is one of the reasons that IPO shares are considered highly risky. In many cases, historically, that initial price jump hasn’t lasted, and investors who bought on the way up have taken a hit on the way down.

Recommended: What Is an IPO?

Problems Indicated by an IPO Pop

Many different factors go into pricing an IPO, including revenue, private investment amounts, public and institutional interest in investing. IPO underwriters try to find a share price that institutional investors will buy.

If the public thinks a company’s shares are more valuable than what early investors, underwriters, and executives thought, that means the company could have raised more money, increasing their own profit. Or they could have raised the same amount of money but with less dilution.

Also, when bankers price an IPO too low, that means their customers benefit — while company founders and VCs miss out on more profits.

If the share price soars on the first day, some investors will be happy, but it means the company could have raised more money if they had priced the stock higher from the start. It also means that existing investors could have given up a smaller percentage of their ownership for the same price.

IPO Trends

In the past, some companies have seen significant IPO pops occur on their first trading day. But in many cases the market cooled down after the first quarter, with some high-profile companies seeing declines on their first day.

Take 2021 as an example; in that year there were a record number of IPOs in the market.

In the first quarter of 2021 many companies were pricing their IPOs at the top of their expected range, due to increased demand, an improving economy, and a strong stock market. Even after that, IPOs still saw increases of 40% on average on the first trading day.

But in the second quarter, companies were pricing below their expected ranges and some weren’t even reaching those prices on the first trading day. This made the public less eager to buy into IPOs. This type of volatility is common to IPOs, and another reason why investors should be cautious when investing in them.

There was also a boom in special-purpose acquisition corporations (SPACs), IPOs of shell companies that go public with the sole purpose of acquiring other companies.


💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.

Direct Listings

Some companies have turned to direct listings as a way to try to avoid an IPO pop. In a direct listing, the company doesn’t have an IPO, they just list their stock and it starts trading in the market. There is a reference price set by a market maker for the stock in a direct listing, but it isn’t nearly as important as the price of a stock in an IPO. Although this can help avoid an IPO pop, it is not as efficient as an IPO as a means of raising capital.

Setting a price for an IPO is a key part of that fundraising strategy. A newer strategy companies are trying is raising a large amount of private capital just before going public, and then doing a direct listing instead of an IPO. The process gives a valuation to the stock price but in a different way from pricing shares for an IPO.

A third strategy is to direct list, and then do a fundraising round some time after the listing, giving the public a chance to establish the market price for the stock.

Do IPOs Usually Go Up or Down?

Although stocks increase an average of 18.4% on their first day of trading, 31% of IPOs decrease when they start to trade. Calculations of IPO profits show that almost 50% of IPOs decrease from their day-one trading price on their second day of trading. While IPO investing may seem like a great investment opportunity, IPOs remain a risky and unpredictable asset class.

Average IPO First Day Return

IPO pops are relatively common. Sometimes average first day returns increase significantly, such as during the dot-com bubble when the average pop was 60%. Larger companies generally have larger pops, since they are in high demand.

Determining the Right IPOs to Invest In

Buying IPO stocks can be profitable, but it also has risks. Just because a company is well known or there is a lot of publicity around its IPO doesn’t mean the IPO will be profitable. As with any investment, it’s important to research the market and each company before deciding to invest.

It’s also important to be patient and flexible, as individual investors don’t always have the ability to trade IPO shares. Or investors may have access at some point after the actual IPO. In addition, IPO shares can be limited.

If you’re interested in upcoming IPOs, it’s important to keep in mind that IPOs increase in price on the first day but quickly decrease again, and almost a third of IPOs decrease on their first listing day. Popular IPOs are more likely to increase, but they are also crowded with investors, so investors might not see their orders fulfilled.

When investing in IPOs through your brokerage account, it’s important to look at broad market trends in addition to individual company fundamentals. When the market is strong, IPOs tend to perform better. Also, when high-profile companies have unsuccessful IPOs, investors may become more wary about investing in upcoming IPOs.

Each sector has different trends and averages. Generally tech companies have higher first day returns than other types of companies, even though they’re also often unprofitable. Investors still want in on these IPOs because they may have strong future earnings potential.

Historically, some of the most successful tech stocks started out with negative earnings, so low earnings are not a strong indicator of future success or failure.

The Takeaway

As exciting as an IPO pop can be, it’s another example of how hard it is for individual investors to time the market. First, there’s no way to predict if a newly minted stock will have a spike after the IPO. Sometimes there is a pop and then the price plunges. This is one reason why IPOs are considered high-risk events.

Investors who find IPOs compelling may want to assess company fundamentals and other market conditions before investing in IPO stock.

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.

Photo credit: iStock/Olemedia

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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. This should not be considered a recommendation to participate in IPOs 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 more information on the allocation process please visit IPO Allocation Procedures.

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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Sep
08
2023
What Is Yield to Call? Formula & Examples

What Is Yield to Call? Formula & Examples

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is Yield to Call? Formula & Examples

An investor calculating yield to call is getting an idea of how much their overall bond returns will be. Specifically, yield to call refers to the total returns garnered by holding onto a bond until its call date. That doesn’t apply to all bonds, naturally, but can be very important for many investors to understand.

For investors who utilize bonds — callable bonds, in particular — as a part of their investment strategy, having a deep understanding of yield to call can be critical.

What Is Yield to Call?

As mentioned, yield to call (often abbreviated as “YTC”) refers to the overall return earned by an investor who buys an investment bond and holds it until its call date. Yield to call only concerns what are called callable bonds, which are a type of bond option.

With callable bonds, issuers have the option of repaying investors the value of the bond before it matures, potentially allowing them to save on interest payments. Callable bonds come with a call date and a call price, and the call date always comes before the bond itself matures.

A little more background: in a YTC scenario, ”yield” refers to the total amount of income earned over a period of time. In this case, the yield is the total interest a bond purchaser has accrued since purchasing the bond.

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How Yield to Call Works

If an investor buys a callable bond, they’ll see interest payments from the bond issuer up until the bond reaches maturity. The callable bond also has a call date, and the investor can choose to hold onto the bond until that date. If the investor does so, then YTC amounts to the total return the investor has received up until that date.

Yield to call is similar to yield to maturity, which is the overall interest accrued by an investor who holds a bond until it matures. But there are some differences, especially when it comes to how YTC is calculated.

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Yield to Call Formula

The raw yield to call calculation formula looks like this:

Yield to Call Formula:

Yield to call = (coupon interest payment + ( The call price – current market value ) ÷ time in years until call date ) ÷ (( call price + market value ) ÷ 2)

An investor should have all of the variables on-hand to do the calculation. Before we run through an example, though, here’s a breakdown of those variables:

•   Yield to call: The variable we are trying to solve for!

•   Coupon interest payment: How much the bondholder receives in interest payments annually.

•   Call price: The predetermined call price of the callable bond in question.

•   Current market value: The bond’s current value.

•   Time until call date: The number of years until the bond’s first call date arrives

The yield-to-call calculation will tell an investor the returns they’ll receive up until their bond’s call date. A bond’s value is roughly equal to the present value of its future earnings or cash flows — or, the return, at the present moment, that the bond should provide in the future.

How to Calculate Yield to Call

It can be helpful to see how yield to call looks in a hypothetical example to further understand it.

Yield to Call Example

For this example, we’ll say that the current face value of the bond is $950, it has an annual coupon interest payment of $50, and it can be called at $1,000 in four years.

Here’s how the raw formula transforms when we input those variables:

Yield to call = ($50 + ( $1,000 – $950 ) ÷ 4 ) ÷ (( $1,000 + $950 ) ÷ 2)

YTC = $25 ÷ $975

YTC = 0.0256 = 2.56%

Interpreting Yield to Call Results

Once we know that our hypothetical, callable bond has a yield to call of 2.56%, what does that mean, exactly? Well, if you remember back to the beginning, yield to call measures the yield of a bond if the investor holds it until its call date.

The percentage, 2.56%, is the effective return an investor can expect on their bond, assuming it is called before it matures. It’s important to remember, too, that callable bonds can be called by the issuer at any time after the call date. So, just because there is an expected return, that doesn’t necessarily mean that’s what they’ll see.

Yield to call calculations make a couple of big assumptions. First, it’s assumed that the investor will not sell the bond before the call date. And second, the calculation assumes that the bond will actually be called on the call date. Because of these assumptions, calculations can produce a number that may not always be 100% accurate.

Yield to Call Comparisons

Two calculations that are similar to YTC are “yield to maturity,” and “yield to worst.” All three calculations are related and offer different methods for measuring the value that a bond will deliver to an investor.

A different type of yield calculation would be needed if you wanted to try and measure the overall interest you’d earn if you held a bond to maturity. That’s different from measuring the overall interest you’d earn by simply holding the bond until its call date.

Yield to Call vs Yield to Maturity

YTC calculates expected returns to a bond’s call date; yield to maturity calculates expected returns to the bond’s maturity date. Yield to maturity gives investors a look at the total rate of return a bond will earn over its entire life, not merely until its call date (if it has one).

Yield to Call vs Yield to Worst

Yield to worst, or “YTW,” measures the absolute lowest possible yield that a bond can deliver to an investor. Assuming that a bond has multiple call dates, the yield to worst is the lowest expected return for each of those call dates versus the yield to maturity. Essentially, it gives a “worst case” return expectation for bondholders who hold a bond to either its call date or for its entire life.

If a bond has no call date, then the YTW is equal to the yield to maturity — because there are no other possible alternatives.

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The Takeaway

Learning what yield to call is and how to calculate it, can be yet another valuable addition to your investing tool chest. For bond investors, YTC can be helpful in trying to figure out what types of returns you can expect, especially if you’re investing or trading callable bonds.

It may be that you never actually do these calculations, but having a cursory background in what the term yield to call means, and what it tells you, is still helpful information to keep in your back pocket.

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FAQ

What is the advantage of yield to call?

Yield to call helps investors get a better idea of what they can expect in terms of returns from their bond holdings. That can help inform their overall investment strategy.

How do you calculate yield to call in Excel?

Calculating yield to call can be done the old fashioned way, with a pen and paper, or in a spreadsheet software, of which there are several. An internet search should yield results as to how to calculate YTC within any one of those programs.

Is yield to call always lower than yield to maturity?

Generally, an investor would see higher returns if they hold a bond to its full maturity, rather than sell it earlier. For that reason, yield to call is generally lower than yield to maturity.

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.


¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

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What Are Real Estate Options? Advantages for Buyers

Understanding the Basics of Real Estate Options

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Understanding the Basics of Real Estate Options


Editor's Note: Options are not suitable for all investors. 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. Please see the Characteristics and Risks of Standardized Options.

Another way to invest in real estate is through buying or selling real estate options. With an options contract, a buyer is granted the right to purchase a property for a specific price by a specific date, but they are not obligated to buy it.

In order to purchase this option, the buyer of the contract pays the seller a premium.

This is a flexible and typically less expensive way to enter the real estate market that may also help reduce risks involved in single property investment.

What Are Real Estate Options?

Real estate options are contracts between a potential buyer and seller. They grant the buyer the exclusive right to purchase a particular property within terms set in the contract. But the buyer doesn’t have to purchase the property.

However, if the buyer decides to exercise the option and purchase the property, the seller is obligated to sell the property at the agreed-upon price. Once the agreement is entered into, the property owner can’t sell to anyone else within the time period set in the option.

An options contract for a purchase is also known as a call option, whereas an option to sell would be called a put option.

Recommended: Call vs Put Options: Main Differences

How Do Options in Real Estate Work?

Generally, real estate options set a particular purchase price and are valid for anywhere from six months to one year. The buyer doesn’t have to purchase the property, but if they want to, the seller is obligated to sell to them even if the market price has gone up.

The buyer pays what is known as a “premium” in options terminology to enter into the contract. If they decide not to buy the property, the property owner (the seller) keeps that premium.

Real estate options are most often used in commercial real estate, but they can be used by retail investors as well. They aren’t sold on exchanges, and each contract is specific for the property it represents. Usually a contract is only for a single property, not multiple properties.

Real estate options are similar to stock options in that they set a specific price, premium, and period of time for a contract related to an underlying asset. Options can be exercised early or at the expiration date. They can also be sold to another investor.

•   Most of the benefits involved in real estate options tilt in the buyer’s favor.

•   If the property value goes up a few months into the contract, the buyer can exercise the contract and purchase the property, and sell it for a profit.

•   If the property value drops, the buyer can simply let the option expire — thus losing only the premium they paid, which is typically a small percentage of the value of the underlying asset or property in this case.

If the buyer decides not to exercise the contract, they can sell it to another buyer at a potentially higher premium (and pocket the difference).

For a seller, there is the potential for them to make a profit if the buyer exercises their option to purchase the property. They may also profit if the buyer doesn’t exercise the option — at which point they can keep the premium amount, and then sell the contract (or the property) to someone else.


💡 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.

Lease Options

In addition to real estate options for purchases, there are also lease options. These are rent-to-own agreements between a buyer and seller. They let someone lease a property with the option to buy it after a certain amount of time, but not the obligation.

Generally with a lease option, some or all of the rental payment goes towards the purchase. Some lease options lock in a particular price, but others just give the buyer the exclusive right to buy at whatever the market price is.

Although lease options can be great for buyers, they are also more expensive than simply renting a property since they involve a premium. For this reason, it’s important for a buyer to carefully consider the contract and their future plans before entering into a lease option agreement.

2 Advantages of Real Estate Options for Buyers

Options are a common investing strategy for commercial real estate investors. There are several reasons a buyer might enter into a real estate option contract with a seller.

It Can Allow Time for the Buyer to Amass Funds

One might choose a real estate option if they want to secure a piece of land or property at a certain price but they need some time to get funds in order for the purchase.

A Real Estate Option Locks in a Price

If a buyer thinks the price of a property might go up, they can purchase an option to lock in the current market price. However, some real estate options are not completely set in their sale prices. There may be clauses in the contract to determine what the final sale price will actually be.

2 Advantages of Real Estate Options for Investors

Real estate investors can also use options to their advantage.

It’s a Lower-Risk Way to Develop Property

For example, let’s say an investor finds a property they’re interested in developing into housing. The investor needs to create a plan for the property and get other investors involved before they can buy it, so they purchase a real estate option to give them the exclusive right to buy the land.

The investor can make a profit by bringing in investors at a higher rate than the option. They can then buy the land and sell it to the developers they brought in to make a profit.

If they aren’t able to get developers and investors involved before the contract expires then they simply don’t buy the land.

An Investor Can Buy and Sell Real Estate Options

Investors can also make a profit just on buying and selling real estate options contracts rather than the properties themselves. This is a much less capital-intensive way to get involved in real estate investing.

For instance, an investor might find a property they expect will increase in value in the coming months. They purchase a real estate option to buy the land at the current market rate within the next year, pay a premium, and wait.

At any point during the period of the agreement the investor can either act on the contract and buy the property, or they can sell the contract to someone else. Let’s say the value of the property increases three months into the contract. The investor can find another investor who wants to purchase the contract for them for a higher price than the premium the original investor paid.

Whether any investor buys the property or not, the seller of the property keeps the premium.

The Takeaway

Real estate options are a way for investors to get involved in real estate investing without directly buying properties. As with any other kind of options, the investor buys the right to buy or sell at a certain price, but is not obligated to do so.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.

Explore SoFi’s user-friendly options trading platform.

🛈 SoFi does not offer real estate options trading at this time.

Photo credit: iStock/Melpomenem

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

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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