Rule of 72 Explained

Consider this fantasy: A person strides into a Las Vegas casino, slaps a stack of money down at the roulette table, putting it all on black. The wheel starts to spin, the ball lands on black, and boom, that money is doubled.

If only making money with investments were so easy, but it often takes years before investment gains reach that point.

The Rule of 72 is a shortcut equation to help you figure out just how long it will take to double an investment at a given rate of return. Best of all, the math is easy to do without the help of a calculator.

What Is the Rule of 72?

The Rule of 72 helps investors understand how different types of investments might figure into their investment plans. The formula for the rule is:

Number of years to double an investment = 72 / Interest rate.

In the case of investing, the interest rate is the rate of return on an investment. And that return compounds regularly.

For example, an investor has $10,000 to invest in an investment that offers a 6% rate of return. That investment would double in 72 / 6 = 12 years. Twelve years after making an initial investment, the investor would have $20,000.

Notice that when making this calculation, investors divide by six, not 6% or 0.06. Dividing by 0.06 would indicate 1,200 years to double the investment, an outlandishly long time.

This shorthand allows investors to quickly compare investments and understand whether their rate of return will help them meet their financial goals within a desired time horizon.

Where Did the Rule of 72 Come From?

The Rule of 72 is a shortened version of a logarithmic equation that involves complex functions you would need a scientific calculator to calculate. That formula looks like this:

T = ln(2) / ln(1 + r / 100)

In this equation, T equals time to double, ln is the natural log function, and r is the compounded interest rate.
This calculation is too complicated for the average investor to perform on the fly, and it turns out 72 divided by r is a close approximation that works especially well for lower rates of return. The higher the rate of return—as the rate nears 100%—the less accurate the Rule of 72 gets.

What is Compound Interest?

To understand how the Rule of 72 works, it’s important to get a clear idea of how the interest rate in the equation functions. There are two types of interest rates: simple interest and compound interest.

Simple interest is calculated using only the principal or starting amount. For example, an individual opens an account with $1,000 and a 1% simple interest rate. At the end of the year, they will have $1,010 in their bank account. But they’ll only earn 1% each year on their principal, aka that initial $1,000.

So even over a longer time period, the individual isn’t earning very much—after 10 years, for example, they will have accumulated a total of $1,100.

Simple interest may be even easier to conceptualize as a savings account from which an individual withdraws the interest each year.

In the example above the individual would withdraw $10 at the end of the year and start again with $1,000 the next year. Every year after that, they would start over with the same principal and earn the same amount in interest.

Compound interest, on the other hand, can help investments grow exponentially. That’s because it incorporates the interest earned on an investment in addition to the initial investment. In other words, an investor earns a return on their returns.

To get an idea of the power of compound interest it might help to explore a compound interest calculator , which allows users to input principal, interest rate, and compounding period.

For example, an individual invests that same $1,000 at a 6% interest rate for 30 years with interest compounding annually. At the end of the investment period, they will have made more than $5,700 without making any additional investments.

That fact is important to consider when conceptualizing the Rule of 72, because compound interest plays a big role in helping an investment double in value within a given time frame. It can help achieve high reward with relatively little effort.

What Can Be Learned From the Rule of 72?

For a relatively simple equation, the Rule of 72 can help investors figure out a lot of helpful information. For one, it can help them compare different types of investments that offer different rates of returns.

For example, an investor has $25,000 to invest and plans to retire in 20 years. In order to meet a certain retirement goal, that investor needs to at least double their money to $50,000 in that time period.

The same investor is presented with two investment options: One offers a 3% return and one offers a 4% return. The investor can quickly see that at 3% the investment will double in 72 / 3 = 24 years, four years past their retirement date. The investment with a 4% return will double their money in 72 / 4 = 18 years, giving them two years of leeway before they retire.

The investor can see that when choosing between the two options, choosing the 4% rate of return will help them reach their financial goals, while the 3% return will leave them short.

Higher returns are often correlated with higher risk. So this rule can help investors gauge whether their risk tolerance—or their return on investment—is high enough to get them to their goal. Depending on what their time horizon is, investors can easily see whether they need to bump up their risk tolerance and choose investments that offer higher returns.

By the same token, this rule can help investors understand if their time horizon is long enough at a certain rate of return. For example, the investor in the above example is already invested in the instrument that offers 3%.

The Rule of 72 can illustrate that they may need to rethink their timeline for when they will retire, pushing it past 20 years. Alternatively, they could sell their current investments and buy a new investment that offers a higher rate of return.

It’s important to understand that the Rule of 72 does not take into account additional savings that may be made to the principal investment. So if it becomes clear that the goal won’t be met at the current savings rate, an investor will be able to consider how much extra money to set aside to help reach the goal.

For example, if a 401(k) plan includes investments that offer a 6% return, the investment will double in 12 years. Is that fast enough according to the investor’s time horizon? If not, they may need to take a closer look at their retirement plan to figure out how to make up the difference.

Digging a Little Deeper

The Rule of 72 is really just a convenient short-hand that can give investors an idea of the effects of compounding interest over time.

In addition to an initial investment, interest rate, and compounding period, these calculators allow investors to input a monthly contribution rate. The resulting calculation will be an accurate picture of how much the investor will save over that given period.

For example, an investor makes an initial investment of $1,000 and a subsequent investment of $100 per month for the next 30 years. At a 6% rate of return compounded monthly, the investor would have saved more than $106,000.

Their total contribution would only have been $37,000, meaning through returns and the power of compound interest, the investor would have made about $69,000 in returns.

These tools can help investors understand how much to change their monthly contribution to reach higher savings goals.

What Else Can the Rule of 72 Be Used For?

The Rule of 72 can be used in other scenarios that use the principle of compounding interest. For example, a borrower that has credit card debt can figure out at what point their debt will double.

If the borrower owes $1,000 on their credit card with a 14% interest rate, they will double what they owe in a little over five years—and that’s if they stop using their card altogether in the interim.

The Rule of 72 can also be used to see the effects of things like inflation or fees that can take a bite out of an individual’s buying power.

For example, at an inflation rate of 2%, an individual’s money will lose half its buying power in 36 years (72 divided by 2). Bump the inflation rate up to 3% and it would only take 24 years for the value of an individual’s money to be cut in half.

Similarly, the Rule of 72 can help you understand the effects of investment fees. If you invest in a mutual fund that charges 3% fees, after 12 years (72 divided by 3), your investment principal will theoretically be cut in half.

Note, this is just the principal, the amount you initially invested, and does not account for gains in value or compounded returns the investment might have achieved.

Finally, the Rule of 72 doesn’t have to be used just for money. It can be used to help understand anything that grows exponentially, such as populations.

Hypothetically speaking, if a country’s population is growing at a constant 2%, the population would double in 72 divided by 2, or 36 years. Of course, this calculation is only an estimate and doesn’t take into account other factors, such as birth rate, that might affect population growth.

Variations on the Rule of 72

The Rule of 72 is only an approximation and depending on what you’re trying to understand there are a few variations of the rule that can make the approximation more accurate. One variation is the Rule of 69.3.

The rule of 72 is most accurate at 8%, and beyond that at a range between 6% and 10%. You can, however, adjust the rule to make it more accurate outside the 6% to10% window.

The general rule to make the calculation more accurate is to adjust the rule by one for every three points the interest rate differs from 8% in either direction.

So for an interest rate of 11%, individuals should adjust from 72 to 73. In the other direction, if the interest rate is 5%, individuals should adjust 72 to 71.

Some people prefer to use the Rule of 69.3, especially when interest compounds daily, to get a more accurate result. That number is derived from the complete equation ln(2) / ln(1 + r / 100). When plugged into a calculator by itself, ln(2) results in a number that’s approximately 0.693147.

Investors may find this calculation more difficult to do without a calculator than the Rule of 72.

Ready to Start Investing?

As we’ve seen, the Rule of 72 works best at interest rates between 6% and 10% , which individuals are likely to achieve through investment accounts. Investors may consider applying the Rule of 72 to an existing account to help estimate the future value of the investment.

For those who don’t already have an investment account, they might consider opening one through their bank or a brokerage firm. Some firms may have minimum deposit requirements to open an account, while others may not.

After a brokerage account is funded, an investor can then start placing orders to buy and sell investments online or through a stock broker who will execute trades on behalf of the investor.

Consider SoFi Invest® and get started with as little as $1 and trade stocks and exchange-traded funds with no management fees.

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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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.


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6 Moves to Make Before a Market Downturn

For Americans who view the stock market as a spectator sport, it can be entertaining to watch TV’s financial pundits roll up their sleeves and start waving around at charts that show large, downward-pointing arrows when stock prices take a dip.

But for investors who go from celebrating their portfolios one day to crying over them the next, a stock market downturn is no joke.

There’s no doubt that investing hard-earned money into a market that’s largely out of individual control comes with some risk, and market volatility is actually a sign that things are working the way they’re supposed to. But logic can quickly take a back seat to panic when stock prices take a nose-dive.

The good news? It’s possible to create a proactive, anticipatory financial plan that can help investors prepare for, get through, and even come out the other side of a market decline with flying colors. Here are some strategies for riding—and surviving—the roller coaster.

Why Does the Stock Market Go Bear?

When the good times roll and stock prices are way (way) up, many people picture the stock market like something out of “Wolf of Wall Street.” It’s referred to as a bull market, and it’s always the ideal—so much so that artists erected a giant bronze bull sculpture in front of the New York Stock Exchange.

But when the major stock indexes fall by 20% or more from their most recent peak—and stay there for two months or more—it’s called a bear market. It’s not a new or unexpected idea, but it’s safe to say that we’re not likely to see a grizzly sculpture in downtown NYC any time soon.

It’s also never easy to predict what might send investors into sell mode. The reasons could be based on economic fears or uncertainties, such as recent worries about a trade war between the US and China, a change in the federal interest rate, or something completely unrelated to business, such as a terrorist attack, public health concerns, or natural disaster.

The stock market, for the most part, seems to follow a “perception is reality” view of the economy where everything—regardless of its source—is connected.

For a real-life, 21st-century example, consider that Peloton ad from December 2019—you know the one.

It went viral on social media and caused a public outcry, and the company’s stock dropped to the tune of $1.6 billion in short order. This stock has since rebounded because of the demand for in-home workouts. But, this example shows the volatile nature of the stock market.

This stock has since rebounded because of the demand for in-home workouts. But, this example shows the volatile nature of the stock market.

And while that’s an individual instance, the resulting supply-and-demand effect is relatively easy to expand to an entire industry or even the US economy as a whole.

Why Volatility is a Good Thing

Reward doesn’t usually come without some risk, so those periods of sell-off and correction are seen by many investors as a necessary evil. But just how much fluctuation is normal?

That’s a loaded question.

The benchmark for the US stock market is the S&P 500, which was officially opened for trading in 1957 as an index of the country’s 500 leading companies. Since then, it’s averaged an annual return of around 7% (based on the inflation-adjusted annual return of the S&P 500 since 1926), and many investors see it as the bellwether for the economy at large.

The S&P 500 has experienced at least 23 corrections over the past three decades, meaning a decrease of 10% or more. Eleven of those were drops of more than 20%, leading to bear markets. On average, the larger drops have happened every five to 10 years or so, with smaller fluctuations in between.

The largest drop in recent history was 57% in October of 2007, brought about by the subprime mortgage crisis and eventually leading to a recession. But the good news is that even that huge decline in stock prices eventually recovered. In fact, every market decline in history has done the same.

How to Plan for a Market Downturn

Some smart financial planning strategies can help keep outlooks (and outcomes) on the up-and-up, no matter what happens on the trading floor.

1. Keeping Your Eye on the Ball, and the Long Haul

In poker, there’s a phrase called “going on tilt”—a player loses a large stack of chips and then loses their cool. Investors can go on tilt, too, if they freak out and sell everything the moment there’s a sign of trouble.
Both versions are driven by emotion vs. strategy, and both can lead to bad decisions and missing out on big opportunities.

And the media may not help, especially when financial commentators take to the airwaves armed with speculations, theories, and advice. When faced with a lot of hype, one of the smartest things an investor can remember is that no one has a crystal ball in their arsenal.

It can also be smart to keep in mind that just as no one can predict the market, most experts aren’t so great at timing their investments, either. In fact, the passive S&P 500 has outperformed active fund managers—whose sole job is to outperform the market—for nine years in a row .

Some experts even recommend investing in a down market, especially in a long-term retirement plan like a 401(k). Why? Because if one thinks of a lower stock price as being on sale, any elective salary contributions have the potential to go further.

2. Evaluating Your Asset Allocation

When it comes to creating a balanced portfolio, whether it’s a personal portfolio or a retirement plan such as a 401(k) or IRA, diversification tends to get all the attention. But it has a first cousin as well, called asset allocation, that is just as important for aiming to minimizing risk.

The two terms are often used interchangeably, but here’s the difference: Diversification is ensuring that a portfolio is well-balanced across one type of asset class—stocks, for example.

A good financial adviser may suggest a mix of large-cap funds, mid-cap funds, mutual funds, indexes, and perhaps individual stocks for diversification. Asset allocation, on the other hand, is investing in not only stocks, but also other asset classes, such as commodities, bonds, cash, or real estate.

Asset allocation can help protect against a market downturn because where one class of assets might go down, another might go up. How assets are divvied up depends on financial goals, risk tolerance, investment timelines, and past performance. Bonds, for example, can be one smart way to balance out stocks because they generally have an inverse relationship with stocks.

And while they operate more like a loan and don’t carry the explosive growth potential that stocks do, they are one way to add stability to a portfolio, especially as an investor reaches retirement age.

Likewise, commodities such as precious metals, oil, or farm futures tend to work in opposition to the value of the US dollar—when one goes up, the other goes down.

All the choices—and the choices within the choices—can quickly get overwhelming for average investors. One easy way to simplify is to invest in mutual funds or exchange-traded funds (ETFs), two types of investments that come pre-packaged with a mix of stocks, bonds, and other assets.

Since mutual funds are actively managed by professionals, they’re likely to incur fees between 1% and 3%. ETFs, on the other hand, are often either managed by robo advisors or not managed at all, and can be traded with low or no commission fees.

3. Looking for Value Stocks

Stocks are generally classified as value (also called defensive) and growth. The growth stocks are the up-and-coming, risky ones that trade above market averages, and value stocks are the old, faithful, long-standing companies that tend to trade lower than average.

Generally speaking, value stocks tend to weather market fluctuations better than their growth counterparts because of their steady growth history or ever in-demand products. They can include companies like utilities, health care organizations, or consumer staples.

Finding a true value stock can involve quite a bit of digging—and math. Here’s our look at how to evaluate individual stocks before you buy.)

4. Determine Your Time Horizon

In investing terms, a time horizon is the amount of time someone plans to hold on to a stock or bond in order to meet a specific goal.

For young investors with time on their side, a personal portfolio or retirement account that’s heavy in high-risk growth stocks could be a smart investment, because they have the ability to go through the downturns and still have time to recover—not to mention a long time to take advantage of compounded interest.

As someone moves closer to retirement, however, and the time horizon becomes shorter, experts often recommend moving money over into more stable investments, such as bonds or value stocks.

The reason is simple: A market correction when someone is only a year or two from retirement could put a serious dent in their financial goals and maybe even force them to re-evaluate leaving work.

5. Shoring up your Savings-vs.-Spending Strategy

If a decline in stock value could negatively affect a portfolio, one alternate strategy to consider could be to invest in cash instead. A good rule of thumb is to have an emergency fund stashed away that covers three to six months of living expenses, and it’s not just to have on hand in case of a job loss.

Recent reports show that around 27% of Americans borrow from their 401(k) plans before reaching retirement age.

It’s a decision that already incurs a penalty for withdrawing the money early—and if that need arises when the fund is already on the low side, the losses could be significant. Having a solid cash account on hand could eliminate that need.

The time horizon comes into play here as well, where cash reserves could be the potential difference between staying on track to retire during a downturn and having to work until the markets recover.

One option at retirement age is having two years’ worth of expenses available in cash and a portfolio that’s 60% stocks and 40% bonds (one that’s likely to recover within two years after a bear market).

6. Remaining Open-Minded (and Open-Ended) About Work

Considering all options to ward off a market slump includes taking a look at employment, both current and future, with an open mind.

If retirement calculators aren’t coming up with numbers that will be workable in a set timeframe, what changes are on the table? If it’s possible, a few extra years of income, especially during a bear market, can help build up a nice cash safety net (not to mention postponing and boosting Social Security benefits.)

That doesn’t have to mean staying in a cubicle a minute longer than necessary, though.

For hustlers of all ages, side gigs have quickly trended as a way to add to income while enjoying life at the same time. And for investors closer to retirement age, leaving one career for another might not only bring in more money but also fulfillment.

Work With a Trusted Partner

In order to make investments work as hard as possible, consider enlisting the help of a professional. SoFi Invest® not only helps members invest based on their risk tolerance, goals, and time horizon, but also provides access to real, live financial advisers who can answer investment questions.

It’s a service that SoFi provides at no cost to members because we value keeping investments on track as much as you do.

For help with online investing during the good times and the bad, SoFi Invest® is an easy, automated way to invest, but with the assistance of real, live wealth advisors.

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.
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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.


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6 Investment Risk Management Strategies

Risk is everywhere, every day. Some people take steps to protect themselves and manage that risk. Others leave it up to luck.

The same holds true when it comes to building wealth for the future. Some investors focus strictly on returns and how fast they can grow their money. Others protect themselves against the inevitability of a correction or a bear market by using various risk management strategies.

That cautiousness doesn’t mean they’re paralyzed with fear, stuffing money under the mattress or sticking only to the safest investments they can find. The purpose of investment risk management is to ensure losses never exceed an investor’s acceptable boundaries.

It’s about understanding the level of risk a person is comfortable taking and building an investment portfolio with appropriate investments that also will work toward achieving that individual’s goals.

An investor’s risk tolerance is usually determined by three main factors:

Risk capacity: How much can the investor afford to lose without it affecting actual financial security? Risk capacity can vary based on age, personal financial goals, and an investor’s timeline for reaching those goals.

Need: How much will these investments have to earn to get the investor where they want to be? (An investor who is depending heavily on investments may be faced with a careful balancing act between taking too much risk and not taking enough.)

Emotions: How will the investor react to bad news (with fear and panic? or clarity and control?), and what effect will those emotions have on investing decisions? Unfortunately, this can be hard to predict until it happens.

Why is risk management important? Those who are able to preserve their capital during difficult periods will have a larger base to grow from when good times return.

With that in mind, here are some strategies investors sometimes use to manage the risk in their portfolio.

Strategies to Help Manage Investment Risk

1. Reevaluating Portfolio Diversification and Asset Allocation

You’ve probably heard the expression “don’t put all your eggs in one basket.” Portfolio diversification—allocating money across many asset classes and sectors—could help with avoiding disaster in a downturn. If one stock tanks, others in different classes might not be so hard hit.

Investors might want to consider owning two or more mutual funds that represent different styles, such as large-cap, mid-cap, small-cap, and international stocks, as well as keeping a timeline-appropriate percentage in bonds. Those nearing retirement might consider adding a fund with income-producing securities.

But investors should beware of overlap. Investors often think they’re diversified because they own a few different mutual funds, but if they take a closer look, they realize those funds are all invested in the same or similar stocks.

If those companies or sectors struggle, investors could lose a big chunk of their money. Investors could avoid overlap by simply looking at a fund’s prospectus online.

To further diversify, investors also may want to think beyond stocks and bonds. Exchange-traded funds, cryptocurrency account, commodities, and real estate investment trusts (REITs) are just a few of the possibilities.

Investors could also diversify the way they invest. Long gone are the days when everyone turned to a stockbroker or a financial advisor to grow their money.

An investor might have a 401(k) through work but also open a traditional IRA or Roth IRA online through a financial company.

2. Lowering Portfolio Volatility

One of the easiest ways to help reduce the volatility in a portfolio is to keep some percentage allocated to cash and cash equivalents.

This may keep an investor from having to sell other assets in times of need (which could result in a loss if the market is down).

The appropriate amount of cash to hold may vary depending on an investor’s timeline and goals. If too much money is kept in cash for the long-haul, it might not earn enough to keep up with inflation.

There are other options, however, including:


The goal of rebalancing is to lower the risk of severe loss by keeping a portfolio well-diversified. Over time, different assets have different returns or losses based on the movements of the market. Rebalancing helps get things back to the mix the investor wants based on personal risk tolerance.

Rebalancing can often feel counterintuitive because it can mean letting go of investments that have appreciated in value (the ones that have been fun to watch) and buying investments that are declining in value.

Forgetful investors may even be able to sign up for automatic rebalancing. Without rebalancing, a portfolio’s mix may become stock heavy or sector heavy, which may significantly increase risk.

Buying bonds

Unless investors are regularly rebalancing their portfolio (or are having it done automatically), their mix may be skewing more toward stocks than they think. Those who are concerned about market volatility might want to rebuild the bond side of their portfolio.

Bonds might not be considered the safe haven they once were, but bonds with a lower duration can still play a defensive role in a diversified portfolio. And bonds often can be used to produce a steady stream of income that can be reinvested or used for living expenses.

Municipal bonds can generate tax-free income. Bonds, bond ETFs, and treasuries can all serve a purpose when the market is going down.


The beta of a stock is a measure of the interrelationship between the stock and the stock market. A beta of one, for example, means the stock will react in tandem with the S&P 500. If the beta is below one, the stock is less volatile than the overall market.

A beta above one indicates the stock will have a more marked reaction. So replacing high beta stocks with lower beta names could help take some of the menace out of market fluctuations.

3. Investing Consistently

For those looking for quick returns, picking the “right” stock and selling it at the “right” time is everything. Using a dollar-cost averaging strategy is different. It’s all about patience, discipline, and looking at the long term. And it can help investors keep emotions out of the process.

With dollar-cost averaging, investors contribute the same amount at regular intervals (usually once or twice a month) to an investment account. When the market is down, the money buys more shares. When the market is up, it buys fewer.

But because markets generally rise over time, investors who can keep their hands off the stash might build a pretty nice pot of money over the long term—especially compared to what they might get from a savings account or money market account.

Some investors hand over their cash every month and don’t pay much attention to where their 401(k) plan administrator or the bank with their IRA might put it. But carefully choosing the companies represented in a portfolio—focusing on those with sustained growth over time—could help make this strategy even stronger.

4. Getting an Investment Risk Analysis

For years, financial professionals have mostly labeled investors’ risk tolerance as “aggressive,” “moderate,” or “conservative.”

Pretty self-explanatory. But it also can be pretty subjective. The term “moderate,” for example, might mean one thing to a young investor and another to an aging financial professional.

An investor might not even know how they’ll react to a market slump until it happens. Or a person might feel aggressive after inheriting some money but conservative after paying a big medical bill.

To help with clarity, many in the financial industry are now using software programs that can help pinpoint an investor’s attitude about risk, based on a series of questions.

They can also better determine how an investor’s current portfolio matches up to a particular “risk score.”

And they can analyze and stress test the portfolio to show just how the client’s investments might do in a downturn similar to the ones in 2000 or 2008.

Identifying an investor’s current position and goals might make it easier to create a more effective plan for the future. This could involve identifying the proper mix of assets and realigning existing assets to relieve any pressure points in the portfolio.

5. Requiring a Margin of Safety

“Buy low, sell high!” is a popular mantra in the financial industry, but actually making the concept work can be tricky. Who decides what’s high and what’s low?

Value investors implement their own margin of safety by deciding that they’ll only purchase a stock if its prevailing market price is significantly below what they believe is its intrinsic value.

(For example, an investor who uses a 20% margin of safety would be drawn to a stock with an estimated intrinsic value of $100 a share but a price of $80 or less per share.

The greater the margin of safety, the higher the potential for solid returns and the lower the downside risk.
Because risk is subjective, every investor’s margin of safety might be different—maybe 20% or 30% or even 40%. It depends on what that person is comfortable with.

Determining intrinsic value can take some research. A stock’s price-to-earnings ratio (P/E) is a good place to start. Investors can find that number by dividing a company’s share price by its net income, then compare the result to the P/E ratio posted by other companies in the same industry.

The lower the number is in comparison with the competition, the “cheaper” the stock is. The higher the number, the more “expensive” it is.

6. Establishing a Maximum Loss Plan

A maximum loss plan is a method investors can use to cautiously manage their asset allocation. It’s designed to keep investors from making bad decisions based on their anxiety about movements in the market.

It gives investors some control over “maximum drawdown,” a measurement of decline from an asset’s peak value to its lowest point over a period of time, and it can be used to evaluate portfolio risk.

This strategy calculates a personal maximum loss limit and uses that percentage to determine appropriate asset allocation, but that asset allocation won’t necessarily be a good fit for someone else. It isn’t a one-size-fits-all plan.

Here are the basic steps:

1. Based on historic market numbers, the investor chooses an assumed probable maximum loss for equities in the stock market. For example, since 1926, there have been only three calendar years in which the S&P 500’s total return was worse than -30%. The worst year ever was 1931, at -44.20%. So the investor might choose 40% as a probable maximum loss number, or maybe 35% or 30%.

2. Next, based on personal feelings about market losses, the investor chooses the maximum amount they are willing to lose in the coming year. Again, it’s up to the individual to determine this number. It could be 20% or 30%, or somewhere in between.

3. Finally, the investor divides that personal portfolio maximum loss number by the assumed probable maximum loss number. (For example, .20 divided by .35 = .57 or 57%.)

In this example, the investor’s target equity asset allocation would be 57% when market valuations are average (or fair value).

The investor might raise or lower the numbers—and be more aggressive or conservative—depending on what’s happening in the market.

The Best Offense Is a Great Defense

Whatever strategy an investor chooses, risk management is critical to keeping hard-earned savings safer and losses to a minimum.

Remember: As losses get larger, the return that’s necessary just to get back to where you were also increases. It takes an 11% gain to recover from a 10% loss. But it takes a 100% gain to recover from a 50% loss.

That makes playing defense every bit as important as playing offense.

Want to put SoFi Invest®️ on your team? SoFi offers an active investing solution for do-it-yourself investors who want to take a hands-on approach to online investing without paying trading fees or commissions.

SoFi also offers an automated investing solution for investors who want a diversified strategy without having to make all the decisions themselves.

Either way, SoFi investors have access to financial advisors who can help them make safe and smart choices.

Ready to get a handle on risk? Learn more about how SoFi Invest can help.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SoFi Invest®
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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