Unit Investment Trust (UIT) Explained Easily

Unit Investment Trust (UIT) Explained Clearly

A unit investment trust or UIT is similar to a mutual fund in that it’s a type of investment company that can hold a variety of securities, like stocks and bonds, that investors can buy as redeemable units.

In fact, UITs belong to the same category as mutual funds and closed-end funds, in that they pool money together from different investors. Similarly, unit investment trusts are designed to provide capital appreciation and/or dividend income, although without active trading of the securities in the portfolio.

UITs differ from most mutual funds several ways, chiefly in that they sell a fixed number of shares or units when the UIT is first opened; and the trust has a set maturity date when the UIT is dissolved and investors can redeem their units.

Unit investment trusts can offer some advantages to investors compared to mutual funds or exchange-traded funds (ETFs). There are, however, some potential downsides that could make them less attractive than other types of pooled investments.

What Is a Unit Investment Trust (UIT)?

A unit investment trust is a type of investment company that issues and invests in securities. The other two types of investment companies are open-end funds (i.e. mutual funds) and closed-end funds.

Similar to a closed-end fund, a UIT raises money from multiple investors, typically through an Initial Public Offering or IPO. Each investor holds a unit in the trust that represents an ownership share and allows them to stake a claim to any capital appreciation or dividend income the trust generates. This type of trust can be established as a grantor trust or a regulated investment corporation.

Unit investment trusts can invest in a variety of different securities, but they tend to concentrate holdings in stocks and bonds. These assets are held in the trust for a set time period until the trust is dissolved. A typical holding period would be anywhere from 15 months to two years, though some UITs may have an end date that’s farther in the future.

Investors can sell their holdings back to the issuing company at any time, but they can’t trade UIT shares as they would shares of a mutual fund.

Once the portfolio manager of a unit investment trust chooses which securities to invest in, the investment focus usually doesn’t change. That means there is typically no active investing management in terms of trading the underlying assets. The investments that a UIT chooses depend on its overall strategy and objectives. So the risk and return profile of unit investment trusts can vary from one to another, based on the underlying holdings.

When a UIT matures, investors can do one of three things:

• Wait for the trust to liquidate its portfolio and receive their share of the proceeds

• Roll the investment over to a new UIT

• Receive a like-kind distribution of stock from the trust’s underlying investments

It’s important to keep in mind that UITs are not guaranteed investments. So it’s possible that returns could be lower than expected or even negative if the trust fails to meet its objectives.

UIT vs. Mutual Fund

As noted above, a mutual fund is a company that pools money from investors and invests them in securities. There are many different types of mutual funds, including but not limited to bond funds, stock funds, blended funds, target-date funds, and index funds. Some mutual funds can be actively managed while index funds follow a passive investing strategy.

Recommended: Active vs Passive Investing: Key Differences

At first glance, a UIT and a mutual fund might seem like the same thing since they fall under the same investment company umbrella. And while they do have some features in common, there are other things that distinguish the two.

How Are UITs and Mutual Funds Similar?

UITs and mutual funds share common ground when it comes to diversification, regulation, and how they pass on capital gains or dividends to investors. A capital gain represents a gain between the price you initially paid for an investment and the price you receive when you sell it. A dividend is a percentage of an investment’s profits that are paid out to investors.

Recommended: How Do Dividends Work?

Since UITs and mutual funds are both types of investment companies, they’re subject to SEC regulation. This means they’re required to meet regular reporting requirements. While this can help to minimize the potential for fraud, investors are still encouraged to read each fund’s prospectus to ensure they understand what the fund invests in.

What Are the Differences Between UITs and Mutual Funds?

The biggest differences between UITs and mutual funds have to do with their structure and management. A UIT has a set beginning when shares are issued, and an end date when it matures — while an open-end mutual fund typically allows investors to continually buy and sell shares. Additionally, a unit investment trust issues a certain number of units when the trust is created while mutual funds can issue new shares periodically.

With UITs, the underlying investments remain largely the same for the entirety of the investment period. Mutual funds, on the other hand, can buy and sell underlying assets as needed to stay aligned with the fund’s objectives. So mutual funds can be more adaptable if an underlying investment doesn’t perform as expected.

How to Invest in UITs

If you’re interested in investing with a unit investment trust, it’s possible to buy them directly from the issuer. UITs can also trade on an exchange, so you could purchase them through an online brokerage account. SoFi Invest®, for example, offers members access to IPO investing.

Before buying a unit investment trust, however, there are a few things to consider. Specifically, look at the following when comparing UITs:

• Duration of the UIT

• Minimum investment requirement

• Underlying investments

• Investment strategy and objectives

• Fees

Also, consider the investment risks. Again, there’s no guarantee that a unit investment trust will perform as expected. And since the trust investments are fixed, your returns (or losses) more or less hinge on whether those investments do well.

It’s also important to think about how well the underlying investments match up with the other investments in your portfolio. If you’re already heavily concentrated in equities, for example, it may not make sense to choose an equity UIT since that could increase your exposure to some of the same companies. A bond UIT, on the other hand, might help to balance out your asset allocation.

Are UITs a Good Investment?

Whether a unit investment trust is a good investment for you personally can depend on what you need and expect a pooled investment to do for you. If you’re an active trader, for example, then a UIT likely wouldn’t be a good fit. On the other hand, if you tend to take the longer view when investing or you prefer a buy-and-hold approach, you may find a unit investment trust fits well in your investment portfolio.

While you could benefit from capital gains distributions and dividends, keep in mind that unit investment trusts offer less flexibility than mutual funds or ETFs. Dividends, for example, can’t be reinvested the way they could with a mutual fund or index fund.

Investment fees are another important consideration when investing in a UIT. Since investment costs can reduce total return amounts over time, it’s important to understand all the costs associated with buying units and redeeming them when the trust matures.

Consider Investing in a Unit Investment Trust

Given their less flexible structure and set maturity date, unit investment trusts may be appealing to investors who take a longer-term approach and tend to prefer a buy-and-hold strategy. If you’d like more flexibility with your investments, you may consider mutual funds or ETFs in place of UITs, which have a set beginning and end date and little or no active trading of the securities within the trust. You also might want to explore alternatives to trusts or funds, like cryptocurrency or investing in IPOs.

Those are all things you can do when you open a brokerage account with SoFi Invest. SoFi offers convenient, low-cost online trading for beginners and more experienced investors who want to build wealth through their portfolios. Learn more about how to get started today.

Photo credit: iStock/Ridofranz


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.

SOIN0721296

Read more
What Is the US Dollar Index?

What Is the US Dollar Index?

The U.S. dollar index, also called the USDX, tracks the value of the dollar compared with six major world currencies — specifically those of the United States’ most significant trading partners.

The USDX fluctuates based on the exchange rates that the dollar maintains with those currencies. Investors and traders use the USDX as a quick way to track the relative value of the dollar and to manage potential currency risks in their portfolio.

There are also several futures and options strategies trading on the New York Board of Trade that allow sophisticated investors to bet that the USDX will go up or down. For investors who want to hedge their currency risks, or just speculate, they can invest in the U.S. dollar index through mutual funds, exchange-traded funds (ETFs), or options.

How the US Dollar Index Is Calculated

Currently, the U.S. dollar index is calculated using the exchange rates of six currencies: the Euro (EUR), the Japanese yen (JPY), the Canadian dollar (CAD), the British pound (GBP), the Swedish krona (SEK), and the Swiss franc (CHF). Given that 19 countries in the European Union use the euro, EUR is the most significant component of the index, representing 57.6% of the basket.

By contrast the yen comprises 13.6% of the index, followed by the British pound (11.9%), the Canadian dollar (9.1%), the Swedish krona (4.2%), and finally the Swiss franc (3.6%).

The U.S. dollar has long been considered the world’s reserve currency, and the index tracks where five of those six currencies stood in relation to the U.S. dollar in 1973 (the euro was added to the index in 1999). At its inception, the U.S. dollar index was set at 100. When the index is over 100, then the dollar is considered strong, and it may be considered weak depending on how far below 100 it falls.

The strength or weakness of a dollar impacts many aspects of the economy. A weak dollar increases the prices that companies pay for globally traded commodities, which contributes to inflation by raising the prices consumers pay for everyday items. A strong dollar makes the goods produced in the U.S. more expensive to overseas consumers, and can hurt exports over time.

The History of the US Dollar Index

When World War II ended in 1945, the United States found itself in a position of unusual strength. Like many countries, the U.S. had suffered enormous casualties, yet its industries, cities, and overall economy had survived the war more or less intact. So it was that in July of 1944, over 700 delegates from 44 countries met in Bretton Woods, NH, to create a roadmap for a more efficient foreign exchange system that would help establish a resilient post-war global economy.

The Bretton Woods Agreement that emerged from this historic conference created a system whereby gold became the basis for the U.S. dollar, and other currencies were pegged to the value of the dollar. The International Monetary Fund and the World Bank were also established as a result of Bretton Woods.

The new global currency system included a promise from the participating countries that their central banks would establish fixed exchange rates between their own currencies and the U.S. dollar. Each agreed that if their currency weakened, they would order their central bank to buy up the currency until its value stabilized relative to the dollar. And if their currency grew too strong compared with the dollar, their central bank would issue more currency until the value dropped and its relationship with the dollar stabilized.

The terms of the Bretton Woods Agreement were so far-reaching that it took until 1958 to be fully implemented. Still, the decision to keep the dollar pegged to gold proved challenging for the U.S. In 1971, when the gold owned by the U.S. government could no longer cover the number of dollars in circulation, President Richard M. Nixon was forced to reduce the dollar’s value relative to gold. The Bretton Woods System collapsed in 1973.

With the end of the Bretton Woods System, countries and their central banks took a wide range of approaches to how they valued their currency. After 1973, each country’s currency had its own value, adjusted through trade, government interventions, and the policies of central banks. To track the value of the dollar against this backdrop of currency valuations, the U.S. dollar index came into being.

When it launched, it had a base of 100, representing the dollar’s value versus the currencies of its major trading partners. Since then, the index has fluctuated relative to that base. Over the last five years, for example, the U.S. dollar index reached a high of 102.39 on December 1, 2016, and a low of 89.13 on January 1, 2018. The value of the index is considered a fair indication of the dollar’s position in global markets. And investors can also use it to trade.

How to Trade the US Dollar Index

Investors who want to bet on the rise or fall of the dollar’s value, or who simply want to hedge it as part of a broader strategy, can trade the U.S. dollar index the same way they trade an equity index like the S&P 500. The U.S. dollar index is popular among foreign exchange (FX) traders who don’t have the time or resources to monitor the movements between the dollar and the other currencies in the index.

Anyone who tracks global trade will notice that two major currencies are missing from the index: Neither the Chinese yuan (CNY) or the Mexican peso (MXN) are in the USDX. Historically the USDX has only been adjusted once since its inception — in 1999 when the euro was added, and certain of the currencies the euro had replaced were then removed from the index. Still, it’s likely that at some point the USDX could be adjusted a second time to include CNY and MXN, given their status as significant trading partners with the United States.

Investing with SoFi

Most investors know that a bond index or equity index is typically comprised of many constituent companies; similarly, the U.S. dollar index is comprised of six global currencies. It tracks the value of the dollar relative to those currencies, and fluctuates based on the exchange rates that the dollar maintains with those currencies. You can use the USDX as a way to track the relative value of the dollar, to manage potential currency risks in a portfolio, and to trade.

You could get started by opening an online investing account with SoFi Invest®. SoFi Invest offers an active investing solution that allows you to choose your stocks and ETFs without paying SoFi commissions. SoFi Invest also offers an automated investing solution that invests your money for you based on your goals and risk, without charging a SoFi management fee.

Photo credit: iStock/FG Trade


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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.
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.
SOIN0621257

Read more
What is Volatility Skew and How Can You Trade It?

What Is Volatility Skew and How Can You Trade It?

What is Volatility Skew?

Volatility skew, also known as Option Skew, is an options trading concept that refers to the difference in volatility between at-the-money options, in-the-money options, and out-of-the-money options. These terms in options trading refer to the relationship between the market price and the strike price of the contract.

Options contracts for the same underlying asset with the same expiration date but different strike prices have a range of implied volatility. In other words, it’s a graph plot of implied volatility points representing different strike prices or expiration dates for options contracts.

Each asset type looks different on a graph but they tend to resemble a smile or a smirk, the volatility skewness is the slope of the implied volatility on that graph. A balanced curve is called a “volatility smile,” and if it is unbalanced to one side it is called a “volatility smirk.”

What is Implied Volatility (IV)?

Implied volatility, denoted by the sigma symbol (σ), is an estimate of the volatility that a particular underlying asset will have between the current moment and the time when the options contract for the asset expires. It’s basically the uncertainty that investors have about an underlying stock and how likely traders think the stock will reach a particular price on a particular date. The volatility of an underlying asset changes constantly. The more the price of the asset changes, the more volatility it has. But implied volatility doesn’t necessarily follow the same pattern because it depends on how investors view the asset and whether they predict it will have volatility. Implied volatility is usually shown using standard deviations and percentages over a particular period of time.

Option pricing assumes that options for the same asset that have the same expiration have the same implied volatility, even if they have different strike prices. But investors are actually willing to overpay for downside-striked stock options because they think there is more volatility to the downside than the upside.

Different types of options contracts have different levels of volatility, and it’s important for traders to understand this when determining their options trading strategy.

What Does Volatility Skew Mean for Investors?

Volatility depends on supply and demand as well as investor sentiment about the options. The volatility skew helps investors understand the market and decide whether to buy or sell particular contracts. It’s an important indicator for investors who trade options.

Stocks that are decreasing in price tend to have more volatility. If there is implied volatility of an underlying entity, the price of an option increases, resulting in a downside equity skew.

If a skew has higher implied volatility, this means prices will be higher. So investors can look at volatility skews to find low- and high-priced contracts to decide whether to buy or sell.

There are two types of volatility skew. Vertical skew shows the volatility skew of different strike prices of options contracts that have the same expiration date. This is more commonly used by individual traders. Horizontal skew shows the volatility skew of expiration dates of options contracts that have the same strike price.

How Do You Measure Volatility Skew?

Investors measure volatility skew by plotting graph points of different implied volatility of strike prices or expiration dates. For example, a trader could look at a list of bid/ask prices for options contracts for a particular asset that expire on the same date. They take the midpoint implied volatility points from the bid/ask prices and chart them out.

The tilt of the skew changes over time as market sentiment changes. Observing these changes can give investors additional insights into the direction the market is heading, which they can use in skew trading. For instance, if the stock price increases in value significantly, traders might think it is overbought and therefore that it will decrease in value in the future. This will change the skew so its curve increases, showing more pressure for on-the-money or downside put options.

There are five factors that influence the price of options:

• Underlying stock or asset market price

• Strike price

• Time to expiry

• Interest rate

• Implied volatility

Investors can calculate the volatility at different strike prices and graph those out to see the volatility skew.

How Do You Trade With Volatility Skew?

As mentioned above, the two types of volatility skew are horizontal and vertical. These can both be used in trading.

Horizontal Skew

There are many factors that drive changes in horizontal skew, such as product announcements, earnings reports, and global events. For instance, if traders are uncertain about the short-term future of a stock because of an upcoming earnings report, the implied volatility may increase and the horizontal skew could flatten.

Traders look for opportunities by using calendar spreads to look at the differences between option expiration implied volatility. Where there is implied volatility in a horizontal skew, there may be inefficient pricing that traders can take advantage of.

If the implied volatility is higher than expected in the front month, the option contract will be relatively more expensive, which is referred to as positive horizontal skew.

On the other hand, if the implied volatility of the back month is higher than expected this is known as negative horizontal skew or “reverse calendar spread.” In this situation traders would sell the back month and buy the front month because they can profit when the price of the underlying asset increases before the back month contract expires.

For example, a trader might look at the market for a stock and find that there is a horizontal skew in the option calls, meaning traders are putting in buy and sell orders with the prediction that it’s more likely the stock will increase a lot in the long term than in the short term.

If the trader doesn’t think the current market predictions are correct, they can use a reverse calendar call spread, similar to shorting a stock and predicting it will go down. If the price of the stock plummets, both the long- and short-term contracts will decrease in value and the trader can buy them back at a lower price than they sold them for.

In this case the trader can also profit if the implied volatility of the options decreases. They chose to sell when the implied volatility was high during the front month, so if the implied volatility decreases they can buy back at a lower price.

Although this has the potential to be a profitable way to trade, it is also risky because it’s a short call that requires a lot of margin. Stock exchanges require traders to have significant funds in their account if they want to do this type of trade.

Recommended: Investment Risks and Ways to Manage

Vertical Skew

Many investors prefer trading with vertical skew because it is simpler than horizontal skew and requires less margin and, therefore, less risk. Also referred to as volatility skew and option skew, vertical skew looks at the differences between the implied volatility of different stock strike prices that have the same expiration date. Using vertical skew, traders can find opportunities to trade debit spreads and credit spreads, finding the best strike prices to buy or sell.

For example, a trader might find a stock they believe will increase in value before its option contract expires. So they want to find a bull put spread to buy to get profits when the price increases. They will have many strikes to choose from, so they can use vertical skew to identify which are the best trades, meaning those that are low or high priced. The trader can identify one with a good price to buy, wait until it increases and sell it for a profit.

The Takeaway

Options trading is popular with many investors, and volatility skew is one way for options traders to evaluate the price of options contracts. Traders might look at either horizontal or vertical skew to make a decision about whether an options contract purchase makes sense for their investing strategy.

For investors who are looking for a more straightforward way to build a portfolio, an easy way to get started is by opening an account on the SoFi Invest® brokerage platform. The investing platform lets you research, track, buy and sell stocks right from your phone. You can easily see all your financial information in one simple dashboard. If you need help getting started, the SoFi team is available to answer your questions at any time.

Photo credit: iStock/Just_Super


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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.
SOIN0521200

Read more
What Is Mean Reversion and How Can You Trade It?

What Is Mean Reversion and How Can You Trade It?

Mean reversion mathematical concept which holds that over time statistical measurements return to a long-run normal. In investing, mean reversion holds that while a market or an asset may go up and down in the short-term, over time, it returns to its long-term trend. If traders expect a market to revert to the mean, they can use that expectation to inform their strategy going forward.

What Is Mean Reversion?

When stocks revert to the mean, their returns or other characteristics match what they’ve been over a longer period of time than the recent past. This can mean that a stock that becomes highly volatile may revert back to being less volatile; a stock that becomes quite expensive (meaning its price far outpaces its earnings) can become cheap; and, quite importantly, the other way around. Mean reversion can work in both directions.

The mean reversion concept not only applies to individual shares, but also to whole sectors of the economy or of the stock market, like, say, consumer product companies or pharmaceutical companies or any other chunk of the market that shares enough with each other to be classed together. Alternative assets, such as commodities or foreign currencies can also revert to the mean.

The theory applies to more than just prices, the volatility of a given asset can mean revert, which can matter for trading and pricing more exotic financial products like options and other derivatives.

Mean Reversion Strategies

With any generality or principle of the market comes the obvious question: Is there a strategy here? Can this be traded? Mean reversion trading is a strategy based on reversion to the mean happening, basically that stocks or some asset will return to its typical, long-run historical behavior.

Actually working out a mean reversion strategy is not as simple as thinking a certain stock is out of whack and waiting for things to get back to normal, it requires the ability to flag patterns to make an educated guess about when mean reversion will happen. After all, if you just know that a stock is going to revert to the mean, you can still pile up large losses or miss out on big gains if you can’t time the reversion correctly — go too early and you’ll have to eat the stock being the “wrong” price before reversion to the mean happens, go too late and the gains have already evaporated as the change in price or returns has already occurred.

The Risks of Mean Reversion Strategy

Mean reversion strategies depend on statistical and historical regularites staying, well, regular. There are some that are pretty well validated, although with sharp and scary exceptions, like that stocks tend to go up over time and outperform other asset classes. But mean reversion involves certain relationships between stocks and assets staying true over time.

In some cases, mean reversion never occurs. Companies or sectors can have continually growing returns over a long period of time if there’s some kind of structural shift in the economy or market in which they operate. This can mean that returns increase over time or stay quite high.

This can happen for a few reasons. A company could gain or lose a dominant position in a given market, technological changes can advantage certain firms and disadvantage others, such that returns move permanently (or at least close enough to permanently for a given investment strategy) to a higher level and lower to another. Or there could be a global pandemic that permanently changes the way that companies do business, or long-run inflation that impacts profitability.

How to Implement a Mean Reversion Strategy

There are some basic statistical and financial tools to help create mean reversion strategy. As always, active trading and trying to time the market is risky and sometimes the whole market moves up and down and that can swamp whatever strategy you might have for an individual stock or sector.

Part of implementing a mean reversion strategy is getting a sense of stock trends or a trend trading strategy, whether past movement in a stock up or down is indicative of continuing in that direction.

This can involve trying to discern bullish indicators for stocks, giving you a sense of when stock returns are likely to go up. Often traders combine this strategy with forms of technical analysis, including the use of candlestick patterns.

Recommended: Important Candlestick Patterns to Know

Alternatively, you will need to have a sense of when a stock is underperforming in order to profit from buying it before it reverts to the mean upwards.

Factors in Creating a Mean Reversion Strategy

There are many factors that institutional and retail investors need to consider when devising a mean reversion strategy.

Determining the Mean

In this case, you’ll need to think about what period of time you are using to determine a stock or sector’s “normal” or “average” behavior. This matters because it will determine how long you decide to hold a stock or when you plan to sell it before or after the reversion to the mean occurs.

Timing

To execute a mean reversion strategy, you have to know when a stock’s price movement is sufficient to execute the trade. It helps to determine this point in advance.

Recommended: Understanding Pivot Points for New Investors

Determine the Bounds

What is the “normal” behavior, whether it’s price-to-equity ratio, volatility, or some other metric you’re looking at. To determine whether something is far beyond it’s mean, either high or low, you need a good sense of it’s normal range.

Recommended: Support and Resistance: A Beginner’s Guide

Qualitative Factors

Mean reversion and trading reversion to the mean is, of course, a quantitative endeavor. You need to compile statistics and make projections going forward in order to implement the strategy. But you also need to know what’s going on in the “real world” beyond the statistics. If something is driving prices or volatility or some other metric higher or lower that’s likely to persist over time, mean reversion may not be a great bet. If, however, there’s something truly transient that’s the catalyst for large moves up and down that will then revert to the mean, then maybe the strategy is more likely to work.

Exit Strategy

As with most investments, it’s helpful to have an exit strategy determined ahead of time. This can help you limit your losses in the case that the asset ultimately does not revert to the mean.

The Takeaway

Traders who follow mean reversion strategies assume that a specific stock or sector will return to its long-term characteristics. The strategy can be helpful when determining an investing strategy for either individual assets or for a market, overall.

In order to pursue any investment strategy, you have to be in the market in the first place. A SoFi Invest® online brokerage account allows you to build your own portfolio or choose a ready made customized portfolio, according to your goals, life situation and risk tolerance.

Photo credit: iStock/LaylaBird


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
SOIN0621244

Read more
What Are the 11 S&P 500 Sectors?

What Are the Different S&P 500 Sectors?

The S&P sectors represent the different categories that the index uses to sort the companies it follows. S&P refers to Standard & Poor; the S&P 500 index tracks the movements of 500 large-cap US companies. A number of mutual funds and exchange-traded funds (ETFs) use this index as a benchmark.

The Global Industry Classification System (GICS) has 11 stock market sectors in its taxonomy. It further breaks down these 11 sectors into 24 industry groups, 68 industries, and 157 sub-industries.

Understanding how the S&P sectors work and break down further can help both institutional and retail investors manage risk through different economic cycles by allocating their portfolio across multiple sectors. For example, cyclical stocks and cyclical sectors tend to fare well when the economy booms. During a recession, however, defensive stocks may outperform them. However, it’s also possible for all 11 sectors to trend in the same direction.

Examining the 11 Sectors of the S&P

Here’s a look at the S&P Sector List:

1. Technology

Technology represents the largest S&P sector. This sector includes companies involved in the development, manufacturing, or distribution of tech-related products and services. For example, companies in the technology sector may produce computer software programs or electronics hardware or research and develop of new technologies.

Tech stock investments are typically cyclical, in that they usually perform better in stronger economies. But during the coronavirus pandemic, many tech stocks saw a boost as demand for things like video-conferencing platforms and cloud storage increased as more companies adopted remote work.

The technology sector includes a number of growth stocks, which are companies that reinvest most or all of their profits in expansion versus paying dividends. Examples of the biggest tech stocks include Facebook (FB), Apple (AAPL), Microsoft (MSFT), Alphabet (Goog), and IBM (IBM).

2. Health Care

The next largest of the S&P sectors is health care. This sector includes pharmaceutical companies, companies that produce or distribute medical equipment, and supplies and companies that conduct health care-related research.

The health care sector also includes alternative health companies. For example, GW Pharmaceuticals is a drug developer focused on cannabis. The company develops medical marijuana products to treat various health conditions. As such, it’s generally considered part of the health care sector.

Recommended: Cannabis Investing 101

More traditional examples of healthcare sector companies include CVS (CVS), Johnson & Johnson (JNJ), UnitedHealth Group (UNH), Thermo Fisher Scientific (TMO), and Regeneron (REGN). Health care stocks are typically non-cyclical, as demand for these products and services usually doesn’t hinge on economic movements.

3. Financials

The financials sector covers a variety of industries, including banking and investing. Banks, credit unions, mortgage companies, wealth management firms, credit card companies and insurance companies are all part of the financial sector.

Financial services companies are usually categorized as cyclical. For example, a credit card issuer’s profit margins may shrink during a recession if unemployment rises and people spend less or can not keep up with credit card payments. But this can be subjective, as mortgage companies may benefit during recessionary periods if lower interest rates spur home-buying activity.

Some of the biggest names in the financial sector include Visa (V), JPMorgan Chase (JPM), Bank of America (BAC), PayPal Holdings (PYPL), and Mastercard (MA).

4. Real Estate

Real estate is a relatively new addition to the S&P sectors list. This sector includes real estate investment trusts (REITs) as well as realtors, developers and property management companies. REITs invest in income-producing properties and pay 90% of profits out to investors as dividends.

Investing in real estate can be a defensive move as this sector is largely uncorrelated with stocks. So if stock prices fall, for example, investors may not see a correlating drop in real estate investments as property generally tends to appreciate over time.

Examples of real estate companies in the S&P 500 include: Digital Realty (DLR), American Tower (AMT), Prologis (PLD), Simon Property Group (SPG), and Boston Properties (BXP).

5. Energy

The energy sector includes companies that participate in the production and/or distribution of energy. That includes the oil and gas industry as well as companies connected to the development or distribution of renewable energy sources.

Energy stock investments can be more sensitive to economic movements and supply-demand trends compared to other sectors. For example, gas and oil prices declined in 2020 as stay at home orders kept drivers off the roads. Gas prices shot up in 2021, however, following the Colonial Pipeline hack which sparked fears of fuel shortages.

Some of the biggest energy sector companies include Exxon Mobil (XOM), Royal Dutch Shell (RDS.A), Chevron (CVX), Conocophillips (COP), and Halliburton (HAL).

6. Materials

The materials sector includes companies connected to the sourcing, processing or distribution of raw materials. That includes things like lumber, concrete, glass, and other building materials.

Materials is one of the cyclical S&P sectors, as it can be driven largely by supply and demand. During a housing boom, for example, the materials sector may benefit from increased demand for lumber, plywood and other construction materials.

Material stocks in the S&P 500 include Dupont (DD), Celanese (CE), Sherwin Williams (SHW), Air Products & Chemicals (APD), and Eastman Chemical (EMN).

7. Consumer Discretionary

The consumer discretionary sector is a largely cyclical sector that includes companies in the hospitality and entertainment sectors, as well as retailers. Starbucks (SBUX), AMC (AMC), Best Buy (BBY), Home Depot (HD), and Nike (NKE) are examples of stocks that fit into the consumer discretionary sector.

Generally, these companies represent things consumers may spend more money on in a thriving economy and cut back on during a downturn. That’s why they’re considered cyclical in nature.

8. Industrials

The industrial sector covers a broad range of industries, including those in the manufacturing and transportation sectors. For example, Honeywell (HON), 3M (MMM), and Stanley Black & Decker are included in the industrials space alongside companies like Delta Airlines (DAL) and Boeing (BA).

Industrials are often considered to be cyclical stocks, again because of how they react to changes in supply and demand. The airline industry, for example, saw a steep decline in 2020 as air travel was curtailed due to the coronavirus pandemic.

9. Utilities

Utilities represent one of the core defensive S&P sectors. This sector includes companies that provide gas, electricity, water, and other utilities to households, businesses, farms, and other entities.

Since these are essentials that people typically can’t do without, they’re generally less sensitive to major shifts in the economic cycle. They also often pay dividends to their investors.

Examples of utilities stocks include AES (AES), UGI (UGI) and CenterPoint Energy (CNP), Duke Energy (DUK) and Dominion Energy (D).

10. Consumer Staples

Consumer staples stocks represent things consumers regularly spend money on. That includes groceries, household products and personal hygiene products. The consumer staples sector is also a defensive sector because even when the economy hits a rough spot, consumers will continue spending money on these things.

From an investment perspective, consumer staples stocks may not yield the same return profile as other sectors. But they can provide some stability in a portfolio when the market gets shaky.

Companies that are recognized as some of the top consumer staples stocks include General Mills (GIS), Coca-Cola (KO), Procter & Gamble (PG), Conagra Brands (CAG), and Costco Wholesale (COST).

11. Communications

Last but not least on the list of S&P sectors is communications. This sector spans companies that provide communications services of some kind. That can include landline phone services, cellular phone services, or internet services. Communications also includes companies responsible for producing movies and television shows.

The communications sector can be hard to pin down in terms of whether it’s cyclical or defensive. In a down economy, for example, people may continue to spend money on phone and internet services but cut back on streaming services. So there’s an argument to be made that the communication sector is a little of both.

Companies that belong to this sector include Comcast (CMCSA), AT&T (ATT), Dish Network (DISH), Discovery Communications (DISC),and Activision Blizzard (ATVI).

The Takeaway

Knowing what the S&P sectors are and which types of industries or sub-industries they represent can help investors achieve diversification through different types of investments. While some financial experts liken the sectors to a pie, with 11 individual slices, it may be more helpful to think of them as a buffet from which investors can pick and choose. You can either purchase stocks within or across sectors, or look for funds that can provide that diversification for you.

If you’re ready to start building a well-rounded portfolio that includes a sampling of market sectors, it’s easy to open an account on the SoFi Invest online brokerage platform. SoFi Invest offers access to financial planners and educational resources that can help you make informed decisions.

Photo credit: iStock/izusek


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
SOIN0621249

Read more
TLS 1.2 Encrypted
Equal Housing Lender