Feb
27
2024
What Is the Rule of 55? How It Works for Early Retirement

What Is the Rule of 55? How It Works for Early Retirement

By | Growing Wealth, invest, Investing | Comments Off on What Is the Rule of 55? How It Works for Early Retirement

The rule of 55 is a provision in the Internal Revenue Code that allows workers to withdraw money from their employer-sponsored retirement plan without a penalty once they reach age 55. Distributions are still taxable as income but there’s no additional 10% early withdrawal penalty.

The IRS rule of 55 applies to 401(k) and 403(b) plans. If you have either of these types of retirement accounts through your employer, it’s important to understand how this rule works when taking retirement plan distributions.

What Is the Rule of 55?

The rule of 55 is an exception to standard IRS withdrawal rules for qualified workplace plans, including 401(k) and 403(b) plans. Normally, you can’t withdraw money from these plans before age 59 ½ without paying a 10% early withdrawal penalty. This penalty is only waived for certain allowed exceptions, of which the rule of 55 is one.

Specifically, the rule of 55 applies to “distributions made to you after you separated from service with your employer after attainment of age 55,” per the IRS. It doesn’t matter whether you quit, get laid off or retired — you can still withdraw money from your retirement plan penalty-free. If you’re a qualified public safety employee, this exception kicks in at age 50 instead of 55.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

How Does the Rule of 55 Work?

The rule of 55 for 401(k) and 403(b) plans allows workers to access money in their retirement plans without a 10% early withdrawal penalty. This rule applies to current workplace retirement plans only.

You can’t use the rule of 55 to take money from a 401(k) or 401(b) you had with a previous employer penalty-free unless you first roll over those account balances into your current plan before separating from service.

This rule doesn’t apply to individual retirement accounts (IRA) either. So, you can’t use the rule of 55 to tap into an IRA before age 59 ½ without a tax penalty. There are, however, some exclusions that might allow you to do so. For example, you could take money penalty-free from an IRA if you’re using it for the purchase of a first home.

Rule of 55 Requirements

To qualify for a rule of 55 401(k) or 403(b) withdrawal, you’ll need to:

•   Be age 55 or older

•   Separate from your employer at age 55 or older

•   Leave the money in your employer’s plan (rule of 55 benefits are lost if you roll funds over to an IRA)

You also need to have a 401(k) or 403(b) plan that allows for rule of 55 withdrawals. If your plan doesn’t permit early withdrawals before age 59 ½ , then you won’t be able to take advantage of this rule.

Also keep in mind that IRS rules require a 20% tax withholding on early withdrawals from a 401(k) or similar plan. This applies even if you plan to roll the money over later to another qualified plan or IRA. So you’ll need to consider how that withholding will affect what you receive from the plan and how much you may still owe in taxes on your 401(k) later when reporting the distribution on your return.

Example of the Rule of 55

Here’s how the rule of 55 works. Say you lose your job or decide to retire early at age 55, and you need money to help pay your bills and cover lifestyle expenses. Under the rule of 55, you can take distributions from the 401(k) or 403(b) plan you were contributing to up until the time you left your job. You will not be charged the typical 10% early withdrawal penalty in this instance.

Also worth noting: If you decide to go back to work a year or two later at age 56 or 57, say, you can still continue to take distributions from that same 401(k) or 403(b) plan, as long as you have not rolled it over into another employer-sponsored plan or IRA.

Should You Use the Rule of 55?

The IRS rule of 55 is designed to benefit people who may need or want to withdraw money from their retirement plan early for a variety of reasons. For example, you might consider using this rule if you:

•   Decide to retire early and need your 401(k) to close the income gap until you’re eligible for Social Security benefits

•   Are taking time away from work to act as a caregiver for a spouse or family member and need money from your retirement plan to cover basic living expenses

•   Want to take some of the money in your 401(k) early to help minimize required minimum distributions (RMDs) later

In those scenarios, it could make sense to apply the rule of 55 in order to access your retirement savings penalty-free. On the other hand, there are some situations where you may be better off letting the money in your employer’s plan continue to grow.

For instance, if your employer’s plan requires you to take a lump sum payment, this could push you into a substantially higher tax bracket. Having to pay taxes on all of the money at once could diminish your account balance more so than spreading out distributions — and the associated tax liability — over a longer period of time.

You may also reconsider taking money from your 401(k) early if you still plan to work in some capacity. If you have income from a new full-time job or part-time job, for instance, you may not need to withdraw funds from your 401(k) at all. But if you change your mind later and decide to return to work, you can continue to take withdrawals from the same retirement plan penalty-free.

Other Ways to Withdraw From a 401(k) Penalty-Free

Aside from the rule of 55, there are other exceptions that could allow you to take money from your 401(k) penalty-free. The IRS allows you to do so if you:

•   Reach age 59 ½

•   Pass away (for distributions made to your plan beneficiary)

•   Become totally and permanently disabled

•   Need the money to pay for unreimbursed medical expenses exceeding 10% of your adjusted gross income (AGI)

•   Need the money to pay health insurance premiums while unemployed

•   Are a qualified reservist called to active duty

You can also avoid the 10% early withdrawal penalty by taking a series of substantially equal periodic payments. This IRS rule allows you to sidestep the penalty if you agree to take a series of equal payments based on your life expectancy. You must separate from service with the employer that maintains your 401(k) in order to be eligible under this rule. Additionally, you must commit to taking the payment amount that’s required by the IRS for a minimum of five years or until you reach age 59 ½, whichever occurs first.

A 401(k) loan might be another option for withdrawing money from your retirement account without a tax penalty. You might consider this if you’re not planning to retire but need to take money from your retirement plan.

With a 401(k) loan, you’ll have to pay the money back with interest. Your employer may stop you from making new contributions to the plan until the loan is repaid, generally over a five-year term. If you leave your job where you have your 401(k) before the loan is repaid, any remaining amount becomes payable in full. If you can’t pay the loan off, the whole amount is treated as a taxable distribution and the 10% early withdrawal penalty also may apply if you’re under age 59 ½.

The Takeaway

Early retirement may be one of your financial goals, and achieving it requires some planning. Maxing out your 401(k) or 403(b) can help you save the money you’ll need to retire early, and you may be able to access the funds early with the rule of 55.

You may also consider investing in an IRA or a taxable brokerage account to save for retirement. A brokerage account doesn’t have age restrictions, so there are no penalties for early withdrawals before age 59 ½. You’ll have to pay capital gains tax on any profits realized from selling investments, but you can allow the balances in your 401(k) or IRA to continue to grow on a tax-advantaged basis.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Easily manage your retirement savings with a SoFi IRA.

FAQ

Can I use the rule of 55 if I get another job?

Yes, you can use the rule of 55 to keep withdrawing from your 401(k) if you get another job. As long as it’s the same 401(k) you were contributing to when you left your job and you haven’t rolled it over into an IRA or another plan, you can still continue to take distributions from it whether you get a full-time or part-time job.

How do I know if I qualify for Rule of 55?

First, find out if your employer allows for the rule 55 withdrawals. Check with your HR or benefits department. If they do, and you are 55 or older (or age 50 or older if you are a public safety worker), you should qualify for the rule of 55 and be able to take distributions from your most recent employer’s plan. You cannot take penalty-free distributions from 401(k) plans with previous employers.

How do I claim the rule of 55?

To start taking rule of 55 withdrawals, typically all you need to do is reach out to your plan’s administrator and prove that you qualify — meaning that you are age 55 or older and that you’re leaving your job.

What is the rule of 55 lump sum?

Some 401(k) plans may require you to take a lump sum payment if you are using the rule of 55. That could create a big tax liability since you will need to pay income tax on the money you withdraw. In this case you might want to explore other alternatives to the rule of 55. It may also be helpful to speak with a tax professional.

Photo credit: iStock/bagi1998

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

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.

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

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Feb
27
2024
Stochastic Oscillator, Explained

Stochastic Oscillator Explained

By | Financial Independence, Growing Wealth, invest, Investing | Comments Off on Stochastic Oscillator Explained

A stochastic oscillator is a technical indicator that traders use to determine whether a given security is overbought or oversold. Traders will use a stochastic indicator, which is considered a momentum indicator, to compare a specific closing price of a security to a range of its prices over a certain time frame.

In other words, by using a stochastic chart traders can gauge the momentum of a security’s price with the aim of anticipating trends and reversals. A stochastic oscillator uses a range of 0 to 100 to determine if an asset is overbought (when the measurements are above 80) or oversold (when the measurement is below 20).

What Is a Stochastic Oscillator?

Let’s consider two main types of analysis that investors and traders commonly use when trading stocks: fundamental analysis and technical analysis.

Fundamental analysis incorporates earnings data, in addition to economic and market news, to predict how an asset’s price might move. Whereas technical analysis relies on various sets of data and indicators, such as price and volume, to identify patterns and trends.

The stochastic oscillator is a key tool in securities trading because it helps gauge how strong the momentum of the market is. Thus the stochastic oscillator, or sto indicator, is an indicator used in trading to assess trend strength.

History of the Stochastic Oscillator

Developed in the 1950s for commodities traders, the stochastic oscillator is now a common technical indicator that investors use to evaluate a variety of assets in many online investing platforms and price chart services.

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

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.

How Does a Stochastic Oscillator Work?

The stochastic oscillator has two moving lines, or stochastics, that oscillate between and around two horizontal lines. The primary “fast” moving line is called the %K and reflects with a specific formula, while the other “slow” line is a three-period moving average of the %K line.

The full stochastic oscillator is a line customized by the user that may combine the traits of the slow and fast stochastics.

Slow vs Fast Stochastics

A signal is generated when the “fast” %K line diverges above the “slow” line or vice versa. The two horizontal lines are often pre-set at 30 and 70, indicating oversold and overbought levels, respectively, but can be modified to other levels, such as 20 and 80, to reduce the risk of entering trades on false or premature signals.

The price is considered “overbought” when the two moving lines rise above the upper horizontal line and “oversold” when they fall below the lower horizontal line. The overbought line indicates price action that exceeds the top 20% (or 30%) of the recent price range over a defined period — typically 14-interval period. Conversely, the oversold line represents price levels that fit into the bottom 20% of the recent price range.

The stochastic oscillator is a form of stock technical analysis that calculates statistically opportune times for trade entries and exits. When both stochastics are above the ‘overbought’ line (typically 80) and the fast %K line crosses below the slow %D line, this may signify a time to exit a long position or initiate a short position.

Conversely, when both stochastics are below the oversold line (typically 20), and the %K line crosses above the %D line, this could signify a time to exit a short position or initiate a new long position.

The stochastic oscillator is especially useful among commonly day-traded assets such as low-float stocks that have limited amounts of shares and are more volatile.

However useful these stock indicators are for determining entry and exit points, most readers use them in connection with other tools. While a stochastic oscillator is useful for implementing an overall strategy, it does not assist with identifying the overall market sentiment or trend direction.

It is only when the trend or sideways trading range is well established that traders can safely and reliably use the stochastic oscillator to look for long entries in oversold conditions and shorts entries in overbought conditions.

Recommended: 15 Technical Indicators for Stock Trading

What Is the Formula for a Stochastic Oscillator?

Below is the calculation for a standard 14-period stochastic indicator, but the time period can be adjusted for any time frame.

Calculation for %K:

%K = [(C – L14) / H14 -L14)] x 100

Key:

C = Latest closing price
L14 = Lowest low over the period
H14 = Highest high over the period

%K is sometimes referred to as the “fast stochastic”, whereas the “slow” stochastic indicator is defined as %D = 3-period moving of %K.

The general idea for this oscillator is that in an uptrending market prices will close near the indicator’s high, and in a downtrending market prices will close near the low. Trade signals are generated when the “fast” %K line crosses above or below the three-period moving average, or “slow” %D.

The Slow %K Stochastic Oscillator incorporates a slower three-interval period that provides a moderate internal smoothing of %K. If the %K smoothing period was set to one instead of three, it would result in the equivalent of plotting the ‘fast stochastic.’

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

Pros of the Stochastic Oscillator

There are several benefits to using the stochastic oscillator when evaluating investments.

Clear Entry/Exit Signals

The oscillator has a simple design and generates visual signals when it reaches an extreme level, which can help a trader determine when it’s time to buy or when to sell stocks.

Frequent Signals

For more active traders who trade on intraday charts such as the five, 10, or 15 minute time frames, the stochastic oscillator generates signals more often as price action oscillates in smaller ranges.

Easy to Understand

The oscillator’s fluctuating lines ranging from 0 to 100 are fairly clear for investors who know how to use them.

Available on Most Trading Platforms

The stochastic oscillator is a ubiquitous technical indicator found in many trading platforms, online brokerages, and technical chart services with similar configurations.

Recommended: How to Open a Brokerage Account

Cons of the Stochastic Oscillator

Despite its benefits, the stochastic oscillator is not a perfect tool.

Possible False Signals

Everyone’s strategy is different but depending on the time settings chosen, traders may misperceive a sharp oscillation as a buy or sell signal, especially if it goes against the trend. This is more common during periods of market volatility.

Doesn’t Measure the Trend or Direction

The stochastic oscillator calculates the strength or weakness of price action in a market, not the overall trend or direction.

How to Trade With the Stochastic Oscillator

Some traders find the stochastic oscillator indicator useful to identify trade entry and exit points, and help decide whether they’re bullish on a stock. The stochastic oscillator does this by comparing a particular closing price based on the user’s selected time frame to a range of the security’s highest and lowest prices over a certain period of time.

Traders can reduce the sensitivity of the oscillator to market fluctuations by adjusting the time frame and range of prices. The oscillator tends to trend around a mean price level because it relies on recent price history, but it also adjusts (with lag) when prices break out of price ranges.

The Takeaway

The stochastic oscillator is a popular technical trading indicator, which can help investors find trading opportunities, measure movements, and calculate valuations. After identifying the direction of a security’s trend, the stochastic oscillator can help determine when the security is overbought or oversold, thus identifying lower-risk trade-entry points.

The oscillator uses a complex formula to calculate recent price averages according to the user’s preset time frame and the most recent price to the average price ranges. The tool plots the final calculation on a scale of 0 to 100, 0 being extremely oversold and 100 being extremely overbought. While technical indicators are not trading strategies on their own, they are useful tools when properly incorporated into an overall trading strategy.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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

FAQ

Which is more accurate, RSI or Stochastic?

Relative strength index, or RSI, tends to be more useful for investors in trending markets, whereas Stochastics tend to be more helpful or reliable in non-trending markets.

What are the default indicator settings for Stochastic?

The default indicator settings for Stochastic Indicator are 5,3,3, though there are other commonly-used settings.

What is divergence in Stochastics?

Divergences are indications of a change, and can be used by traders or investors to try and determine whether a trend is getting weaker, stronger, or continuing.

Photo credit: iStock/alvarez

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

Claw Promotion: 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.

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Feb
27
2024
notebook on desk

Margin Calls: Defined and Explained

By | Growing Wealth, invest, Investing | Comments Off on Margin Calls: Defined and Explained

A margin call is when an investor is required to add cash or sell investments to maintain a certain level of equity in a margin account if the value of the account decreases too much.

Margin trading — when an investor borrows money from a brokerage firm to enhance trades — is a risky endeavor. Placing bets with borrowed funds can boost gains but can also supercharge losses. Brokers require traders to keep a minimum balance in their margin accounts for this reason.

If the margin account dips below a certain threshold, this is when the brokerage firm will issue a margin call. A margin call is one of several risks associated with margin trading.

Margin calls are designed to protect both the brokerage and the client from bigger losses. Here’s a closer look at how margin calls work, as well as how to avoid or cover a margin call

Key Points

•   A margin call occurs when an investor must contribute cash or sell investments to uphold a specific equity level in their margin account.

•   Margin trading involves borrowing money from a brokerage firm to enhance trades, but it comes with risks.

•   If the equity in a margin account falls below the maintenance margin, a margin call is issued by the brokerage firm.

•   Margin calls are designed to protect both the brokerage and the client from bigger losses.

•   To cover a margin call, investors can deposit cash or securities into the margin account or sell securities to meet the requirements.

What Is a Margin Call?

A margin call is when a brokerage firm demands that an investor add cash or equity into their margin account because it has dipped below the required amount. The margin call usually follows a loss in the value of investments bought with borrowed money from a brokerage, known as margin debt.

A house call, sometimes called a maintenance call, is a type of margin call. A brokerage firm will issue the house call when the market value of assets in a trader’s margin account falls below the required maintenance margin — the minimum amount of equity a trader must hold in their margin account.

If the investor fails to honor the margin call, meaning they do not add cash or equity into their account, the brokerage can sell the investor’s assets without notice to cover the shortfall in the account. This entails a high level of responsibility and potential risk, which is why margin trading is primarily for experienced investors, not for investing beginners.

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

How Do Margin Calls Work?

When the equity in an investor’s margin account falls below the maintenance margin, a brokerage firm will issue a margin call. Maintenance margins requirements differ from broker to broker.

Additionally, regulatory bodies like the Federal Reserve and FINRA have rules for account minimums that all firms and investors must follow to limit risk and leverage.

Regulation T

The Federal Reserve Board’s Regulation T states that the initial margin level should be at least 50% of the market value of all securities in the margin account. The minimum equity amount must be valued at 50% or more of the margin account’s total value. For example, a $10,000 trade would require an investor to use $5,000 of their own cash for the transaction.

Recommended: Regulation T (Reg T): All You Need to Know

FINRA

The Financial Industry Regulatory Authority (FINRA) requires that investors have a maintenance margin level of at least 25% of the market value of all securities in the account after they purchase on margin. For example, in a $10,000 trade, the investor must maintain $2,500 in their margin account. If the investment value dips below $2,500, the investor would be subject to a margin call.

Example of Margin Call

Here is how a margin trade works. Suppose an investor wants to buy 200 shares of a stock at $50 each for an investment that totals $10,000. He or she puts up $5,000 while the brokerage firm lends the remaining $5,000.

FINRA rules and the broker require that the investor hold 25% of the total stock value in his or her account at all times — this is the maintenance requirement. So the investor would need to maintain $2,500 in his or her brokerage account. The investor currently achieves this since there’s $5,000 from the initial investment.

If the stock’s shares fall to $30 each, the value of the investment drops to $6,000. The broker would then take $4,000 from the investor’s account, leaving just $1,000. That would be below the $1,500 required, or 25% of the total $6,000 value in the account.

That would trigger a margin call of $500, or the difference between the $1,000 left in the account and the $1,500 required to maintain the margin account. Normally, a broker will allow two to five days for the investors to cover the margin call. In addition, the investor would also owe interest on the original loan amount of $5,000.

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 10%* and start margin trading.

*For full margin details, see terms.

Margin Call Formula

Here’s how to calculate a margin call:

Margin call amount = (Value of investments multiplied by the percentage margin requirement) minus (Amount of investor equity left in margin account)

Here’s the formula using the hypothetical investor example above:

$500 = ($6000 x 0.25%) – ($1,000)

Investors can also calculate the share price at which he or she would be required to post additional funds.

Margin call price = Initial purchase price times (1-borrowed percentage/1-margin requirement percentage)

Again, here’s the formula using the hypothetical case above:

$33.33 / share = $50 x (1-0.50/1-0.25)

💡 Quick Tip: When you trade using a margin account, you’re using leverage — i.e. borrowed funds that increase your purchasing power. Remember that whatever you borrow you must repay, with interest.

2 Steps to Cover a Margin Call

When investors receive a margin call, there are only two options:

1.    They can deposit cash into the margin account so that the level of funds is back above the maintenance margin requirement. Investors can also deposit securities that aren’t margined.

2.    Investors can also sell the securities that are margined in order to meet requirements.

In a worst case scenario, the broker can sell off securities to cover the debt.

How Long Do I Have to Cover a Margin Call?

Brokerage firms are not required to give investors a set amount of time. As mentioned in the example above, a brokerage firm normally gives customers two to five days to meet a margin call. However, the time given to provide additional funds can differ from broker to broker.

In addition, during volatile times in the market, which is also when margin calls are more likely to occur, a broker has the right to sell securities in a customer’s trading account shortly after issuing the margin call. Investors won’t have the right to weigh in on the price at which those securities are sold. This means investors may have to settle their accounts by the next trading day.

Tips on Avoiding Margin Calls

The best way to avoid a margin call is to avoid trading on margin or having a margin account. Trading on margin should be reserved for investors with the time and sophistication to monitor their portfolios properly and take on the risk of substantial losses. Investors who trade on margin can do a few things to avoid a margin call.

•   Understand margin trading: Investors can understand how margin trading works and know their broker’s maintenance margin requirements.

•   Track the market: Investors can monitor the volatility of the stock, bond, or whatever security they are investing in to ensure their margin account doesn’t dip below the maintenance margin.

•   Keep extra cash on hand: Investors can set aside money to fulfill the potential margin call and calculate the lowest security price at which their broker might issue a call.

•   Utilize limit orders: Investors can use order types that may help protect them from a margin call, such as a limit order.

The Takeaway

While margin trading allows investors to amplify their purchases in markets, margin calls could result in substantial losses, with the investor paying more than he or she initially invested. Margin calls occur when the level of cash in an investor’s trading account falls below a fixed level required by the brokerage firm.

Investors can then deposit cash or securities to bring the margin account back up to the required value, or they can sell securities in order to raise the cash they need.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, 10%*

FAQ

How can you satisfy your margin call in margin trading?

A trader can satisfy a margin call by depositing cash or securities in their account or selling some securities in the margin account to pay down part of the margin loan.

How are fed and house calls different?

A fed call, or a federal call, occurs when an investor’s margin account does not have enough equity to meet the 50% equity retirement outlined in Regulation T. In contrast, a house call happens when an investor’s margin equity dips below the maintenance margin.

How much time do you have to satisfy a margin call?

It depends on the broker. In some circumstances, a broker will demand that a trader satisfy the margin call immediately. The broker will allow two to five days to meet the margin call at other times.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

*Borrow at 10%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Feb
27
2024
How to Start Investing in Stocks

How to Invest in Stocks: A Beginner’s Guide for Getting Started

By | Growing Wealth, invest, Investing | Comments Off on How to Invest in Stocks: A Beginner’s Guide for Getting Started

Stocks are shares of ownership in a company. To start investing in stocks, you would find a company that you like and think might grow in value and then purchase its stock through a brokerage account. If the stock price rises, you could sell your shares and potentially make a profit — or not if share prices decline.

Of course, when it comes to investing for beginners, you need to learn some basics to invest in stocks and do it well. Thanks to technology and various educational resources, you can get started using an app or online brokerage account and learn as you go. It has never been easier to build investing confidence as you gain experience. Here is a step-by-step guide for those who want to start investing in stocks now.

Key Points

•   Stocks represent shares of ownership in a company and can be purchased through a brokerage account.

•   Before investing in stocks, determine your investing approach and consider your time horizon.

•   Different ways to invest in stocks include self-managed investing, using a financial advisor, or utilizing robo-advisors.

•   The amount you invest in stocks depends on your budget and financial goals.

•   Choose stocks based on thorough research, including analyzing a company’s financial statements and valuation metrics.

How to Start Investing in Stocks: 5 Steps

1. Determine Your Investing Approach

Before you get started investing in stocks, you need to determine your investing approach. Because every person has unique financial goals and risk tolerances, there is no one-size-fits-all strategy to begin investing in the stock market.

Most people will need to decide whether they want a hands-on approach to investing or whether they’d like to outsource their wealth building to some sort of financial advisor.

Additionally, investors need to consider their time horizons before investing in stocks. Some investors want to invest long-term — buying and holding assets to build wealth for retirement. In contrast, other investors are more interested in short-term trading, buying and selling stocks daily or weekly to make a quick profit. The type of investor you want to be will help determine what kind of stocks you should buy and your investing approach.

The Different Ways to Invest in the Stock Market

Fortunately, various options are available for every type of investor as they begin to invest in stocks.

As mentioned above, some investors like to have a hands-on approach to investing. These investors want to make decisions on their own, picking what stocks are right for them and building a portfolio from the ground up. This self-managed strategy can be time-consuming but an excellent option for investors who have a general understanding of the markets or would like to learn more about them.

Other investors like to have experts, like a money manager, manage the investing process for them. While this investing approach may cost more than doing it yourself, it can be an ideal choice for individuals who do not have the time or energy to devote to financial decision-making.

2. Decide How Much you Will Invest in Stocks

How much you invest depends entirely on your budget and financial goals. Many financial experts recommend saving between 10% and 15% of your after-tax annual income, either in a savings account or by investing. With that guideline in mind, you may decide to invest with whatever you can comfortably afford.

Fortunately, it’s much easier to invest these days, even if you only have a few bucks at a time. Many brokerage firms offer low or no trading fees or commissions, so you can make stock trades without worrying about investment fees eating into the money you decide to invest.

Additionally, many brokerage firms offer fractional share investing, which allows investors to buy smaller amounts of a stock they like. Instead of purchasing one stock at the value for which the stock is currently trading — which could be $1,000 or more — fractional share investing makes it possible to buy a portion of one stock. Investors can utilize this to use whatever dollar amount they have available to purchase stocks.

For example, if you only have $50 available to invest and want to buy stock XYZ trading at $500 per share, fractional share investing allows you to buy 10% of XYZ for $50.

Asset Allocation

Asset allocation involves spreading your money across different types of investments, like stock, bonds, and cash, in order to balance risk and reward. Determining a portfolio’s asset allocation can vary from person to person, based on financial goals and risk tolerance.

Asset allocation is closely tied with portfolio diversification. Diversification means spreading one’s money across a range of assets. Generally, it’s like taking the age-old advice of not putting all your eggs in one basket. An investor can’t avoid risk entirely, but diversifying their investments can help mitigate the risk one asset class poses.

3. Open an Investment Account

Once you determine your investing approach and how much money you can invest, you’ll need to open a brokerage account to buy and sell shares of companies or whatever other assets you’d like to invest in.

Several investment accounts might make sense for you, depending on your comfort level in managing your investments and your long-term financial goals.

Professional option: Full-service brokerages

Many investors may use traditional brokerage firms, also known as full-service brokerages, to buy and sell stocks and other securities. A full-service brokerage offers additional services beyond just buying and selling stocks, such as investment advice, wealth management, and estate planning. Typically, full-service brokerages provide these services at high overall costs, while discount and online brokerages maintain scaled-down services with lower overall costs.

A full-service brokerage account may not be the best option for investors just getting started investing in stocks. These firms often require substantial account minimum balances to open an account. This option may be out of reach for most in the early stages of their investing journey.

Do-it-yourself option: Online brokerage

An online brokerage account is ideal for most beginning investors looking to have a hands-on approach to trading stocks and building a financial portfolio. Many online brokers offer services with the convenience of an app, which can make investing more streamlined. If you feel confident or curious about how to start investing at a lower cost than a full-service brokerage firm, opening an account with an online broker could be a great place to start.

Hands-off, automated option: Robo-advisor

If you’re interested in investing but want some help setting up a basic portfolio, opening an investment account with a robo-advisor might be best for you. A robo-advisor uses a sophisticated computer algorithm to help you pick and manage investments. These automated accounts generally don’t offer individual stocks; instead, they build a portfolio with a mix of exchange-traded funds (ETFs). Nonetheless, it’s a way to become more familiar with investing.

Retirement option: 401(k) and IRAs

Retirement accounts like employer-sponsored 401(k)s or individual retirement accounts (IRAs) are tax-advantaged investment accounts that can be great for the beginning investor trying to build a retirement nest egg. These accounts offer investors a range of investment choices, including individual stocks. You may also have access to tutorials, advisors, or other resources to help you learn how to start investing in these accounts.

💡 Ready to start retirement investing? Consider opening an IRA online.

Tip: Compare Costs and Features

No matter where you decide to open your investment account, be sure to research and compare costs and features within the account. For example, many brokerage accounts charge investment fees and commissions for making trades. Although investment costs can be quite low — and you can trade stocks without paying a commission — any investment fee can add up over time and ultimately reduce your overall investment returns.

Additionally, it helps to check if the investment account requires a minimum deposit to open an account. A minimum deposit can be a barrier to getting started for the beginning investor who doesn’t have much money to invest. However, many firms do not have minimum deposit requirements any longer.

4. Choose Your Stocks

Deciding what individual stocks to invest in can be challenging for most investors. There are countless ways to evaluate stocks before you buy.

Before choosing your stocks, you generally want to do a deep dive into a company’s inner workings to understand the company’s overall valuation and the stock’s share price.

As a beginning investor, you want to get comfortable reading a company’s balance sheet and other financial statements. All publicly-traded companies must file this information with the Securities and Exchange Commission (SEC), so you shouldn’t have trouble finding these financials.

One of the most fundamental metrics for understanding a stock’s value compared to company profits is its price-to-earnings (PE) ratio. Others include the price-to-sales (PS) ratio and the price/earnings-to-growth (PEG) ratio, which may be helpful for companies that have little to no profits but are expanding their businesses quickly.

These metrics, and other financial ratios, can help you determine what stocks to buy. And the advantage of owning individual stocks is that you can get direct exposure to a company you believe has the potential to grow based on your research. The downside, of course, is that investing doesn’t come with guarantees, and your stock’s value could decline even with thorough research.

💡 Recommended: 15 Technical Indicators for Stock Trading

5. Continue Building Your Portfolio

After you’ve decided what stocks to invest in, you generally want to continue building a portfolio that will help you meet your financial goals.

One way to bolster your portfolio is by buying mutual funds and ETFs rather than individual stocks. A benefit to investing in funds that hold stocks is that you can avoid some of the risks of being invested in individual stocks that may not perform well.

Whether investing in individual stocks or funds, you may want to consider the level of diversification in your portfolio that feels right for you. There is no consensus about the right way to diversify investments. For one person, ideal diversification could mean owning 20 stocks in different industries. For another, it could mean owning the “whole” market via a handful of mutual funds.

Once you get more comfortable investing in stocks and funds, you can employ numerous other investing strategies. You can add various securities, like bonds, commodities, and crypto, to your portfolio.

The Takeaway

Historically, investing in the stock market has been a way for some individuals to build personal wealth. These days, it’s never been easier for new investors considering getting into stocks to start. Whether you choose to work with a financial advisor or use an online broker or app, there are several ways to find a method that makes stock investing easy, fun, and potentially profitable. Of course, there are no guarantees, so it’s wise to take a step-by-step approach, start small if you prefer, do some research using the many resources available, and see what comes as you gain experience and confidence.

Investors can open an online investing account with SoFi Invest® to trade individual stocks, ETFs, or fractional shares with no commissions. Additionally, SoFi’s Automated Investing builds, manages, and rebalances portfolios with no SoFi management fee for those interested in investing in stocks through a more hands-off approach.

Start investing with your SoFi Invest account today.

FAQ

How do I invest $100?

You can invest $100 by opening an investing account that does not require a minimum account balance and purchasing shares of a stock or ETF that are less than $100. You can also use your funds to purchase fractional shares of whatever stocks you want to own.

How do I open a brokerage account?

You’ll need to take a few steps to open a brokerage account. First, you’ll need to find a broker that fits your needs. Once you’ve found a broker, you’ll need to complete an application and submit it to the broker. The broker will then review your application and, if approved, will open an account for you.

What is the S&P 500?

The Standard and Poor’s 500, commonly known as the S&P 500, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ stock exchanges. It is one of the most commonly followed stock market indices in the United States, along with the Dow Jones Industrial Average and Nasdaq Composite.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Stock Bits
Stock Bits is a brand name of the fractional trading program offered by SoFi Securities LLC. When making a fractional trade, you are granting SoFi Securities discretion to determine the time and price of the trade. Fractional trades will be executed in our next trading window, which may be several hours or days after placing an order. The execution price may be higher or lower than it was at the time the order was placed.
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Feb
27
2024
Sell-to-Open vs Sell-to-Close: How They Work

Sell-to-Open vs Sell-to-Close: How They’re Different

By | Growing Wealth, invest, Investing | Comments Off on Sell-to-Open vs Sell-to-Close: How They’re Different

Sell-to-open and sell-to-close are two of the four order types used in options trading. The other two are buy-to-open and buy-to-close. Options contracts can be created, closed out, or simply exchanged on the open market.

A sell-to-open order is an options order type in which you sell (also described as write) a new options contract.

In contrast, a sell-to-close order is an options order type in which you sell an options contract you already own. Both types of options, calls and puts, are subject to these order types.

Key Points

•   Sell-to-Open involves selling a new options contract, while Sell-to-Close involves selling an existing options contract.

•   Sell-to-Open profits from decreasing option values, while Sell-to-Close profits from options that have increased in value.

•   Sell-to-Open can increase open interest, while Sell-to-Close can decrease open interest.

•   Sell-to-Open writes a new options contract, while Sell-to-Close closes an existing options contract.

•   Sell-to-Open benefits from time decay and lower implied volatility, but can result in steep losses and be affected by increasing volatility. Sell-to-Close avoids extra commissions and slippage costs, retains extrinsic value, but limits further upside before expiration.

What Is Sell-to-Open?

A sell-to-open transaction is performed when you want to short an options contract, either a call or put option. The trade is also known as writing an option contract.

Selling a put indicates a bullish sentiment on the underlying asset, while selling a call indicates bearishness.

When trading options, and specifically writing options, you collect the premium upon sale of the option. You benefit if you are correct in your assessment of the underlying asset price movement. You also benefit from sideways price action in the underlying security, so time decay is your friend.

A sell-to-open order creates a new options contract. Writing a new options contract will increase open interest if the contract stays open until the close of that trading session, all other things being held equal.

How Does Sell-to-Open Work?

A sell-to-open order initiates a short options position. If you sell-to-open, you could be bullish or bearish on an underlying security depending on if you are short puts or calls.

Writing an option gives the buyer the right, but not the obligation, to purchase the underlying asset from you at a pre-specified price. If the buyer exercises that right, you, the seller, are obligated to sell them the security at the strike price.

An options seller benefits when the price of the option drops. The seller can secure profits by buying back the options at a lower price before expiration. Profits are also earned by the seller if the options expire worthless.

Pros and Cons of Selling-to-Open

Pros

 Cons
Time decay works in your favor A naked sale could result in steep losses
Benefits from lower implied volatility Increasing volatility hurts options sellers
Collects an upfront premium Might have to buy back at a much higher price

An Example of Selling-to-Open with 3 Outcomes

Let’s explore three possible outcomes after selling-to-open a $100 strike call option expiring in three months on XYZ stock for $5 when the underlying shares are trading at $95.

1. For a Profit

After two months, XYZ shares dropped to $90. The call option contract you sold fell from $5 per contract to $2. You decide that you want to book these gains, so you buy-to-close your short options position.

The purchase executes at $2. You have secured your $3 profit.

You sold the call for $5 and closed out the transaction for $2, $5 – $2 = $3 in profit.

A buy-to-close order is similar to covering a short position on a stock.

Keep in mind that the price of an option consists of both intrinsic and extrinsic value. The call option’s intrinsic value is the stock price minus the strike price. Its extrinsic value is the time value.

Options pricing can be tricky as there are many variables in the binomial option pricing model.

2. At Breakeven

If, however, XYZ shares increase modestly in the two months after the short call trade was opened, then time decay (or theta) might simply offset the rise in intrinsic value.

Let’s assume the shares rose to $100 during that time. The call option remains at $5 due to the offsetting changes in intrinsic value and time value.

You decide to close the position for $5 to breakeven.

You sold the call for $5 and closed out the transaction for $5, $5 – $5 = $0 in profit.

3. At a Loss

If the underlying stock climbs from $95 to $105 after two months, let’s assume the call option’s value jumped to $7. The decline in time value is less than the increase in intrinsic value.

You choose to buy-to-close your short call position for $7, resulting in a loss of $2 on the trade.

You sold the call for $5 and closed out the transaction for $7, $7 – $5 = $2 loss.

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

What Is Sell-to-Close?

A sell-to-close is executed when you close out an existing long options position.

When you sell-to-close, the contract you were holding either ceases to exist or transfers to another party.

Open interest can stay the same or decrease after a sell-to-close order is completed.

How Does Sell-to-Close Work?

A sell-to-close order ends a long options position that was established with a buy-to-open order.

When you sell-to-close, you might have been bullish or bearish an underlying security depending on if you were long calls or puts. (These decisions can be part of options trading strategies.) A long options position has three possible outcomes:

1.    It expires worthless

2.    It is exercised

3.    It is sold before the expiration date

Pros and Cons of Selling-to-Close

Pros

 Cons
Avoids extra commissions versus selling shares in the open market after exercising There might be a commission with the options sale
Avoids possible slippage costs The option’s liquidity could be poor
Retains extrinsic value Limits further upside before expiration

An Example of Selling-to-Close with 3 Outcomes

Let’s dive into three plausible scenarios whereby you would sell-to-close.

Assume that you are holding a $100 strike call option expiring in three months on XYZ stock that you purchased for $5 when the underlying shares were $95.

1. For a Profit

After two months, XYZ shares rally to $110. Your call options jumped from $5 per contract to $12.

You decide that you want to book those gains, so you sell-to-close vs sell-to-open your long options position.

The sale executes at $12. You have secured your $7 profit.

You purchased the call for $5 and closed out the transaction for $12, $12 – $5 = $7 in profit.

2. At Breakeven

Sometimes a trading strategy does not pan out, and you just want to sell at breakeven. If XYZ shares rally only modestly in the two months after the long call trade was opened, then time decay (or theta) might simply offset the rise in intrinsic value.

Let’s say the stock inched up to $100 in that time. The call option remains at $5 due to the offsetting changes in intrinsic value and time value.

You decide to close the position for $5 to breakeven.

You purchased the call for $5 and closed out the transaction for $5, $5 – $5 = $0 in profit.

3. At a Loss

If the stock price does not rise enough, cutting your losses on your long call position can be a prudent move. If XYZ shares climb from $95 to $96 after two months, let’s assume the call option’s value declines to $2. The decline in time value is more than the increase in intrinsic value.

You choose to sell-to-close your long call position for $2, resulting in a loss of $3 on the trade.

You purchased the call for $5 and closed out the transaction for $2, $5 – $3 = $2 loss.

What Is Buying-to-Close and Buying-to-Open?

Buying-to-close ends a short options position, which could be bearish or bullish depending on if calls or puts were used.

Buying-to-open, in contrast, establishes a long put or call options position which might later be sold-to-close.

Understanding buy to open vs. buy to close is similar to the logic with sell to open vs sell to close.

The Takeaway

Selling-to-open is used when establishing a short options position, while selling-to-close is an exit transaction. The former is executed when writing an options contract, while the latter closes a long position. It is important to know the difference between sell to open vs sell to close before you start options trading.

If you’re ready to try your hand at options trading, you can set up an Active Invest account and, if qualified, trade options from the SoFi mobile app or through the web platform.

And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commissions, see full fee schedule here, and members have access to complimentary financial advice from a professional.

With SoFi, user-friendly options trading is finally here.

FAQ

Is it better to buy stocks at opening or closing?

It is hard to determine what time of the trading day is best to buy and sell stocks and options. In general, however, the first hour and last hour of the trading day are the busiest, so there could be more opportunities then with better market depth and liquidity. The middle of the trading day sometimes features calmer price action.

Can you always sell-to-close options?

If you bought-to-open an option, you can sell-to-close so long as there is a willing buyer. You might also consider allowing the option to expire if it will finish out of the money. A final possibility is to exercise the right to buy or sell the underlying shares.

How do you close a sell-to-open call?

You close a sell-to-open call option by buying-to-close before expiration. Bear in mind that the options might expire worthless, so you could do nothing and avoid possible commissions. Finally, the options could expire in the money which usually results in a trade of the underlying stock if the option is exercised.

Photo credit: iStock/izusek

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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