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In general, economies are classified into two broad categories: developed economies and emerging economies. To answer the question, “what are emerging markets?” one first needs to understand developed markets.

Developed economies have higher standards of living, well-developed infrastructure, and more mature capital markets. Most developed market economies can be found in North America, Western Europe, and Australia.

Emerging market economies (EMEs), on the other hand, are those that are still in the process of becoming developed economies. Emerging markets are ones that are beginning to institute regulatory bodies, seeing rapid growth, and increasing amounts of money flowing through their stock markets.

EMEs make up the majority of the global economy—up to 80%, in fact. India, China, and Russia are just a few large countries that fall into this category.

What Are Emerging Markets?

In essence, an emerging market refers to an economy that has the potential to become a developed, advanced economy in the near future.

Investors tend to see these countries as potential cash cows because their economies resemble that of an established yet still young startup company. The infrastructure and blueprint for success has already been laid out, things just need a little more time before the economy can really take off.

If an investor selects an emerging market economy accurately, the payoff could potentially far exceed most investments in already advanced economies that have already experienced their most substantial stages of growth.

China is an interesting example of an emerging market. The country is quite advanced in many ways, with a large manufacturing base, plenty of technological innovation, and the largest population of any country in the world. China is the second-largest economy in the world by gross domestic product (GDP) and accounts for 16.38% of the entire global economy. So why is it considered an emerging market economy?

China has a few characteristics that are typical of an emerging market, in particular, having an economy that relies heavily on exports. India is another economy that is advanced in some ways, yet has a low per capita income that is typical of an emerging market.

Correctly identifying emerging markets isn’t exactly scientific. Not everyone agrees on which countries are emerging markets and which countries are not.

On the list are some large countries like China, Russia, Brazil, Korea, Mexico and others, in addition to smaller countries like Qatar, Poland, Peru, United Arab Emirates, and the Philippines.

Other financial institutions, like the International Monetary Fund, the S&P, Russell, and Dow Jones have their own lists that aim to help investors understand the question “what are emerging markets?”

How Investors Recognize Emerging Markets

While there are some differences among these lists, there is also a general theme. Certain indicators tend to be included time and again among those trying to differentiate emerging market economies from developed ones.

Here are seven tips for recognizing emerging markets, in addition to how to invest in emerging markets, the pros and cons, and why someone might want to invest in this area.

Fast-Paced Growth

An emerging market economy is one in a state of rapid expansion. There is perhaps no better time to be invested in the growth of a country than when it enters this phase.

At this point, an EME has laid much of the groundwork necessary for becoming a developed nation. Capital markets and regulatory bodies have been established, personal incomes are rising, innovation is flourishing, and GDP is climbing.

Lower Per Capita Income

The World Bank keeps a record of the gross national income (GNI) of many countries. For the fiscal year of 2021, lower-middle income economies are defined as having GNI per capita of between $1,036 and $4,045, while upper middle-income economies are defined as having GNI per capita between $4,046 and $12,535.

The vast majority of countries that are considered EMEs fall into the lower-middle and upper middle-income ranges. India, Pakistan, and the Philippines are lower-middle income, for example, while China, Brazil, and Mexico are upper-middle income. All of these countries are referred to as emerging markets despite the considerable differences in their economic progression.

Volatility

For EMEs, volatility is par for the course. Risk and volatility tend to go hand in hand, and both are common among emerging market investments.

Emerging market economies are often rife with conflict, political turmoil, economic upheaval, and booms and busts. Some of these countries might see violent revolutions, political coups, or become targets of sanctions by more powerful developed nations.

Any number of things could happen that threaten to throw an EME into disarray at a moment’s notice.

Political and Economic Instability

One of the reasons that developing economies can see a lot of volatility has to do with their inherent trend toward instability.

This can come from any source, including the type of situations mentioned in the last point.

Another potential point of conflict can come in the form of natural disasters, which can hit export-heavy nations hard. If a country relies on agricultural exports for a large portion of its trade, a tsunami, hurricane, or earthquake could derail a lot of related commerce.

Instability could result through either social unrest, economic devastation, political upheaval, or related factors.

Currency Crises

A currency crisis can sometimes be accompanied by a political crisis. When people lose faith in the leadership of a country, they might also lose faith in the currency of that country.

When this happens, a currency can enter freefall. When currencies lose value rapidly, prices for consumer goods start going up faster and faster.

The value of a country’s currency is an important factor to keep in mind when investing in emerging markets.

Sometimes it can look like stock prices are soaring, but in reality, the currency that those stocks have their values measured in is declining.

If a stock goes up by 50% in a month, but the national currency declines by 90% during the same period, investors will still see a net loss, although they might not recognize it as such until converting gains to their own native currency.

For example, Venezuelan stocks have soared against the Venezuelan Bolivar during the last five to ten years as the currency has entered hyperinflation, although those same stocks have collapsed in value against the US dollar.

Heavy Reliance on Exports

Emerging market economies tend to rely heavily on exports. That means their economies depend in large part on selling goods and services to other countries.

A developed nation might house all the needs of production within its own shores while also being home to a population with the income necessary to purchase those goods and services. Developing countries, however, must export the bulk of what they create.

Growth Potential

One of the biggest defining factors of an emerging market economy might be its potential for high growth.
These are countries that have shown a determination to join the developed world and have already laid most of the groundwork for achieving that.

So, the theory goes that if such a country were to continue progressing, its industry would flourish, its population would grow and earn higher incomes, and as a result related investments would outperform those in most other markets.

Why Invest in Emerging Markets?

Emerging markets are generally thought of as high-risk, high-reward investments.

They are also yet another way to diversify an investment portfolio. Having all of a portfolio invested in the assets of a single country puts an investor at the mercy of that country’s circumstances. If something goes wrong, like social unrest or revolution, a currency crisis, or widespread natural disasters, that might damage related investments.

Being invested in multiple countries can help mitigate the risk of something unexpected happening to any single economy.

The returns from emerging markets might also exceed those found elsewhere. If investors can capitalize on the high rate of growth in an emerging market at the right time and avoid any of the many potential mishaps, they stand to profit.

Over the period of 2000-2010, for example, the S&P 500 gave investors an annual return of -0.95%. At the same time, the MSCI Emerging Market Index returned 16% during that period.

Pros and Cons of Investing in Emerging Markets

Let’s recap some of the pros and cons associated with EME investments.

Pros

•  High profit potential: Selecting the right investments in EMEs at the right time can result in returns that might be greater than most other investments. Rapidly growing economies provide ample opportunity for profits.
•  Global diversification: Investing in EMEs provides a chance to hold assets that go beyond the borders of an investor’s home country.

This creates a kind of diversification that can’t be had any other way. Even if an unforeseen event should happen that contributes to slower domestic growth, it’s possible that investments elsewhere could exceed expectations.

Cons

•  High volatility: As a general rule, investments with higher liquidity and market capitalization tend to be less volatile because it takes larger capital inflows or outflows to move their prices.
EMEs tend to have smaller capital markets combined with many uncertainties, making them vulnerable to exceptional volatility.

•  High risk: With high volatility and uncertainty comes high risk. What’s more, that risk can’t always be quantified. The situation might be even more unpredictable than usual due to conflict, political turmoil, economic upheaval, and natural disasters.

All investments carry risk, but EMEs bring with them a host of fresh variables that can twist and turn in unexpected ways.

•  Low accessibility: While some emerging market funds do exist, it’s not always easy to gain access to these kinds of investments. There may not be a ticker symbol to select in a brokerage account, as is the case with most domestic securities.

While liquid capital markets are a characteristic of emerging markets, that liquidity still doesn’t match up to that of developed economies.

It may be necessary to consult with an investment advisor or pursue other means of deploying capital that may be undesirable to some investors.

The Takeaway

When contemplating how to invest in emerging markets, there is no one correct answer that works for every investor.

Emerging market Exchange-traded Funds (ETFs) might invest in different assets within a single country or spread their investments throughout multiple countries. The more countries included in a fund, the more diversification it will achieve. As usual, greater diversification can limit risks but also tends to limit rewards.

Bonds can also play a role in an emerging market portfolio. Many countries with developing economies have used the issuance of new debt to borrow money to build out their infrastructure. That means some emerging market economies could offer bonds with attractive yields.

Investors with low risk tolerance might choose to limit their exposure to emerging markets. Not only are related investments often volatile and high-risk, but the risk can be difficult to assess.

Whether playing it safe or taking a risk in emerging market stocks, SoFi Invest® has all the tools a new or experienced investor might need, including a cutting-edge trading platform and free financial advisors at your fingertips.

If you’re interested in learning more about emerging markets and other investment options, check out SoFi Invest.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
For additional disclosures related to the SoFi Invest platforms described above, please visit http://www.sofi.com/legal.
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Growth funds, or growth equity mutual funds, are stock portfolios with a primary goal of capital appreciation. These funds are a type of mutual fund—groups of stocks which can be purchased all at once in a bundle—along with value funds and blend funds.

Growth mutual funds don’t necessarily only contain stocks, they can also include bonds and other investments, but they tend to mostly contain growth stocks.

Unlike some value stock funds, growth funds pay little to no dividends, so investors make money on the appreciation of the growth stock or growth fund over time. The stocks in the growth fund portfolio are chosen for the likelihood that they will grow more quickly than other stocks in the market. For this reason, growth mutual funds are considered riskier investments, with a high risk of loss along with a higher risk of gain.

Growth funds tend to have a higher P/E ratio (price to earnings ratio), which is the cost of a company’s stock relative to its per-share earnings (EPS) than other funds. This can make them more expensive investments, but their quick growth can make the extra cost worth it.

Examples of Growth Stocks

Growth stocks can be either large-cap corporations, mid-cap, or smaller companies. Small companies can often have more potential for growth, but large-cap companies can scale their manufacturing to produce more products at cheaper prices, allowing them to continue growing. Plus, these companies tend to reinvest the money they make into research and development, acquisitions, or expansion.

Most growth stocks are companies within the technology industry, but there are growth stocks in all industries. Some growth funds are industry specific, while others include stocks from a mix of industries.

Certain growth funds that focus on only large-cap companies with a market capitalization of $10 billion or higher.

Large-cap growth funds make up most of the growth fund market and hold $2.2 trillion in total assets. Two examples of growth stocks from large companies are Apple (AAPL) and Facebook (FB). Currently the largest growth fund is the Growth Fund of America. Over the past 10 years this fund has seen an average growth of 12.6% each year. The Growth Fund of America is made up of 20.5% technology stocks, 18.8% communication services stocks, while 5.6% of the fund is Facebook stock.

In recent years, international growth funds have become more popular, as investors are looking to benefit from global growth. Some of the companies found in foreign and international growth funds include Alibaba, Baidu, Tencent, ASML Holding, and MercadoLibre Inc.

There are also growth index funds, which passively invest by tracking the performance of a particular stock index.

Benefits of Investing in Growth Mutual Funds

Growth stocks are more likely to see returns during an economic boom cycle, when many companies are growing and thriving.

Since growth funds invest in stocks that are expected to have a relatively high amount of growth, these investments have the potential for solid returns.

For example, in 2018 growth funds averaged a 10-year return of about 13%, which is higher than both the Dow Jones Industrial Average and the S&P 500.

Downsides and Risks of Growth Mutual Funds

While growth stocks can potentially increase in value more quickly than other stocks, this also makes them a riskier and more volatile investment. In order for a growth stock to keep growing, the company must continue to earn more money. This is challenging for any company to maintain over a long period of time. If there is a recession, a company has an unforeseen loss, or can’t continue to grow, the value of the stock will go down.

To manage this risk, investors may choose to hold growth stocks and growth mutual funds for the long term, so that they can ride out the fluctuations and ultimately be more likely to make a profit.

Investing in Growth Mutual Funds

When choosing which growth stocks or growth funds to invest in, there are several factors investors may choose to consider. These include:

•  Historical performance
•  Stocks in the fund
•  Cost and potential earnings

Growth funds can often—but not always—be identified by the word growth in their name, such as the Fidelity Growth Company (FDGRX), the T. Rowe Price Blue Chip Growth Fund (TRBCX), and the Vanguard Growth Index (VIGAX).

Some investors choose to put their money in blended funds, which combine growth stocks with less risky stocks. These funds allow investors to benefit from some of the upsides of growth funds without quite as much risk.

Certain growth funds are exchange-traded funds, or ETFs. These funds differ from growth mutual funds or index funds in that they can be traded online like a stock.

Growth stocks and growth mutual funds tend to have a higher degree of risk than other types of ETFs and index funds, but they can also have a greater potential for returns. There is no guarantee that a company’s investments aimed at growth will lead to increased profits.

It’s important for investors to understand the risks before investing in any stock or fund, and to build a diversified portfolio of assets in order to mitigate risk. With a diversified portfolio, investors hold both riskier assets and safer assets, in an effort to reap the benefits of growth without losing too much along the way.

Determining When to Invest in Growth Mutual Funds

By investing small amounts of money consistently over time, rather than attempting to time the market, investors average out the price they pay for investments. However, if there is a stock market correction, it can be a good time to pick up some extra assets while they’re at particularly low prices.

Investing in growth funds during an economic downturn may seem like a scary time to buy, but the point of buying a little bit consistently over time is to buy stocks at both lower and higher prices to get a solid average price.

Growth stocks tend to do well during bull markets, so while they may not see significant gains during a recession, they are still good long-term investments to pick up before the next economic boom.

As always, investing is personal. If an investor has just lost their job or sees financial hardship ahead, it may not be the right time to invest. That money is better off set aside for housing costs and other immediate expenses.

Experts consistently advise investors to build up an emergency fund and pay off any high-interest debts before putting significant amounts of money into potentially risky investments.

The Takeaway

Growth stocks have a primary goal of capital appreciation. These stocks are expected to grow more quickly than other stocks in the market growth, and because of this, growth mutual funds are considered riskier investments than other mutual funds, with a high risk of loss along with a higher risk of gain.

Growth funds tend to have a higher P/E ratio (price to earnings ratio), which is the cost of a company’s stock relative to its per-share earnings (EPS) than other funds. This can make them more expensive investments, but their quick growth can make the extra cost worth it.

These types of funds are more likely to see returns during an economic boom cycle, vs a recession. During a recession or economic downturn, companies may not have the cash or earnings to be able to invest in growth, and the value of the stock will go down.

On the other hand, if an investor is in a financially secure place, they might strategically invest in growth stocks during a recession, buying low in order to recoup their investments in the long term.

Investors who know the basics about growth mutual funds may be interested in adding some of these assets, or other types of mutual funds, to their investment portfolio. One way for an investor to add mutual funds and ETFs to their holdings is with the SoFi app. With SoFi, investors can track favorite stocks, stay up to date on the latest market news, and purchase stocks right from their phone.

SoFi Invest® offers the most popular growth funds, as well as ETFs. SoFi also gives investors the ability to keep track of their expenses and set financial goals. A team of professional financial advisors are available to answer investors’ questions and help them create a personalized investment plan.

Learn how to get started investing with SoFi Invest.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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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The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA / SIPC , (“SoFi Securities”).
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The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, please visit http://www.sofi.com/legal.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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Options are contracts that give investors the right, but not the obligation, to buy or sell an asset like shares of a company stock. Purchasers can buy or sell by a certain date at a set price, while sellers have to deliver the underlying asset. Investors can use options if they think an asset’s price will go up or down or to offset risk elsewhere in their portfolio.

How to Trade Options

Both at-home investors and professional traders can trade options. At-home investors can make options trades by opening up an account with a retail trading platform.

The market for equity options is typically open from 9:30 a.m. to 4 p.m. ET, Monday through Friday, while futures options can usually be traded almost 24 hours.

People can use options when they think an asset’s price will go up or down. Investors also use options to hedge or offset risk from other assets that they own.

Some of the earliest mentions of options are from Ancient Greece and were related to the olive harvests. Options were also used during the 17th century Tulip craze when Dutch aristocrats speculated on prices of tulip bulbs.

In more modern times, the Chicago Board Options Exchange was the first market to list stock options in 1973.

Investors have also turned to selling options as a way to collect income. Selling put options in particular, when markets are calm, has been a source of income in recent years, as investors collected premiums for the contracts with the hope that they don’t get exercised.

What Are Calls and Puts?

When purchased, call options give investors the right to buy an asset. Call buyers are essentially giving up some profit in exchange for the lower risk of not owning an asset outright, since the price of the asset can potentially fall.

Say for example, an investor thinks that the stock of Company X, which is trading at $100 a share, will climb to $120 a share. He could buy call options that give him or her the choice of buying the shares at a later date should they reach that price.

If the stock fails to reach $120 by the specified time frame, the investor would lose the amount of money he or she spent on the premium but also be less exposed to the risk of the share price declining.

Meanwhile, puts are options that give investors the right to sell an asset. Investors pay a premium and are more likely to be protected against losses in case the price of the asset falls.

What Is the Put-Call Ratio?

A stock’s put-call ratio—or the number of put options traded in the market relative to calls—is one measure that investors look at to determine sentiment toward the shares. A high put-call ratio indicates bearish sentiment, whereas a low one signals more bullish investor views.

Options are considered financial derivatives because they’re tied to an underlying asset. Stock options are common examples of the contracts and are based on the shares of a single company. Meanwhile, ETF options are contracts that give the right to buy or sell shares of an exchange-traded fund.

A stock option typically represents 100 shares of the underlying stock. Other types of derivatives include futures, swaps, and forwards. Options that exist for futures contracts, such as S&P 500 or oil futures, are also popular among traders and investors.

Common Phrases in Options Trading

In order to trade options, investors need to know the strike price—the level at which the option holder can exercise the contract. In a trade, the option seller is obliged to deliver the promised shares if the buyer decides to exercise the option.

Options can be “in the money,” “at the money” or “out of the money.” For calls, if the shares of the underlying stock are higher than the strike price, then the options are considered “in the money.” For puts, options are in the money when the shares are trading below the strike price.

“At the money” is when the options strike price is equal to the price of the asset in the market. Contracts that are at the money tend to see more volume or trading activity, as investors are looking to exercise the options.

“Out of the money” is when the security’s price is below a call option’s strike price or above a put option’s strike level. For example, if shares are trading at $50 each and the call option’s strike price is at $60, the contracts are out of the money.

With put contracts, if the shares are trading at $50 but the contract’s strike price is $40, then the options are out of the money.

These options tend to be cheaper since there’s less of a possibility that investors will be able to exercise them. If the strike prices are significantly above or below from where market prices are, traders and investors often refer to the contracts as ”deep out of the money.”

Important Concepts in Options Trading

Another concept that investors need to understand about an option is its expiration, or the date by which the contract needs to be exercised. The closer an option is to its expiration, the lower the value of the contract. The length of time before the option’s expiration typically ranges from one day to nine months, although longer-term contracts exist as well.

While expiration dates that are one month to three months away have historically been popular, shorter-term contracts—such as weeklies and dailies—have gained in popularity in recent years as more exchanges have listed them and investors have been drawn to the potential short-term profits they can generate.

Premiums are the cost of the options. The Black Scholes model is the mathematical formula for determining the price of options. The model takes into account factors such as the price of the underlying stock, the option’s strike price, the time before expiration, the stock’s volatility and interest rates.

Investors also look at a stock’s implied volatility, which is the expected volatility of the stock in the future based on the prices of its options.

What Are “The Greeks” in Options Trading?

Traders use a range of figures known as “The Greeks” to gauge the value of options. Delta is the measure of the impact of the price of the underlying asset on the option’s value. Beta is how much a single stock moves relative to the overall equity market.

Gamma tracks the sensitivity of an option’s Delta. Theta is the sensitivity of the option to time. Vega is the sensitivity of the option to implied volatility. Rho is the sensitivity of the option to interest rates.

Pros of Options Trading

Options trading is complex and involves risks, but once investors understand the fundamentals of the contracts and how to trade them, options can be an important tool to make investments while putting up only a premium.

In other words, the options market can give investors the exposure that they want without having to own the asset or security outright.

Options can also be an important way to protect a portfolio. Some investors offset risk for a company stock with options for an exchange-traded fund that gives broader exposure.

For instance, an investor with a big position in a bank stock can also hold puts for an ETF that gives exposure to a broad swath of financial companies.

If the price of the bank stock falls after bearish news for the financial industry hits the market, the investor can sell the put options for the ETF and therefore mitigate some of the losses incurred from the bank stock.

The practice of selling options to collect income can also be a way for investors who are seeking income to collect premiums consistently.

This was a popular strategy particularly in the years leading up to 2020 as the stock market tended to be quiet and interest rates were low, pushing investors to seek alternative sources of income.

Cons of Options Trading

Expirations are a risk in options. Securities like stocks don’t have expirations, but options contracts can expire without getting exercised by their buyer. While premium costs are generally low, they can still add up if options are used strategically by an investor.

This is why it’s important for an investor to understand the concept of time decay and how the value of an option decays as its expiration date approaches.

Another risk that options investors face is liquidity. Because options are either calls or puts and often have multiple different strike prices as well as expirations that can range from one week to years, there are many contracts that are outstanding in the market.

The plethora of different types of options contracts means investors may encounter issues with liquidity, or the ease with which they can be traded without moving prices. One way to try to measure this for an option is to look up its open interest. Open interest is the number of contracts that exist for an option.

For instance, an option that gives investors the right to sell a stock in three months may be easy to find and trade in the market, because investors commonly utilize them.

Meanwhile, there may be few contracts in the market that give investors the right to sell in a year—meaning trading those options is more likely to move their premiums.

Types of Options Trades

While simply buying a call or put is one way to trade in the options market, there are also multiple strategies involving the contracts that investors often employ.

Covered calls: A trade in which an investor sells bullish calls while also owning the underlying security. The selling of options helps the investor generate an additional stream of income while running the risk of having to deliver the shares they own if the security rises and the strike price is triggered.

An investor might do this trade when it seems there’s not much upside left in the security they hold.

Spreads: These trades involve buying or selling and equal number of options for the same underlying asset but at different strikes or expirations. Horizontal spreads involve different strike prices, while vertical spreads use different expiration dates.

Straddles and strangles allow investors to profit from a potential big move in the asset, rather than the direction of the move. In a straddle, an investor buys both bullish calls and bearish puts with the same strike prices and expiration dates.

The investor would pocket a profit if the asset price posts a big move, regardless of whether it rises or falls. In a strangle, the investors also buys both calls and puts but with different strike prices.

Options Trading in Recent Months

While it’s up for debate how often the derivatives market affects price moves in the underlying market it is tied to, business publications were reporting that that’s what happened in 2020 with technology stocks. Huge volumes in call options of technology stocks caused sellers of those contracts, typically banks, to hedge themselves.

They were reported to do this by buying shares of the underlying technology companies. This caused stock prices of the technology stocks to climb, which in turn, may have increased volatility in the market as the buying happened quickly and when there was a sudden reversal in prices that caused rapid selling.

The Takeaway

Options are derivative contracts that give the right, but not the obligation, to buy or sell an asset, making them a potentially useful tool if investors want to trade or hedge their portfolios.

If you’re looking for other investing options, SoFi Invest® may be a good choice. SoFi Active Investing allows you to buy and sell stocks and ETFs with no trading fees.

You work hard for your money—put your money to work. Open a SoFi Invest account today.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Active Investing
The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, please visit http://www.sofi.com/legal.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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Some pressing questions are common among investors:

•  What’s the best way to generate income during and after prime working years?
•  What’s the best way to protect assets from the ravaging effects of inflation?
•  What might be the most feasible way to get returns while minimizing risk?

To some, finding answers may seem like a daunting task. Where might an investor begin? The specifics will vary according to individual circumstances.

Fortunately, it doesn’t have to be quite as complicated as it sounds.

One of the most common goals of investing is capital appreciation. Capital appreciation investments include things like real estate, mutual funds, ETFs, municipal securities, and other assets that tend to (but not always) involve higher-than-average risk.

What is Capital Appreciation?

Capital appreciation is a way to grow money over time. The term refers to an increase in the price of an investment. The total appreciation of an asset equals the difference between the price at the time of purchase and the price at the time of sale.

Let’s say an investor purchases 100 shares of stock in imaginary Company A for $5 a share, for a total of $500. The imaginary company does well, and one year later the share price increases to $10 a share.

Those same 100 shares would now be worth $1,000. The capital appreciation is calculated by subtracting the original amount of capital invested from the total amount the investment is now worth.

In this example, the equation would look like this:

$1,000 – $500 = $500

The capital appreciation would be $500, which is sometimes also expressed as a percentage. In this imagined example, the appreciation would be 100% because the price doubled, or increased by 100% of its original value.

Of course, things don’t always work out so nicely. All investments carry risk.

Risks Associated With This Type of Investment

Assets intended for capital appreciation tend to come with greater risk than those intended for capital preservation.

For example, government-backed Treasury bonds are considered to be among the lowest-risk assets on the market. But bonds are for capital preservation and income (the interest paid to the bondholder), not for capital appreciation. Dividend-yielding stocks are similar to bonds in that they earn income and carry less risk than capital appreciation assets.

Equities that do not yield dividends only become profitable when their prices appreciate, and therefore are considered to carry more risk. Investing in equities for the capital appreciation alone is also known as growth investing. The term has its roots in the fact that a small company with a low share price needs to grow to return higher value to its shareholders.

Smaller companies tend to be risky because they have had less time to prove themselves and have a greater chance of going bankrupt than larger companies. That’s why penny stocks (stocks that trade under $5) are considered to be among the riskiest equities available.

But individual stocks are not the only assets intended for capital appreciation.

Assets Designed for Capital Appreciation

There are a few main categories of assets designed for profit through appreciation. These are things that investors typically hold for the long-term in the hopes that prices will rise. While this isn’t an exhaustive list, it provides a good overview.

Real Estate

Real estate is a piece of land and anything attached to that land. Residential real estate is only one example. There is also real estate related to commercial, industrial, and agricultural activities.

Real estate investment trusts (REITs) are securities tied to companies that own real estate or operate related assets. REITs trade like stocks and give investors exposure to real estate without having to own physical property. REITs pay dividends but are often considered to be higher-risk than dividend-yielding stocks.

Mutual Funds

A mutual fund consists of a pool of money from many investors. The fund might invest in any variety of assets including stocks, bonds, short-term Treasury notes, or anything else.

ETFs

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 they can track all the stocks in an entire index such as the S&P 500.

ETFs are referred to as passive investing because they don’t require any management on the part of the investor—investors simply buy the ETF as they would an ordinary stock and continue to hold it.

Stocks

Stocks are a type of security that represent ownership in a corporation. They can be thought of as little pieces of a publicly traded company that can be purchased on an exchange.

For long-term capital appreciation, the stocks of large companies tend to be sought after. As mentioned earlier, penny stocks tend to be seen as highly risky and speculative.

Commodities

Some examples of commodities include oil; copper; agricultural commodities like corn, wheat, and soy; and precious metals like gold, silver, and platinum. Commodities have what’s known as “intrinsic value,” meaning they have value in and of themselves. Whereas stocks, bonds, or other securities have their value tied to something else like the profits of a company, commodities are desirable for their different use cases (e.g., oil is needed to fuel vehicles).

Precious metals, in particular, may be used by some investors as long-term stores of value and sometimes see significant capital appreciation in times of crisis. Gold and silver have many industrial uses, particularly in making electronics like computers, smartphones, tablets, and TVs. Measured against the value of national government-issued fiat currencies (like the US dollar, also known as the Federal Reserve Note), gold and silver have appreciated well over time.

What Causes Capital Appreciation?

There are a number of things that can lead to capital appreciation of a given asset. These include factors specific to an individual investment as well as those affecting the financial world as a whole.

Company Growth

In the most traditional and straightforward sense, a stock price rises because the fundamental value of the company it represents rises.

Central Bank Policy

Ultra-low interest rates, including zero-interest rate policy (ZIRP) can also play a role in rising asset prices. Some countries in the European Union and elsewhere have even instituted negative-interest rate policy (NIRP).

How do interest rates influence asset prices?

A lower interest rate gives corporations the ability to borrow money at a lower cost. They can then use the borrowed money to invest in and grow their business, or they can buy shares of their own stock, known as corporate share buybacks. In this way, lowering interest rates allows central banks to flood the economy with money without having to create new currency.

Quantitative easing (QE), on the other hand, refers to a method of central bank intervention in which central banks purchase long-term securities to increase the supply of money and encourage investment and lending.

These methods can lead to asset prices rising because more money is being added to the economy—money that then flows into assets, bidding their prices higher.

Macroeconomic Factors

A strong economy overall can also contribute to certain assets rising in value. When economic growth is positive across the board and most companies are doing well, people typically have good jobs and can afford to spend more money. This can cause the price of assets to rise, as people are more willing and able to pay higher prices for things.

The opposite of this scenario is also true. When the economy as a whole endures a downturn, asset prices can fall. A good example of this would be the housing crash and resulting recession of 2008.

Speculation

Another potential cause of appreciation is speculation. Rather, speculation can lead to the illusion of legitimate appreciation.

Speculation occurs when many investors perceive the value of a particular asset as being higher than it really is and start buying the asset in anticipation of a higher price. This leads to the price being bid higher, but eventually it drops sharply as investors sell in a panic when they realize there’s no fundamental reason to keep holding the asset.

Capital Appreciation Bonds

Capital appreciation bonds are sometimes referred to as municipal securities because they are backed by local governments. They’re also sometimes referred to as zero coupon bonds because they don’t pay out interest until their maturity date. With these bonds, investors hope to receive a large return in the future by investing a small amount upfront.

Like all bonds, municipal securities yield interest. But instead of paying out interest annually, the interest gets compounded regularly until maturity. This leads to greater appreciation and gives the investor one lump sum payout at the end of the bond’s lifetime.

There are a few terms investors should be familiar with when it comes to capital appreciation bonds.

•  The initial amount of money invested into a bond is known as the principal. On the maturity date, the company issuing the bond must pay back the principal plus accumulated interest.

•  Par value refers to the amount investors receive when holding a municipal security until maturity. The difference between the principal and the par value is the amount of profit an investor will make, which is also referred to as the return on investment (ROI).

•  The interest on a bond is the money paid to bondholders in exchange for investing. With most other bond types, interest is paid out on an annual basis. With capital appreciation bonds, however, no interest payments are made until maturity. This is beneficial to both investors and bond issuers. Companies that issue these bonds don’t have to make interest payments until later, when their company may be earning greater profits. And investors receive a greater return due to compounding interest.

•  Time frame is the amount of time investors must wait before the bond reaches maturity. It can be possible to cash out of a bond early, but there will often be penalties associated with doing so. Capital appreciation bonds tend to offer longer terms than other municipal or corporate bonds. Ten years or 20 years are common time frames. This makes these bonds well-suited for long-term financial goals.

Capital Appreciation vs. Capital Gains

It should be noted that there is a difference between gains in terms of the price of an asset and the profits or losses realized from selling that asset. Profits and losses are not considered to be “realized” until a sale is made, at which point the capital gain or loss has been made real.

That’s an important point to keep in mind when witnessing the value of an investment going down, as will happen from time to time. Price declines don’t always spell losses, as losses are only realized at the time of sale.

Let’s go back to our previous example.

An equity investment worth $500 that becomes worth $1,000 saw capital appreciation of $500. If our imaginary investor were to sell at that position, the $500 appreciation would become a capital gain, subject to capital gains tax.

Capital gains tax can get complicated. The amount owed on capital gains varies according to three main factors:

•  If the capital gain or loss was short term (less than 12 months) or long term (more than 12 months).
•  The type of asset bought and sold.
•  Which tax bracket an investor falls into, which is mostly determined by annual income.

Long-term capital gains tax rates are lower than those on short-term capital gains—just another reason why some investors might choose to hold investments for the long-term.

The Takeaway

Capital appreciation is one part of a long-term investing strategy. Without it, building wealth over time might be much more difficult. SoFi can help investors get started managing their assets and making sure they grow well into the future. The no-cost financial planning offered to SoFi members can help build a budget, reach investment goals, borrow the right way, and more.

Talk with a SoFi financial planner to help plan your long-term financial goals and get started with SoFi Invest.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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To some, day trading may sound exciting. During the day, when the stock market exchanges are open, day traders attempt to capitalize on the short-term changes of the prices of stocks and other volatile investments. They may place many trades throughout the day in an effort to quickly secure profit. They may even use borrowed money to place trades, which both increases risk and the potential for reward.

But others may wonder, Is day trading bad? According to the US Securities and Exchange Commission
(SEC) , the regulatory body created to protect investors after the Great Depression, day trading is “neither illegal nor is it unethical.” But it is highly risky. The SEC’s take: “Most individual investors do not have the wealth, time, or the temperament to make money and to sustain the devastating losses that day trading can bring.”

Here’s a peek into the high-stakes world of day trading, as well as some day trading risks.

Who is a Day Trader?

In the world of investing, there are long-term investors, day traders, and everything in between. While a long-term investor may employ a strategy that involves purchasing investments to hold for years or even decades, a day trader may keep a stock for only minutes or hours, and close out all positions prior to the end of the trading day, due to the possibility of wide price swings overnight. Day traders may also look to exploit changing prices using ETFs, futures, options, and currencies.

Investing implies the desire to purchase an item that will increase in value over time—to pick a “good” investment. This is often done through a fundamental analysis of that investment, including it’s price relative to value. That in-depth analysis is not of interest to a day trader.

Both “bad” and “good” investments may experience price fluctuation, despite (or in lockstep with) its overall trajectory. And that’s where a trader hopes to capitalize—on price short-term volatility, whether or not the investment is “fit” for long-term holding.

Day traders often use what is called technical analysis—the study of what has happened to the price of stock in the past. Day traders attempt to detect patterns of motion, called trends. (It should be noted that across the industry, there is plenty of disagreement as to whether such patterns exist, or whether there is any real way to read trends in a consistently repeatable way.)

In the short-term, factors such as changes in investor sentiment may drive stock prices. In other words, the very forces of buying and selling—also known as supply and demand—cause prices to wiggle. Goings-on at the company and the world at large absolutely matter, but nothing has a unilateral impact on prices. For example, a solid earnings report may influence investors to buy—but it also might not. Also, what incentivizes one investor to buy or sell a stock may not factor into another investor’s decision. All of the many factors that influence demand, added together, create volatility.

Top Risks of Day-Trading

Because there is no single method for consistently predicting global investor demand, day trading is particularly tricky. Further, the market may process out any widely-known strategy. (For any popular strategy, there will surely be plenty of market participants willing to take the opposing stance.) Day trading relies on imperfect science, resulting in plenty of opinions on whether or not day trading is bad.

Day trading is certainly not for the risk averse. Here are some of the biggest risks of day trading.

Financial losses

Depending on the day trading strategy, it is certainly possible to lose hundreds or thousands of dollars—or more—in the course of just one trading day. Further, it is possible to both lose the entire amount invested (the principal) including any borrowed money, which must be repaid.

Trading on margin—and losing

It is a common practice for day traders to use borrowed money to engage in popular strategies such as short selling and forex trading. Trading or investing on a loan from the broker is called “buying on margin” or “trading on margin.” By using borrowed money, investors have the opportunity to multiply their profits using leverage. But just as quickly as leverage can generate profit, it can destroy wealth.

Stress

Imagine a scenario where an investor has been watching trend graphs on a computer screen for hours on end, only to have a small fortune wiped away by one wrong bet. Between the constant possibility of losing money and the time spent monitoring the market, day trading is a demanding endeavor.

Time commitment

Day trading requires hours at a time at a computer, tracking the prices of different stocks. It also requires research into different methods, training and practice, and ongoing learning—none of which comes with a guaranteed pay-off. For some day traders, what starts as a hobby can morph into a full-time job, an obsession, or even a case of pathological trading.

Expense

Day trading can be expensive. Though the total cost will depend on factors like the types of transactions and the brokerage bank or trading platform used, traders should prepare for fees and commissions. Additionally, training, software, computers, and research can easily run up a trader’s bill—all of which could impact any return on their investment strategy.

Scams, False Claims, and “Expert Advice”

Day traders are typically in the market to make a quick buck. Combine this with the sheer difficulty of forecasting the direction of the stock market in any predictable way and it creates a rich environment for which scams, false claims, and pricey advice from non-experts.

When working with a trading firm, the SEC recommends that investors inquire as to the proportion of their clients that have lost money. Furthermore, when receiving any financial advice—whether from individuals, firms, educational seminars, classes, or books—it is important to know both the experience and credentials of the person giving the advice, as well as their incentive structure.

All trading firms must register with both the SEC and the states in which they operate. One thing day traders can do to ensure their safety is call their state securities regulator and inquire about both the firm’s registration and track record with regulators, and customer complaints. To obtain the number of a state regulator, visit the North American Securities Administrators Association’s website .

The Takeaway

Day trading is a high-risk, high-pressure pursuit. For those interested in utilizing day trading strategies, it’s smart to consider the cost. Many major brokerage firms can accommodate day trading, however, it can be costly to place each trade. It’s important to account for the cost of these fees, called transaction or trading fees, when calculating any potential profits.

With SoFi Active Investing, investors can buy and sell stocks and ETFs with no commissions. This allows investors the opportunity to test their trading strategies and skills without prohibitive costs.

For investors that prefer a fully-built portfolio and passive strategy, SoFi Automated Investing builds an investment strategy tailored to the individual—and does all the work to keep it running smoothly.

Find out more about no-fee trades and no account minimums with SoFi Invest®.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Automated Investing
The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA / SIPC , (“SoFi Securities”).
Active Investing
The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, please visit http://www.sofi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer to sell, solicitation to buy or a pre-qualification of any loan product offered by SoFi Lending Corp and/or its affiliates.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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