Investing Archives | Page 143 of 221

Dec

2022

Benefits of ETFs — Pros & Cons in Investment Portfolio

By Inyoung Hwang | Growing Wealth, Investing | Comments Off

Exchange-traded funds (ETFs) are a popular way to build a simple and low-cost diverse portfolio. There are many investing benefits to ETFs, which is why they’ve grown in popularity both for DIY investors and for more traditional money managers.

ETFs may be a good investment strategy if you’re looking to invest a lump of money for a long-term investment goal. Let’s understand how ETFs work, how they get traded, and their advantages and disadvantages.

What Are the Benefits of ETFs?

Exchange-traded funds (ETFs) have become increasingly popular in recent years, especially with the rise of online brokerages allowing people to buy and sell them quickly.

As an investment tool, ETFs have become popular: there were more than 8,500 ETFs in the world with more than $10 trillion in assets under management (AUM) at the end of 2021. Meanwhile, in the U.S., there were about 3,000 ETFs that had approximately $5.9 trillion AUM as of September 2022.

Easy to Trade

ETFs are traded on stock exchanges and can be bought and sold throughout the day, like individual stocks. The market determines the price for a share of an ETF and changes throughout the day. This means investors can easily buy and sell ETFs, making them a convenient investment option.

Portfolio Diversification

An additional benefit of an ETF is that you don’t need a lot of money to invest in many different things. One share of an ETF offers investors a way to diversify their portfolio by investing in a basket of assets, such as stocks, bonds, or commodities, rather than just a single asset. This can help to reduce the overall risk of an investment portfolio.

Accessible Across Markets

There is also a range of ETFs on the market now: stocks, bonds, commodities, real estate, and hybrids that offer a mix. ETFs also vary in how they target certain assets — aggressively or defensively, specific to one asset class or broad. So investors should be able to find what they want and build a diverse portfolio.

Lower Costs

Most ETFs are passively managed and track a benchmark index, meaning portfolio managers don’t actively manage the fund to try to beat the market or an index. Passive investing, as opposed to active investing, may be more cost-effective because there is less overhead and fewer investment fees.

Because there is less overhead, ETFs generally charge investors a lower operating expense ratio than actively managed mutual funds. The operating expense ratio is the annual rate the fund charges to pay for portfolio management, administration, and other costs.

There are other costs investors need to consider, like commissions for trades and a bid/ask spread.

💡 Recommended: What Are the Different Types of Investment Fees?

Tax Efficiency

ETFs tend to be more tax efficient than mutual funds because they typically generate fewer capital gains and capital gains taxes. This is because passively managed ETFs tend to have lower turnover than actively managed mutual funds, which means they sell fewer assets and, thus, result in fewer capital gains.

Transparency

ETFs generally disclose their holdings daily, so investors can see exactly what assets the ETF holds. This can be helpful for investors who want to know what they are investing in.

Flexibility

ETFs can be used in various investment strategies, including as part of a long-term buy-and-hold strategy or as a short-term trading tool. This makes them a flexible investment option for a wide range of investors.

Moreover, investors can trade thematic ETFs — funds focusing on a specific trend or niche industry, like robotics, artificial intelligence, or gender equality. However, there are pros and cons to thematic ETFs. While they allow investors to make more targeted investments, the shares of these funds can be volatile. Because they’re so focused, these ETFs may also diminish the most important benefit of ETFs: broad, diverse exposure.

Disadvantages of ETFs

While ETFs offer many benefits to investors, there are also some potential disadvantages to consider. These disadvantages include the following:

Lack of Personalization

Because ETFs are not actively managed, they do not consider an investor’s specific financial goals or risk tolerance. A lack of personalization means that ETF investors may be unable to tailor their investment portfolio to their particular financial needs.

Tracking Error

ETFs are usually designed to track the performance of a particular index or basket of assets. However, the performance of the ETF may not precisely match the performance of the underlying index due to various factors, such as the fund’s expenses or the timing of when it buys and sells assets. This is known as a tracking error.

Short-Term Trading Costs

ETFs can be traded on the market throughout the day, making them attractive to short-term traders. However, the commission costs of trading ETFs can add up over time, which can eat into investment returns.

Limited Choices

While many ETFs are available, the range of options may be limited compared to other investment vehicles, such as mutual funds. Thus, investors may be unable to find an ETF that perfectly matches their investment needs.

💡 Recommended: ETFs vs. Mutual Funds: Learning the Difference

Counterparty Risk

Certain ETFs may use financial instruments, such as futures contracts or swaps, to gain exposure to specific assets. These instruments carry counterparty risk, which means that there is a risk that the counterparty will not fulfill its obligations under the contract. This can expose ETF investors to additional risks.

Complexity

Some ETFs use complex investment strategies, such as leveraged or inverse ETFs, which can be difficult for some investors to understand. Complex investing strategies can make it challenging for investors to fully understand the risks and potential returns of these types of ETFs.

Market Risk

ETFs, like all investments, are subject to market risk, meaning the value of an ETF can go up or down depending on the performance of the underlying assets.

What to Consider When Investing in ETFs

When investing in ETFs, it is essential to consider the following factors:

• Investment objective: Determine your investment goals and how ETFs fit into your overall investment strategy. This can help you choose an ETF that aligns with your financial goals and risk tolerance.

• Asset class: Consider which asset classes you want to invest in and whether an ETF that tracks those assets is available. For example, if you want to invest in large-cap domestic stocks, look for an ETF that tracks a particular large-cap domestic stock index.

• Diversification: ETFs offer a way to diversify your investment portfolio by investing in a basket of assets rather than just a single asset. Consider the level of diversification an ETF offers and whether it aligns with your investment goals.

• Expenses: ETFs typically have lower fees than mutual funds because they are not actively managed. However, it is still important to compare the expenses of different ETFs to ensure you are getting the best value for your money.

• Tax considerations: ETFs tend to be more tax efficient than mutual funds because they generate fewer capital gains. However, it is still important to consider the tax implications of investing in an ETF and whether it aligns with your overall financial plan.

Investing With SoFi

ETFs are becoming increasingly more popular, with some being more targeted in focus than others. So, being aware of an ETF’s investments can be important for an investor who chooses to put dollars into this financial vehicle.

For those who are ready to dive into ETF investing on their own, opening a SoFi Invest® online brokerage account may be a good option. With SoFi, you can trade ETFs, as well as stocks, IPOs, fractional shares, and more, with no commissions (though investors are responsible for paying operating expense ratios when investing in ETFs). And we know that when starting out investing, it can help to get professional guidance. So SoFi offers its members complimentary access to financial planners who can give advice on risk tolerance and investment horizons.

Take a step toward reaching your financial goals with SoFi Invest.

FAQ

What is the benefit of investing in an exchange-traded fund?

Exchange-traded funds (ETFs) offer investors a convenient and cost-effective way to diversify their portfolios by investing in a basket of assets. ETFs are also typically more tax efficient than mutual funds and offer investors the ability to buy and sell their shares on a stock exchange.

Are ETFs a good investment?

Depending on their investment goals and risk tolerance, ETFs may be a good investment for some investors. ETFs offer a convenient and cost-effective way to diversify a portfolio and provide access to a wide range of asset classes. However, it is important for investors to consider the specific ETF they are considering and how it fits into their overall investment plan.

Why are ETFs better than stocks?

For some investors, ETFs may be a better investment option than individual stocks because they offer diversification by investing in a basket of assets rather than just a single stock.

Is an ETF better than a mutual fund?

Whether an ETF is better than a mutual fund depends on the specific circumstances of the investor and their investment goals. ETFs tend to have lower fees than mutual funds because they are not actively managed and may also be more tax efficient due to their lower turnover. However, mutual funds offer a more comprehensive range of investment options and may be more suitable for some investors.

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Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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Dec

2022

Explaining the Shareholder Voting Process

By Rebecca Lake | Growing Wealth, Investing | No Comments

Shareholder voting rights allow certain stockholders to vote on issues impacting company performance, including mergers and acquisitions, dividend payouts, new securities, and who is elected to the board of directors.

Investors who own shares of common stock of a company usually have shareholder voting rights. Investors with common stock are generally allowed one vote per share they own. Thus, an investor who owns 1,000 shares of stock may have 1,000 votes to cast.

If the idea of potentially participating in a company’s decision-making process is appealing to you, keep reading to learn more about the voting rights of equity shareholders and how they work.

What Are Stockholder Voting Rights?

Stockholder voting rights are the privileges granted to shareholders of a company to vote on matters that affect the company, such as the election of directors and the approval of major corporate actions, and to have a say in how the company is run.

First, it helps to distinguish between common and preferred stock. As noted above, investors who own shares of common stock are typically granted voting rights, usually at one vote per share.

Meanwhile, investors with preferred stock generally can’t vote on matters relating to the company’s governance and policies, but these investors are given preferred treatment in terms of dividend payouts. In the case of bankruptcy, preferred shareholders are usually paid before common stockholders.

There’s another wrinkle when understanding the voting rights of equity shareholders. In a privately held company, the corporation itself (along with state corporation laws) oversees and can restrict shareholder voting rights. In a publicly traded company, shareholder voting follows company rules but must also adhere to the Securities and Exchange Commission (SEC) guidelines.

And while investors who own common stock generally have shareholder voting rights, only “investors of record” are allowed to vote at the annual company meeting. “Of record” status refers to the process whereby investors are added to company records, which isn’t determined simply by which type of shares they own but by when they bought the shares. Investors must buy their shares before the record date to be added to the company record before a meeting — and thereby allowed to vote.

What Do Shareholders Vote On?

Shareholders vote on matters such as the election of the board of directors, the approval of significant corporate actions, like mergers and acquisitions, and the adoption of changes to the company’s bylaws.

The voting rights of equity shareholders don’t extend to issues concerning day-to-day operations or management issues, like hiring and firing, budget allocation, product development, etc. The management team of a company makes these decisions throughout the year.

Nonetheless, the issues shareholders vote on can significantly impact a company’s bottom line, strategy, and overall profitability.

Given the one vote per share rule, the more shares an investor owns, the more influence they can exert if they actively exercise their voting rights — which is why many large investors pay close attention to critical issues where their vote might make a difference. Many shareholder activists use the voting process to exert influence over their investments.

Shareholders are generally alerted to the annual meeting via mail, including a package that summarizes the main issues to be addressed at the company meeting. These can include topics like:

• Electing directors to the board

• Approving a merger or acquisition

• Approving a stock compensation plan

• Executive salaries and benefits

• Major shifts in company goals

• Fundamental corporate structure changes

• Approving stock splits

• Dividend payments

As you’re considering which stocks to invest in, you may want to look into how shareholder voting works with each company. For instance, some companies don’t allow shareholders to call special meetings, and a supermajority vote is required to change some of the company’s bylaws.

What Happens at a Shareholder Meeting?

If you choose to attend the annual general meeting of a company in which you own stock, this is typically the only time that the company directors and shareholders will interact.

In certain states, public and private companies hold annual meetings, but the rules about holding these meetings are stricter for public companies.

The agenda will probably be similar to the following:

Notice of Meeting

The voting rights of equity shareholders allow those investors to get advance notice of what will be covered at the annual meeting. Each company has specific rules about how far in advance they must notify shareholders of the meeting, but in most cases, the company sends physical mailers with pertinent information.

The company must also file a statement with the SEC outlining the date, time, and location of the next meeting. This statement will also include the topics to be discussed and voted on at the meeting.

Minutes of Previous Meeting

Notes from what happened at the previous general meeting are presented and approved.

Presentation of Financial Statements

The company will present current financial statements to the shareholders.

Ratification of Director Actions

Decisions made by the board of directors over the previous year are presented and approved or denied by the shareholders. This can include the payment of dividends according to a set dividend payment schedule.

Speeches

Certain companies will present an overall vision of the company’s goals for the upcoming year or other information relevant to shareholders.

Open Floor for Shareholder Questions

Typically there will be a time when shareholders are allowed to ask questions.

Election of the Board of Directors and Other Votes

Shareholders vote on who will be members of the company’s board of directors for the upcoming year. Voting on other issues will also take place.

Extraordinary Matters

If a special meeting is called during the year, which is different from the annual general meeting, other topics will be discussed and voted on. These could include the removal of an executive, an urgent legal matter, or another issue that requires immediate attention.

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How Does the Voting Process Work?

There are a few different ways you can exercise your shareholder voting rights. These differ depending on the company and what type of owner you are. As mentioned, certain companies may give shareholders one vote per share of stock they own, while others give each shareholder one vote in total.

If you get one vote per share, this means you have a larger say in decision-making at the corporate level if you are more heavily invested in the company.

However, for voting to commence, the meeting must have a quorum. Reaching a quorum refers to the minimum number of shareholders that must be present or represented at a shareholder meeting for the meeting to be valid and for votes to be counted. Usually, this is a simple majority of share votes.

Registered owners hold shares directly with the company, while beneficial owners hold shares indirectly through a bank or broker. Most U.S. investors are beneficial owners. As either type of owner, you should receive instructions on how to vote in each of the following ways:

In Person

Companies typically hold annual meetings that shareholders are allowed to attend. They can also hold special meetings throughout the year.

Shareholders receive materials in the mail or via e-mail containing details of upcoming meetings. Most companies hold their annual meetings between March and June, within six months after the close of the previous fiscal year.

By Mail

You can exercise your stock voting rights by mail if you are a registered owner. You will receive instructions on filling out a proxy card so that a delegate can vote on your behalf. You will receive a voting instruction form if you are a beneficial owner.

By Phone

The materials you receive in the mail might include a phone number and directions to vote over the phone.

Over the Internet

Some companies are now providing instructions for shareholders to vote online. This can be a more convenient way to complete shareholder voting.

What Are Proxy Requirements?

Many shareholders live too far away and are too busy to attend company meetings and vote in person. For this reason, shareholders may vote by proxy, meaning they authorize someone to vote on their behalf.

You may be familiar with the estate planning term “health care proxy” or “financial proxy” — a designation allowing an agent to make decisions on behalf of someone else. It’s similar in that a formal power of attorney or other permission must be granted to allow a proxy vote.

As a shareholder, you will receive a proxy ballot in the mail containing information about the issues on which you can vote.

The proxy statement also may include information about the company’s management and the qualifications of any potential board members, the agenda for the meeting, and the company’s largest shareholders. These statements are filed with the SEC annually before the general meeting.

If you own stocks through a mutual fund, the investment managers can also cast proxy votes on your behalf.

The proxy voter is often someone on the company’s management team. Even if you choose to vote by proxy, there are some issues you can still directly vote for or against, such as the election of directors and the chief executive officer’s salary.

How Do You Know When to Vote?

Part of understanding how the voting rights of equity shareholders work hinges on knowing when you can vote. If a company is preparing to hold a vote, it sets what is known as a “record date.” As noted above, if you own shares of that company on the record date, you have a right to vote. The company will send all eligible voters one of the following three notices:

• A physical notice stating that proxy materials are available for viewing online,

• A package containing a voting instruction form or proxy card, as well as an annual report, or

• A package containing an information statement and annual report but no proxy card.

When deciding whether to invest in a stock, you may want to look for any news regarding previous shareholder meetings. You can find out more about what shareholders have voted on in the past and how shareholder voting works with that company to make the best choices about how you might decide to cast your votes.

The Takeaway

The voting rights of equity shareholders can be summed up pretty simply: Investors of record who own shares of common stock are generally entitled to one vote per share, which they can cast at the annual shareholder meeting to shape company policy — and potentially profitability.

Now that you know more about this compelling aspect of being a stockholder, you might be inclined to start investing in shares in a company you want to be more involved with. Fortunately, SoFi can help. With a SoFi Invest® online brokerage account, you can trade stocks, ETFs, fractional shares, and more with no commissions. Plus, if you have questions, the SoFi team can offer complimentary, personalized investment advice.

Take a step toward reaching your financial goals with SoFi Invest.

FAQ

Which type of stock comes with voting rights?

Most publicly traded companies issue two types of stock: common stock and preferred stock. Common stock typically comes with voting rights, while preferred stock does not.

What is the difference between registered and beneficial owners when voting on corporate matters?

A registered owner is a person or entity whose name is recorded on the company’s books as the owner of a particular share of stock. This person or entity has the right to vote on corporate matters and to receive dividends and other distributions from the company. On the other hand, a beneficial owner is a person or entity that ultimately owns or controls the stock, even though their name may not be recorded on the company’s books. Beneficial owners may have acquired their ownership interest in the stock through a brokerage account or a trust, for example.

How do shareholders vote for the board of directors?

Shareholders typically vote for the board of directors at the annual meeting of shareholders. In most cases, shareholders can vote in person at the meeting or by proxy, which allows them to appoint someone else to vote on their behalf. Some companies may also allow shareholders to vote by mail or online.

What is the impact of voting rights?

Voting rights are an important aspect of ownership in a publicly traded company. As a shareholder, your voting rights give you the ability to influence the company’s direction and hold its management accountable.

What is e-voting in shares?

E-voting, or electronic voting, is a process that allows shareholders to cast their votes electronically rather than in person or by mail. E-voting is usually done through an online platform provided by the company or a third-party service provider.

Dec

2022

Annual Report: The Key Info Companies Provide in Theirs

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

An annual report is a document that provides insight into a company’s operations and financial performance over the previous year. While annual reports are primarily associated with large, publicly traded companies, small businesses and non-profit organizations may also release yearly reports.

Companies issue annual reports to provide shareholders, potential investors, employees, and other interested parties with a comprehensive overview of the company’s financial position. Companies also use annual reports to inform investors about the company’s performance and prospects for the future. Annual reports can be an essential tool for investors to make informed decisions about their investments.

What Is an Annual Report?

As noted above, an annual report is a document that publicly traded companies are usually required to issue each year to share information about their financial performance and activities with their shareholders. These reports typically include quantitative and qualitative details about the company’s revenue, expenses, profits, losses, and plans for the future.

Companies send annual reports to their shareholders before they hold annual meetings, often to assist in the shareholder voting process. Additionally, reporting companies will post their annual reports on their websites.

A company’s annual report is typically prepared by the company’s management team, with input from other members of the organization, such as the finance department and the board of directors.

The individuals and teams preparing the annual report can vary depending on the company and the information it wishes to include. It is typically a collaborative effort involving many different people within the organization. In some cases, a company may also enlist the help of external parties, such as auditors or consultants, to assist with preparing the annual report.

Often a company’s creative and communications teams will be involved in preparing the report, as they contribute to the narrative text, graphics, and photos that may be in an annual report. By making it visually appealing, companies can make it easier for readers to digest the information.

A publicly traded company’s annual report is related to, but different from, the Form 10-K annual report that they must file with the Securities and Exchange Commission (SEC). The Form 10-K annual report may contain more detailed information about the company’s earnings and financial condition than the annual report. Companies may send Form 10-K to their shareholders instead of – or in addition to – providing them with a separate annual report.

What Information Is Contained In an Annual Report?

The main components of an annual report typically include an overview of the company’s operations and financial performance, financial statements, and information about the company’s management and board of directors.

The specific components of an annual report can vary depending on the company and the information it wishes to share with its shareholders. In addition to the main features outlined below, the contents of an annual report may also include other information, such as details about the company’s corporate governance practices, its environmental and social impact, and any additional information that the company feels is important for shareholders to know.

Letter from the CEO

Annual reports usually start with a letter from the chief executive officer (CEO) or chairman of the board that provides an overview of the company’s performance and highlights any significant events or developments that have occurred over the past year.

Performance Overview

Companies often provide a review of the company’s operations, including information about its products or services, market position, and any important milestones or achievements that have occurred over the past year, in an annual report.

Financial Statements

Financial statements, such as the balance sheet, income statement, and statement of cash flows, providing detailed information about the company’s financial performance and position, are a critical part of an annual report.

Corporate Leadership Overview

Annual reports include information about the company’s management and board of directors, including biographies and details about their backgrounds and experience. The reports may also have detailed information about executive compensation.

Future Outlook

A discussion of any risks or uncertainties that the company faces and how it plans to address them in the future is often included in the annual report. This can be helpful for shareholders and potential investors to gain an understanding of the company’s possible performance in the future.

Example of an Annual Report

Annual reports can vary depending on the company, its industry, and whether it is a publicly traded or privately held firm.

For example, an annual report for a company in the retail industry might include information about the company’s same-store sales over the past year. Additionally, the report may provide details about the products it sells, a breakdown of its inventory, an overview of its financial position, and information about the company’s management team and any potential risks or challenges it faces in the coming year.

To find out more about a specific company’s annual reports, you can usually find them under the investor relations portion of the company’s website or through the SEC’s EDGAR database .

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Who Can Benefit From Reading an Annual Report?

Several groups of people may benefit from reading an annual report. For example, the company’s shareholders are usually interested in an annual report to use the information to understand the company’s financial performance and make more informed decisions about their investments.

Other groups who may find annual reports useful include potential investors, who can use the information in the annual report to assess the company’s financial health and determine if it is a good investment opportunity. In addition, analysts, customers, journalists, and other stakeholders may find annual reports to be a valuable source of information about a company and its operations.

The Takeaway

An annual report is a crucial document that provides a comprehensive overview of a company’s performance and financial position. These documents can be a critical resource for investors to make informed investment decisions. It is important to understand the information contained in the report and to analyze the information critically. By doing so, investors can make informed decisions about their investments as they build a wealth-building portfolio.

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Photo credit: iStock/Charday Penn

Dec

2022

Business Cycle Investing

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Investors often pay attention to the ups and downs of economic activity – fluctuations known as the business cycle – and readjust their investments accordingly. With this business cycle investing strategy, investors typically adjust their exposure to various sectors with stocks or bonds in their portfolios. Some industries outperform during economic expansions, while others do better during contractions.

Business cycle investing is not an exact science, and past performance isn’t indicative of future returns. But historically, specific industries have prospered during each stage of the business cycle. Here’s a rundown of the different business cycle stages and which industries have been more favorable to invest in during each phase.

What Is a Business Cycle?

A business cycle refers to the periodic expansion and contraction of a nation’s economy. Also known as an economic cycle, it tracks the different stages of growth and decline in a country’s gross domestic product (GDP), or economic activity.

Worker productivity, population growth, and technological innovations are all factors that can contribute to whether an economy is going through a period of boom or bust. Such elements play a role in how many goods and services a nation’s businesses produce and how much its consumers purchase.

Other factors, such as wars, pandemics, natural disasters, and political instability, can also influence the economy. These can cause a recession to happen sooner or otherwise shift the economic environment of a nation or the world.

In the U.S., the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) announces whether the economy is in a recession or a new iteration of the business cycle. Policymakers attempt to manage the business cycle by adjusting fiscal and monetary policies, such as taxes, stimulus packages, or interest rates.

Some people refer to business cycles and market cycles interchangeably. However, the business cycle measures the entire economy, while market cycles refer to the ups and downs of the stock market. Although the two can be correlated, they aren’t the same.

How Does the Business Cycle Work?

The business cycle works by alternating between periods of economic growth and decline. During the expansion phase, economic activity grows, and the economy is relatively healthy. A period of economic expansion is typically characterized by low unemployment, rising wages, and increasing consumer and business confidence.

Eventually, the economy will reach its peak and start to contract. This is typically characterized by slowing economic growth, rising unemployment, and declining consumer and business confidence. As businesses see a decline in demand, they may lay off workers or reduce production, leading to a downward spiral of declining economic activity.

The trough phase is the lowest point in the business cycle. Economic activity is at its weakest, and unemployment is at its highest. This phase is also known as the recession bottom. From here, the economy begins to recover, and the business cycle starts over again.

How Reliable Is the Business Cycle?

The business cycle is a reliable pattern of economic activity observed over time, but it is not always predictable. Business cycles tend to follow a similar pattern, with periods of expansion followed by periods of contraction, but each phase’s timing, length, and severity can vary significantly.

Stages of the Business Life Cycle

There are four stages of the business cycle, which fall into two phases: a growth phase of expansion and a declining phase of contraction. A business cycle can last anywhere from one year to 10 or more years. Since 1945, there have been 12 business cycles.

Stage 1: Recession

The recession phase is the lowest point in the business cycle. Also known as the contraction phase, a weak economy and high unemployment define this period.

GDP, profits, sales, and economic activity decline during this stage. Credit is tight for both consumers and businesses due to the policies set during the last business cycle. It’s a vicious cycle of falling production, incomes, employment, and GDP.

The intensity of a recession is measured by looking at the three Ds:

• Depth: The measure of peak-to-trough decline in sales, income, employment, and output. The trough is the lowest point the GDP reaches during a cycle. Before World War II, recessions used to be much deeper than they are now.

• Diffusion: How far the recession spreads across industries, regions, and activities.

• Duration: The amount of time between the peak and the trough.

A more severe recession is called a depression. Depressions have deeper troughs and last longer than recessions. The only depression that has happened thus far was the Great Depression, which lasted 3.5 years, beginning in 1929.

Recessions generally lead to shifts in monetary policy and government spending that lead to a recovery phase.

Stage 2: Early Cycle

Following a recession, the economy enters an expansion phase, where there tends to be a sharp recovery as growth begins to accelerate. The stock market tends to rise the most during this stage, which generally lasts about one year. Because of loose monetary policy by the central bank, interest rates are low, so businesses and consumers can borrow more money for growth and investment. GDP begins to increase.

Just as a recession is a vicious cycle, recovery is a virtuous cycle of rising income, employment, GDP, and production. And similar to the three D’s, a recovery period, which includes Stages 2-4, is measured using three P’s: how pronounced, pervasive, and persistent the expansion is.

Stage 3: Mid-Cycle

The mid-cycle phase is generally the longest phase of the business cycle, with moderate growth throughout. On average, the mid-cycle phase lasts three years. Monetary policies shift toward a neutral state: interest rates are higher, credit is strong, and companies are profitable.

Stage 4: Late Cycle

At this stage, economic activity reaches its highest point, and while growth continues, its pace decelerates. Monetary policies become tight due to rising inflation and low unemployment, making it harder for people to borrow money. The GDP rate begins to plateau or slow.

Companies may be engaging in reckless expansions, and investors are overconfident, which increases the price of assets beyond their actual value. Late cycles last a year and a half on average.

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What Industries Do Well During Each Stage?

Historically different industries have prospered during each stage of the business cycle, depending on whether they are cyclical or non-cyclical stocks.

When money is tight and people are concerned about the economy, they cut back on certain purchases, such as vacations and fancy clothes. Also, when people anticipate a recession, they tend to sell stocks and move into safer assets, causing the market to decline.

Industries do better or worse depending on supply and demand, and the need for specific products shifts throughout the business cycle. In general, the following sectors perform well during each stage of the business cycle:

Recession

During the recession phase, the lowest point in the business cycle, economic activity is at its weakest, and unemployment is at its highest. Many industries may struggle during this phase, especially those dependent on consumer spending or business investment.

However, certain industries are able to weather the storm during a recession because they offer products and services that people need no matter how the economy is performing. These industries include healthcare, consumer staples, and utilities.

💡 Recommended: How to Invest During a Recession

Early Cycle

During the early cycle expansion phase, when economic activity is growing and the economy is healthy, many industries tend to do well. These can include consumer-oriented sectors, such as retail and leisure, as well as industries that benefit from increased business investment, such as construction and manufacturing. Other sectors that benefit from increased borrowing due to low interest rates include financial services, real estate, and household durables.

Mid-Cycle

During the mid-cycle phase, when the economy is operating near full capacity, some industries may start to see slowing growth or declining profits. These can include industries sensitive to changes in consumer demand or highly competitive, such as technology and media. However, some industries perform well during the mid-cycle, like information technology and energy, because companies in these areas deploy capital that helps them grow.

Late Cycle

During the late cycle, economic activity slows down and the labor market shows signs of weakness. Additionally, the economy may face inflationary pressures due to the previous period of economic growth and low unemployment. While this inflationary pressure and economic slowdown negatively impact many industries, utilities and energy companies may do well during this period. Additionally, investors could research stocks that do well during volatility.

Who Should Invest With the Business Cycle?

Business cycle investing involves trying to anticipate changes in the business cycle and buying or selling assets based on the expected performance of those assets during different phases of the business cycle. For example, an investor following a business cycle investing strategy might buy stocks when the economy is expanding and sell them before the peak in anticipation of a downturn.

However, this active investing strategy is not suited for everyone. Investing and rebalancing a portfolio with the business cycle is difficult because timing the market is easier said than none. Business cycle investing is best for investors who have the time to stay up to date with the latest economic indicators and stock market news while also having the risk tolerance to time the market.

In contrast, some investors prefer a long-term buy and hold strategy, in which they don’t try to time the market and make few changes to their portfolio.

💡 Recommended: Is Stock Market Timing a Smart Investment Strategy?

Pros and Cons of Business Cycle Investing

Business cycle investing involves trying to anticipate and profit from changes in the business cycle. The goal is to buy assets likely to do well during certain business cycle phases and sell them before the next phase begins.

However, investors should note that the business cycle is not always predictable, and there are no guarantees that a business cycle investing strategy will be successful. Thus, it’s good to consider the pros and cons of business cycle investing.

Pros

The advantages of using a business cycle investing approach include the following:

• The ability to potentially profit from changes in the business cycle: By anticipating and acting on changes in the business cycle, investors may profit from the upswing of a recovery or the downtrend of a recession.

• A framework for decision-making: The business cycle provides a framework for analyzing economic trends and making investment decisions. This can help investors make more informed decisions about buying or selling assets.

• Diversification: Business cycle investing can help investors diversify their portfolio by adding assets likely to do well in different phases of the business cycle.

Cons

The disadvantages of using a business cycle investing approach include the following:

• Difficulty in predicting the business cycle: The business cycle is not always predictable, and it can be difficult to anticipate changes in the economic environment. This can make it challenging for investors to implement a business cycle investing strategy successfully.

• Market volatility: Business cycle investing can involve buying and selling assets at different points in the business cycle, exposing investors to stock volatility.

• Opportunity cost: By focusing on the business cycle, investors may fail to take advantage of opportunities to invest in assets that are not correlated to the business cycle but may still provide strong returns.

Investing With SoFi

No business cycle is identical, but history shows there can be a rough pattern to which industries do better as the economy expands and contracts. Investors can take cues from which stage of the business cycle the economy is in order to allocate money to different sectors.

One way to invest and keep track of the market is by using an online investing app like SoFi Invest®. With a SoFi online brokerage account, you can stay up-to-date with the latest financial market news, and trade stocks, exchange-traded funds (ETFs), and more with no commissions. Plus, you’ll have access to educational resources to support you as you continue to learn about the markets.

Take a step toward reaching your financial goals with SoFi Invest.

FAQ

What is an investment cycle exactly?

An investment cycle is a pattern of investment activity that occurs over time, usually in conjunction with the business cycle. It is typically characterized by periods of rising prices followed by periods of declining prices. The length and severity of the investment cycle can vary, and various factors, including economic conditions, market trends, and investor sentiment, can influence it.

How long are investment cycles?

The length of investment cycles can vary significantly, depending on economic activity and investor sentiment. Some investment cycles may last only a few months, while others may last several years or more.

What are the 4 stages of investment cycles?

The four stages of an investment cycle are expansion, peak, contraction, and trough. During the expansion phase, economic activity grows and investor confidence is high. Prices of investments, such as stocks and real estate, tend to rise, and demand for assets is strong. The peak phase is the highest point in the investment cycle. Prices of investments have reached their highest point, and demand for assets may start to wane. During the contraction phase, economic activity slows down and investor confidence may decline. Prices of investments tend to fall, and demand for assets may decrease. The trough phase is the lowest point in the investment cycle. Prices of investments have reached their lowest point, and demand for assets is at its weakest.

Dec

2022

Bid and Ask Price: Definition, Example, How It Works

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Bid and ask are commonly used investing terms, and they refer to the best potential price at which a security on the market could be bought or sold for at any given time. In other words, the best price that buyers and sellers would potentially be willing to buy (the “bid” price) or sell (the “ask” or offer price) the asset.

It’s important for traders to understand the bid vs ask price of a security, as well as the difference between the two, which is known as the bid-ask spread.

The market price is a historical price: the price of the last trade that occurred with the security. The bid and ask prices, on the other hand, show what buyers and sellers would be willing to trade the security for now.

What Are Bid and Ask?

If you’re just getting started investing in stocks, you’re probably wondering about bid vs. ask prices. Bid and ask prices show the current market supply and demand for the security. The bid price represents demand for a security; the ask price represents supply.

When an asset has high liquidity — i.e. the market has a high trading volume not dominated by selling — the bid and ask prices will be fairly close. In other words the bid-ask spread, or the difference between the bid and ask prices, will be narrow in a highly liquid market. When there’s a greater gap between demand and supply, the spread will be wider.

That’s why the bid-ask spread is often considered a gauge of liquidity.

Bid Price

The bid price is the best potential price that retail investors would be willing to pay to buy a security.

So if a trader wants to sell a security, they would want to know how much they’d be able to sell it for. They can find out the best price they could get for the security by looking at the current bid price in the market, which would show the highest potential amount they could get for it.

Ask Price

Conversely, ask price is the lowest price investors are willing to sell a security for at any given time. If a trader wants to buy a security, they want to get the lowest possible price, so they look at the ask price to find out what that is.

Bid and Ask Price Examples

Let’s imagine that an investor wants to buy Stock X at the quoted price of $75, so they plan to buy 10 shares for $750. But they end up paying $752. That’s not an error, but rather because the ask price (the selling price) is $75.20.

The current price of $75 per share is the last traded price. But prices can change quickly, and in this case the ask price was 20 cents higher. The bid or buyer’s price is almost always lower than the ask price.

Investors can use limit orders to set specific parameters around the price at which they’re willing to buy or sell a security. This can give investors some control, so they’re not simply paying the current price, which may or may not be advantageous.

Evaluating the bid-ask spread can be part of an investor’s due diligence when trying to gauge rates of return for different securities.

What the Bid-Ask Spread Signals

How far apart the ask price and bid price are can give you a sense of how the market views a particular security’s worth.

If the bid price and ask price are fairly close together, that suggests that buyers and sellers are more or less in agreement on what a security is worth. On the other hand, if there’s a wider spread between the bid and ask price, that might signal that buyers and sellers don’t necessarily agree on a security’s value.

How Are Bid and Ask Prices Determined?

Essentially it’s the supply and demand of the market that sets the bid and ask prices. And many factors can play into supply vs. demand. Because of this, investors who are interested in active investing can use the difference in price between the bid and the ask of a security to gauge what the market thinks the security is worth.

Investors and market-makers can place buy or sell orders at a price they set. These orders will be fulfilled if someone is willing to sell or buy the security at that bid or ask price. Those order placements determine the bid and ask price.

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.

*Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

What’s the Difference Between Bid and Ask Prices?

In any market, from stocks to real estate to lemonade stands, there is almost always a difference between what someone is willing to pay for an item versus what someone wants to sell it for.

A buyer may want to buy a house for $300,000, but the seller is selling it for $325,000. An investor may want to buy a stock for $100, but the sell or ask price is $105.

That difference in price is called the spread, and when the spread is narrow it’s a lot easier to close the sale. When the spread is wider, there is a bigger gap between what the buyer thinks an item is worth vs. what the seller thinks it’s worth.

What Does It Mean When Bid and Ask Are Close?

A narrow spread, i.e. when the bid and ask price are close, means traders will be able to buy and sell the security at roughly the same price. This generally means there is a high trading volume for the security, with a lot of people willing to buy and sell because of high demand.

If demand increases for the security, the bid and ask prices will move higher, and vice versa. If there is a surge in demand, but not enough supply, that might drive the bid price up. Conversely, if supply outpaces demand, the bid price of a security could fall In either case, the spread would likely get wider when the bid or the ask prices outweighs the other.

The Bid-Ask Spread

The bid-ask spread is the gap between the two prices: the bid or buyer’s price and the ask or offer price. There are different factors that can affect a stock’s spread, including:

• Liquidity. A measure of how easily a stock or security can be bought and sold or converted to cash. The more liquid an investment is, the closer the bid and ask price may be, since the market is in agreement about what the security is worth.

• Trading volume. This means how many shares of a stock or security are traded on a given day. As with liquidity, the more trading volume a security has, the closer together the bid and ask price are likely to be.

• Volatility. A way of gauging how rapidly a stock’s price moves up or down. When there are wider swings in a stock’s price, i.e. more volatility, the bid-ask price spread can also be wider as market makers attempt to profit from the price changes.

Who Benefits From the Bid-Ask Spread?

The difference in price between the bid and the ask is where brokers and market makers make their profit.

But traders can also benefit from the bid-ask spread, if they use limit orders to get the best possible price on a desired trade, as opposed to using market orders.

How the Bid-Ask Spread Is Used

When you understand how bid-ask spread works, you can use that to invest strategically and manage the potential for risk. This means different things whether you are planning to buy, sell, or hold a stock.

If you’re selling stocks, that means getting the best bid price; when you’re buying, it means paying the best ask price. Essentially, the goal is the same as with any other investing strategy: to buy low and sell high.

Bid-Ask Spread Impact on Trading Profits

Naturally, the bid-ask spread impacts trading profits, and in fact can act almost as a hidden cost.

For example, if an investor places a market order on a stock with a bid price of $90 and an ask price of $91, they’ll get the stock at $91 per share. If the price of the stock rises 5%, so the bid price is now $94.50 and the ask price is $95.55 and the bid-ask spread is $1.05.

If the investor decides to sell the shares they bought at $91 through a market order, they will receive $94.50 per share. So their profit is $3.50 per share, even though the stock price rose by $4.55. The $1.05 gap in profit reflects the $1.05 bid-ask spread on this stock.

Wide vs Narrow Bid-Ask Spread

What is the difference between wide and narrow bid-ask spreads, and what is the significance of each?

Narrow Bid-Ask Spreads

The bid-ask spread, often just called the spread, is tighter when a security has more liquidity, i.e. there’s higher trading volume for that stock. When you think of big companies, industry leaders, constituents of different indexes like the Dow Jones or the S&P 500, those companies may have higher volume and narrower spreads.

Wider Bid-Ask Spreads

Conversely, smaller companies or those that aren’t in demand tend to have wider spreads, reflecting a lower level of market interest. These trades tend to be more expensive, as investors must contend with lower liquidity.

Impact of the Bid-Ask Spread

The narrower the bid-ask spread, the more favorable it is for traders. If an investor wants to buy 100 shares of Stock A at $60, but shares are being offered at $60.25, that 25 cent spread may not seem like much. It would add up to $25 (100 x 0.25). But if that trader wanted to buy 500 shares or more, the cost of the spread is about $125.

The Takeaway

Bid and ask prices help traders know exactly how much they may buy and sell securities for. The bid price is the highest price a buyer is willing to pay for a security. The ask price is the lowest price a seller is willing to accept. The difference between them is the bid-ask spread, or “spread.”

The spread ends up being a transaction cost, as market makers pocket the cost of the spread.

Since the bid price and the ask price are essentially a function of supply and demand in the market, investors can consider the bid-ask spread as a gauge of risk. The narrower the spread, the more aligned buyers and sellers are on the value of a certain security, and thus there’s higher volume and more liquidity — and lower risk to the investor that the stock or security might lose value (although it could, as there are no guarantees).

To understand bid and ask prices, you can start trading stocks with only a few dollars using the SoFi app. When you set up an Active Invest account, you can research, track, buy and sell stocks, right from your phone or laptop. SoFi doesn’t charge a commission, and you can see all your financial information in one simple dashboard.

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

FAQ

Do I buy a stock at the bid or ask price?

You buy a stock at the ask price, that’s the lowest price the seller is willing to offer.

Is the last price the same as the market price?

The last price is the last traded price for a security, or the last price at which it closed. The market price is the best current price.

Is it better if your bid is higher than the asking price?

The bid price is typically lower than the seller’s price or ask price, so it would be unusual if the bid was higher than the ask. If a bid price is higher than the ask, a trade would occur, but it would put the buyer at risk of a potential loss.

Photo credit: iStock/eclipse_images