Jan
26
2024
What Is a Liquid Certificate of Deposit?

Guide to Liquid Certificates of Deposit (CDs)

By | Family Finances, Investing, money | Comments Off on Guide to Liquid Certificates of Deposit (CDs)

If you’re in search of a low-risk way to grow your money, a liquid certificate of deposit (CD) might be worth a closer look. A liquid CD gives you a fixed, guaranteed rate of interest for a specific term, but unlike standard CDs, you don’t pay a penalty if you withdraw the funds before the maturity date.

Granted, the returns you earn on a liquid CD may not compete with stock market investments, but knowing that your money is earning interest and likely won’t incur any losses can be powerful benefits.
Here, you’ll learn more about liquid CDs, including:

•   What a liquid CD is

•   How to withdraw money from a liquid CD

•   The pros and cons of liquid CDs

•   Alternatives to liquid CDs.

What Is a Liquid Certificate of Deposit?

Before you think about investing in a CD, here’s a look at definitions:

•   A certificate of deposit, or CD, is a savings vehicle that usually gives you a bit of interest with virtually no risk, provided you keep the money in place for a certain term. If, however, you withdraw funds before the CD matures (or reaches the end of its term), you are usually penalized. You will likely lose some or all of the interest earned and perhaps even a bit of the principal. In other words, are certificates of deposit liquid? Usually not.

•   A liquid certificate of deposit, on the other hand, gives you flexibility. It allows the account holder to withdraw money from their account prior to the maturity date without incurring penalties. This means you can access funds in the CD should you need them without penalty. However, the rates for liquid CDs tend to be lower than other kinds of CDs.


💡 Quick Tip: Typically, checking accounts don’t earn interest. However, some accounts do, and online banks are more likely than brick-and-mortar banks to offer you the best rates.

Understanding a Liquid CD

You may be wondering, “What are liquid assets?” In the realm of finance, the concept of “liquid” means that an asset can quickly be converted to cash. A liquid CD is a time-bound deposit account where you can earn interest for a specific period of time. Compared to traditional CD’s however, liquid CDs will not charge you early withdrawal penalties. This means you can easily liquidate (turn into cash) your CD without taking a hit in terms of its value.

As noted above, there’s a “but” to this proposition, which you may hear referred to as no-penalty CDs: Liquid CDs typically pay less than traditional CDs. Depending on which financial institution you go to, these products can offer various terms, either as little as a few months or up to several years or longer. Your fixed interest rate will vary according to the length of the term you’ve chosen. Typically, the longer you hold your money in the liquid CD, the higher the rate of return.

What can be a big plus about CD rates is that they are locked in during the full term. This means even if interest rates decrease, your rate would not change. Some financial institutions may require a minimum deposit for these CDs, and they can be significantly higher than traditional CDs; some are at the $10,000 and up level. What’s more, the minimum deposit may go up if you are seeking a higher interest rate, while others don’t have a minimum deposit requirement at all.

How Do You Withdraw Money From a Liquid CD?

If you have decided that you need to withdraw from your liquid CD, here’s what usually happens:

•   Check with your bank about how long it will take to process a withdrawal and whether you need to withdraw a certain percentage at a time. (Some banks may require you to close the account entirely.)

•   When ready, notify your bank of your withdrawal.

•   You will likely have to wait about a week after opening the liquid CD before you can start withdrawing.

•   Wait for your funds. Withdrawal is likely not as quick as withdrawing funds from a checking or savings account; your financial institution might require anywhere from a week to a month to process the transaction.

Recommended: What Happens If a Direct Deposit Goes to a Closed Account?

Liquid CD: Real World Example

Once you have decided a no-penalty CD is right for you, you will need to go to a bank or credit union that offers this account. Once you’ve opened an account, you have to fund it.

How it grows will depend on the principal, your APY (annual percentage yield), and how often the CD compounds the interest, which could be, say, daily or monthly.

•   If you invested $10,000 in a liquid CD with a three-year at a rate of 5.30%, at the end of the three-year period with interest compounded monthly, you will have a total balance of about $11,719.28.

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Pros of a Liquid CD

When evaluating liquid CDs, it’s worthwhile to review the benefits of these accounts. Some of the key upsides are:

•   Liquidity. You can access and withdraw your funds prior to the term’s end. Perhaps you’re having an emergency that requires cash, or you decide to move around your money to better meet your financial goals. It’s possible!

•   No penalties. If you dip into the account before it matures, you won’t be assessed a fee.

•   Security. Liquid CDs are safe investments. These accounts are federally insured up to $250,000 per depositor, per account ownership category, per insured institution. You’ll know your money is protected when you open a liquid CD with a bank or credit union. Even in the very rare situation of a bank failure, you’re covered as noted.

•   Guaranteed returns. When you start a liquid CD account, you usually know the interest rate upfront. It may not be stratospheric, but it’s a sure thing.

Cons of a Liquid CD

Now that we’ve explored the good things about a liquid CD, we need to give equal time to the potential downsides:

•   Lower rate of return. The interest rates are significantly lower compared to certificate of deposit rates.

•   Withdrawal rules. Yes, these accounts are more accessible, but after your deposit has been in place for a week, your withdrawal guidelines may be quite specific. For instance, you may have to remove all your funds if you want to make a withdrawal, or the amount might be limited to a certain percentage that doesn’t suit your needs. Check before starting a liquid CD investment.

•   Tax implications. Earnings on your liquid CD will be taxed at your federal rate, which is something to keep in mind as that will take your return down a notch.

Recommended: How to Automate Your Personal Finances

Alternatives to a Liquid CD

If the idea of a liquid CD doesn’t sound like an appealing low-risk investment option, there are alternatives to also consider.

Traditional CDs

Traditional certificates of deposit require you to stow your money away for a certain period of time. In exchange, you receive a return at the end of that period. The catch is, you are not able to withdraw your funds during this holding period. If you have a financial emergency, for example, and need the money from your CD, you will receive penalties for withdrawing your cash before the period of maturity.

However, this might be a gamble you are willing to take, especially if you have a nice, healthy emergency fund set aside. You’ll earn a better rate of return than with a liquid CD.

Laddering

CD laddering usually involves opening CDs of different term lengths. This strategy allows you to invest long-term CDs which provide higher rates of return, while having the ability to access your funds through a shorter-term CD maturing.

Money Market Account

Another CD alternative is a money market account, which is similar to a savings account with some added benefits. Money market accounts typically require minimum balances and offer rates comparable to savings accounts, which can change over time. While the rates may be lower than a CD, money market accounts typically allow you to withdraw and transfer your money six times per month or more.

Emergency Fund

An emergency fund, or a rainy-day fund, is a savings account that should only be used in times of financial emergencies or unexpected expenses. Depending on your financial position, you can have an emergency fund in a regular savings account, money market account, CD, or liquid CD. It depends on how much you plan to access your emergency fund and how much interest you want to earn in the account.

High-Yield Savings Account

A high-yield savings account can offer a competitive rate of interest, depending on the financial institution offering it (online banks tend to pay more than traditional ones). And you’ll have more liquidity than a CD because you can deposit and withdraw from the account more frequently, though the specifics may vary with each bank. If you want easy access to your funds plus interest, a high-yield bank account may be a good option.

The Takeaway

Liquid CDs are a financial product that offers the safety and guaranteed return of a traditional CD with the bonus of not being penalized if you make an early withdrawal. For those who are comfortable locking their money into a CD but worry an emergency or other need might pop up, this accessibility can be very attractive. Worth noting: Expect lower interest rates from a liquid CD than a standard one. Alternatives to a liquid CD can include a high-yield savings account.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.


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FAQ

Are CDs liquid investments?

Traditional CDs are not liquid investments. Funds held in a CD cannot be accessed until the account term is reached. If you need to withdraw money from your CD prior to its maturity date, you will have to pay a penalty. A liquid CD, however, offers flexibility to withdraw money from your account prior to its term date without the usual fees.

What is a non-penalty CD?

A non-penalty CD, also known as a liquid CD, is a time deposit that offers interest on your money. However, the rate is usually somewhat lower than the rate for a typical CD (the kind with penalties). The longer the term you choose for your liquid CD, the more you usually can earn.

How much is the penalty for early withdrawal from a CD?

Each financial institution has its own way of calculating this, but it usually involves losing some of all of the interest you have accrued. If you have a two-year traditional CD and withdraw funds early, the fee could vary considerably; a recent search found anywhere from two months’ to a year’s’ worth of interest. If you have a liquid or no-penalty CD, you will of course avoid these fees.

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SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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.

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Jan
25
2024
investment charts

Essential Stock Market Terms Every Trader Should Know

By | Growing Wealth, invest, Investing, Terminology | No Comments

If you are new to trading stocks, the sheer volume of stock market terms can be off-putting. But learning some basic stock trading terminology is a great place to begin before investing any money. For any new investor just getting into trading, getting a grasp on some basic stock market terms can be extremely helpful.

The Significance of Knowing Stock Market Terminology

It’s important to have at least a grasp of some basic stock market terms if you plan on trading or investing. If you don’t do a bit of homework beforehand, you may find yourself feeling in over your head, and grasping for help from family members, friends, or a financial professional.

While there are a multitude of different stock market terms out there, it isn’t terribly difficult to develop an understanding of the basics. Yes, it’ll take some time and practice, but like learning anything else, once you get the hang of it, it should become easier as you move along in your investment journey.


💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Fundamental Terms

To get a fundamental understanding of the stock market, it can be helpful to start with some relatively basic terms, including the following.

Asset Allocation

Asset allocation involves investing across asset classes in a portfolio in order to balance the different potential risks and returns, and there are three main asset classes, which are typically stocks, bonds, and cash. Asset allocation is closely tied with portfolio diversification.

Asset Classes

There are several asset classes, or types of assets, that investors can invest in. This can include, but is not limited to, stocks, bonds, money market accounts, cash, real estate, commodities, and more. You can also think of certain assets as equities, debt securities, and more.

Bid

Bid, in the context of bid-ask spread, refers to the “bid price” that an investor is willing to pay for a security or investment.

Ask

Ask, in the context of bid-ask spread, is the opposite of bid, and is the lowest price that investors are willing to sell a security for.

Bid-Ask Spread

The bid-ask spread is the difference between the bid and ask price, and can be a measure of liquidity. When the bid and ask prices match, a sale takes place, on a first-come basis if there is more than one buyer. The bid-ask spread is the difference between the highest price a buyer is willing to bid, and the lowest price a seller is willing to ask.

Market Phrases

There are a number of market phrases, or types of jargon that may be used in and around the stock market, too. Here are some examples.

Bull Market

A bull market describes market conditions when a market index rises by at least 20% over two months or more, and is often used to describe high levels of confidence and optimism among investors.

Bear Market

A bear market describes a 20% fall in a market index, and is the opposite of a bull market. It can signal overall pessimism among investors.

Market Volatility

Market volatility refers to how much a market index’s value increases or decreases within a specific period of time. Volatility can occur for a number of reasons.

Investment Vehicles

There are many specific investment vehicles that investors should know about, too, including different types of stocks, bonds, and more.

Bonds

Bonds are a type of debt security, which effectively means that investors are loaning money to the issuer. There are many types of bonds, and they’re often considered to be a less-risky investment alternative to, say, stocks.

Common Stock

Common stock, also known as shares or equity, is like owning a piece of a company. You purchase stock in a company, and receive a proportional part of that corporation’s assets and earnings. The price of stock is different for each company and fluctuates over time.

Preferred Stock

Preferred stock is similar to common stock, but usually grants shareholders some sort of preferential treatment, such as advanced dividend payments, and more.

ETFs

ETFs, or “exchange-traded funds,” are types of funds that trade on exchanges like stocks. Investors can purchase shares of ETFs, which incorporate numerous different types of securities (like a “basket” of different investments), and may offer built-in diversification as an advantage for investors.

Mutual Funds

Mutual funds are companies or entities that pool money from numerous different investors and then invest it on their behalf. A manager oversees a mutual fund, and actively manages it. Investors can purchase shares of mutual funds, which are similar to ETFs in many ways.

Stock Analysis Terms

Analyzing the stock market incorporates its own set of terminology, and it can be helpful for investors to know a bit of the vernacular.

Earnings Per Share (EPS)

Earnings per share, often shortened as “EPS,” is a ratio that helps determine a company’s ability to drive profits for shareholders. It’s a common and oft-cited business metric for investors.

Dividends

A dividend is a payment made from a company to its shareholders, often drawn from earnings. Usually, these are made in cash, but sometimes they are paid out as additional stock shares. They are typically paid on an annual or quarterly basis, and typically only come from more established companies, not startups.

Dividend Yield

Dividend yield refers to how much a company pays out to shareholders on an annual basis relative to its share price. It’s a ratio that’s calculated by dividing the company’s dividend by its share price.

The Price-to-earnings (P/E) Ratio

The price-to-earnings ratio (often written as the P/E ratio, PER, or P/E) is a ratio of a company’s current share price relative to the company’s earnings per share. It can be used to compare performances of different companies.


💡 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.

Price Movements and Pattern Terms

There are also a number of movement and pattern terms that investors may want to familiarize themselves with.

Trading Volume

Trading volume refers to how much trading is happening on an exchange. For a stock trading on a stock exchange, the stock volume is typically reported as the number of shares that changed hands during any given day. It’s important to note that even with an increasing price, if it’s paired with a decreasing volume, that can mean a lack of interest in a stock. A price increase or drop on a larger volume day (i.e., a bigger trading day) is a potential signal that the stock has changed dramatically.

Volume-weighted Average Price (VWAP)

Volume-weighted average price, or VWAP, is a short-term price trend indicator used when analyzing intraday, or same-day, stock charts. It’s a type of technical analysis indicator.

Trading Order Types and Execution

Investors need to know the types of orders that they’re likely to use throughout their investing journey. Those include market orders, limit orders, and stop-loss orders.

Market Order

A market order is the most common type of order, and it means that an investor wants to buy or sell a security as soon as possible at the current market price.

Limit Order

Limit orders are another common type of order, and involve an investor placing an order to buy or sell a security at a specific price or within a specific time frame. There are two types: Buy limit orders, and sell limit orders.

Stop-loss Orders

Stop-loss orders, or sometimes called stop orders, are orders that specify a security to be sold at a certain price.

Day Trading Terms

For the prospective day-trader, there are a slate of terms to know as well.

Day Trading

Day trading involves an investor making short-term trades on a daily or weekly basis in an effort to generate returns off of price fluctuations in the market. There are numerous day trading strategies that investors can utilize.

Pattern Day Trader

A pattern day trader is a designation created by FINRA, and refers to traders who trade securities four or more times within five days. There are rules and stipulations that pattern day traders, and their chosen trading platforms, must follow.

Trading Halt

A trading halt can refer to a specific stock or the entire market, and involves a halt to all trading activity for an indefinite period of time.

Long-term Investment Terms

The opposite of day trading, long-term investing also ropes in its own jargon.

Averaging Down

Averaging down involves a scenario in which an investor already owns some stock but then purchases additional stock after the price has dropped. It results in a decrease in the overall average price for which you purchased the company stock. Investors can profit if the company’s price subsequently recovers.

Diversification

Diversification refers to investing in a wide range of assets and asset classes, as opposed to concentrating investments in a specific area or class.

Dollar-cost Averaging

Dollar-cost averaging is a strategy to manage volatility in a portfolio, and involves regularly investing in the same security at different times, but with the identical amount. Effectively, the cost of those investments will average out over time.

Derivatives and Market Predictors

Getting into the weeds now — derivatives and market predictors are more high-level market elements, but it can be helpful to know some of the terminology.

Futures

Futures, or futures contracts, are a form of derivatives that are a contract between two traders, agreeing to buy or sell an asset at a specific price at a future date.

Options Trading

Options trading involves buying and selling options contracts, of which there are many types.

Arbitrage

Arbitrage refers to price differences in the same asset on different markets. Traders may be able to take advantage of those differences to generate returns.

Financial Health Indicators

We’re not done yet — these terms involve financial health indicators.

Debt-to-equity (D/E)

Debt-to-equity is a financial metric that helps investors determine risks with a specific stock, and is calculated by dividing a company’s equity by its debts.

Liquidity

Market liquidity is essentially how easily shares of stock can be converted to cash. The market for a stock is “liquid” if its shares can be sold quickly, and the act of selling only minimally impacts the stock price.

Profit Margin

Profit margin refers to how much profit is generated from a trade when expenses are considered. Lowering related expenses can increase profit margin, all else being equal.

Economic Terms

Knowing some key economic terms can be helpful when trying to size up larger economic and market trends.

Volatility

Volatility refers to the range of a stock price’s change over time. If the price stays stable, then the stock has low volatility. If the price jumps from high to low and then back to high often, it would be considered more of a high-volatility stock.

Economic Bubbles

Economic bubbles or market bubbles are often created by widespread speculative trading, and involve a runup or buildup of prices for a given asset, which can be detached from its actual value. Eventually, the bubble tends to burst and investors may incur a loss.

Recession

A recession is a period of economic contraction, and is usually accompanied by higher unemployment rates, business failures, and lower gross domestic product figures. Recessions are officially declared by the Business Cycle Dating Committee at the National Bureau of Economic Research.

Adaptation and Risk Management

For particularly savvy investors, knowing some terms relating to adaptation and risk management can also be helpful when navigating the markets.

Sector Rotation

Sector rotation involves investing in different sectors of the economy at different times, and rotating holdings between those sectors in an effort to generate the biggest returns.

Hedging

Hedging is an investment strategy that involves limiting risk exposure within different parts of a portfolio, and there are many methods or strategies for doing so.

The Takeaway

Learning some basic stock market terms can go a long way toward helping an investor navigate the markets, and there are a lot of terms and jargon to get familiar with. But doing a bit of homework early on can be enormously helpful so that you’re not trying to figure things out on the fly as an investor.

While you’re not going to learn everything right off the bat, if you start to spend a lot of time investing and trading, you’re likely to quickly catch on to certain terms, while others will come with time. As always, if you have questions, you can reach out to a financial professional for help — or do a bit more research on your own.

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.

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25
2024
What is private equity?

Private Equity: Examples, Ways to Invest

By | Financial Independence, Growing Wealth, invest, Investing | Comments Off on Private Equity: Examples, Ways to Invest

Private equity is financing from investors to invest in or buy companies that aren’t listed on a public market and then make improvements to those companies. Their goal is to sell the companies for more than they bought them for. Many people aren’t as familiar with this style of investment as they are with the public trading done through the stock market.

If you’ve ever wondered, what is private equity?, read on to learn more about what it is, how it works, and how to invest in private equity.

What Is Private Equity?

Private equity (PE) is a type of investment where qualified investors can purchase shares of companies that are not publicly traded on a stock exchange or regulated by the Securities and Exchange Commission (SEC). They typically do this through investment partnerships or funds managed by private equity firms.

With publicly traded companies, investors purchase shares of the company on a public market such as the New York Stock Exchange. With private equity, qualified investors can combine their assets to invest in private companies that aren’t typically available to the average investor.

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How Do Private Equity Firms Work?

Private equity firms have funds that allow various investors to pool their assets in order to invest in or buy private companies and manage them.

These investors are referred to as limited partners. They are often high-net-worth individuals or institutions such as insurance companies. Equity firms usually require a sizable financial commitment from limited partners to qualify for this investment opportunity.

The equity firm uses the assets from investors to help the companies they invest in achieve specific objectives — like raising capital for growth or leveraging operations.

To help further these objectives, equity firms offer a range of services to the companies they invest in, from strategy guidance to operations management. The amount of involvement and support the firm gives depends on the firm’s percentage of equity. The more equity they have, the larger the role they play.

In helping these private companies reach their business objectives, private equity firms are working toward their own goal: to end the relationship with a large return on their investment. Equity firms may aim to receive their profits a few years after the original investment. However, the time horizon for each fund depends on the specifics of the investment objectives.

The more value a firm can add to a company during the time horizon, the greater the profit. Equity firms can add value by repaying debt, increasing revenue streams, lowering production or operation costs, or increasing the company’s previously acquired price tag.

Many private equity firms leave the investment when the company is acquired or undergoes an initial public offering (IPO).

Types of Private Equity Funds

Typically, private equity funds funnel into two categories: Venture Capital (VC) and Leveraged Buyout (LBO) or Buyout.

Venture Capital Funds

Venture capital (VC) funds focus their investment strategy on young businesses that are typically smaller and relatively new with high growth potential, but have limited access to capital. This dynamic creates a reciprocal relationship between VC fund investors and emerging businesses. The start-up depends on VC funds to raise capital, and VC investors can possibly generate large returns.

Leveraged Buyout

In comparison to VC funds, a leveraged buyout (LBO) is typically less risky for investors. LBO or buyouts target mature businesses, which tend to turn out larger rates of return. On top of that, an LBO fund typically holds ownership over a majority of the corporation’s voting stock, otherwise known as controlling interest.

Can Anyone Invest in Private Equity?

When it comes to how to invest in private equity, only qualified or accredited investors are allowed to become limited partners in a private equity fund. Because private equity funds are not registered with the SEC, they don’t require SEC security disclosures. Thus, investors must understand the highest risk of such investments and be willing to lose their entire investment if the fund doesn’t meet performance expectations.

Since the initial investment is typically pretty high, and may be well into the millions of dollars, an individual must meet strict criteria to qualify as an individual accredited investor. A person must make over $200,000 per year (for two consecutive years) as an individual investor or $300,000 per year as a married couple. Alternatively, an investor can qualify as accredited if they have a net worth of at least $1 million individually or as a married couple to qualify (excluding the value of their primary residence), or if they hold a Series 7, 65, or 82 license. Other examples of accredited investors include insurance companies, pension funds, and banks.

How to Invest in Private Equity

Many private equity funds require very large investments that are out of reach for many individuals. And directly investing in private equity funds is not possible for investors who are not accredited. However, there are an increasing number of options for average investors seeking to gain exposure to private equity, including:

Exchange-traded funds (ETFs): Investors can invest in ETFs that have shares of private equity firms.

Publicly traded stock: Some private equity firms have publicly traded stock that investors can buy shares of. This includes PE firms like the Carlyle Group, the Blackstone Group, and Apollo Global Management.

Funds of funds: Mutual funds are restricted by the SEC from buying private equity, but they can invest indirectly in publicly traded private equity firms. This is known as funds of funds.

Interval funds: These closed-end funds, which are not traded on the secondary market and are largely illiquid, may give some investors access to private equity. Interval funds may invest directly or indirectly through a third-party managed fund in private companies. Investors may be able to sell a portion of their shares back to the fund at certain intervals at net asset value (NAV). Interval funds typically have high minimum investments.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

Advantages and Disadvantages of Private Equity

While private equity funds provide the opportunity for potentially larger profits, there are some key considerations, costs, and high risks investors should know about.

Advantages

Here are some possible benefits of private equity investments.

Potentially Higher Returns

With private equity, returns may be greater than those from the public stock market. That’s because PE firms tend to invest in companies with significant growth potential. However, the risk is higher as well.

More Control Over the Investment

Private equity investors are typically involved in the management of the companies they are invested in.

Diversification

Private equity investments allow investors to invest in industries they may not be able to invest in through the public stock market. This may help them diversify their holdings.

Disadvantages

The drawbacks of investing in private equity include:

Higher Risk

Private companies are not required to disclose as much information about their finances and operations, so PE investments can be riskier than publicly traded stocks.

Lack of Liquidity

Private equity funds tend to lack liquidity due to the extensive time horizon required for the investment. Since investors’ funds are tied up for years, equity firms may not allow limited partners to take out any of their money before the term of the investment expires. This might mean that individual investors are unable to seek other investment opportunities while their capital is held up with the funds.

Contradicting Interests

Because equity firms can invest, advise, and manage multiple private equity funds and portfolios, there may be conflicts. To uphold the fiduciary standard, private equity firms must disclose any conflicts of interest between the funds they manage and the firm itself.

High Fees

Private equity firms typically charge management fees and carry fees. Upon investing in a private equity fund, limited partners receive offer documentation that outlines the investment agreement. All documents should state the term of the investment and all fees or expenses involved in the agreement.

Private Equity Comparisons

Private equity is one type of alternative investment, but there are others. Here’s how a few of them compare.

Private Equity vs IPO Investing

From an investor’s standpoint, private equity investing means you’re putting money into a company, and hopefully making money in the form of distributions as the company becomes profitable.

Investing in an IPO, on the other hand, means you’re buying stocks in a new company that has just gone public. In order to make money, the company’s stock price needs to rise, and then you need to sell your stocks in that company for more than you initially paid.

Private Equity vs Venture Capital

Venture capital funding is a form of private equity. Specifically, venture capital funds typically invest in very young companies, whereas other private equity funds typically focus on more stable companies.

Private Equity vs Investment Banking

The difference between these two forms of investing is of the chicken-and-egg variety: Private equity starts by building high-net-worth funds, then looks for companies to invest in. Investment banking starts with specific businesses, then finds ways to raise money for them.

The Takeaway

Private equity firms manage funds that invest in private companies that might otherwise not be available to investors. Sometimes these companies are small and new with high growth potential; in other cases, the companies are well-established, and may offer a higher rate of return.

Not everyone qualifies to invest in private equity. If you do qualify, it’s important to remember that while private equity funds may offer the opportunity for profitability, they also come with some hefty risks. As with any investment, it’s a good idea to make sure you fully understand the risks of investing in a private equity fund before moving forward.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.


Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

What’s the history of private equity?

Pooling money to buy stakes in a private company can be traced back to 1901, when JP Morgan bought Carnegie Steel for $480 million and merged it with two other companies to create U.S. Steel. That is considered one of the earliest corporate buyouts. In 1989, KKR bought RJR Nabisco for $25 billion, which, adjusting for inflation, is still considered the largest leveraged buyout in history.

How does private equity make money?

Private equity firms make money by buying companies they consider to have value and potential for improvement. PE firms then make improvements, which in turn, can increase profits. These firms also benefit when they can sell the company for more than they bought it for.

How much money do you need to invest in private equity?

Private equity funds typically have very high minimum investments that are often tens of millions of dollars. Some firms may have lower requirements around $250,000. In addition to putting up the minimum investment amount, an individual needs to be an accredited investor with a net worth of at least $1 million or an annual income higher than $200,000 for at least the last two years.


An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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.

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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Understanding Lower-Risk Investments in Today’s Market

By | Growing Wealth, invest, Investing | Comments Off on Understanding Lower-Risk Investments in Today’s Market

There’s no such thing as a safe investment, but some types of investments may be less risky than others. For instance, bonds tend to be less risky than stocks, though that’s not always the case. Depending on an individual investor’s risk tolerance, knowing which investments tend to be more conservative and which tend to be riskier, can be important to forming an investment strategy.

The Essence of Conservative Investing

It’s difficult to identify the least-risky investments on the market since they’re all subject to different types of investment risk. Your personal risk tolerance as an investor also comes into play, as you may have a much higher or lower appetite for risk compared to someone else. When viewed through that lens, an investment that seems relatively conservative to you might seem risky to someone else.

Defining Lower-risk Investment

You might assume that it simply means any investment that carries zero risk — but that’s not necessarily a definitive answer, or a realistic one, since all investments have risk. As such, when constructing a portfolio, it’s important to look at the bigger picture which includes an individual investment’s risk profile as well as an investor’s risk tolerance, as mentioned. Risk capacity, or the amount of risk required to achieve a target rate of return, can also play a part in investing decisions, and which can help investors define lower-risk investment options.

The Appeal of Fixed Income

Fixed-income securities can be particularly attractive to risk-averse investors. These types of securities tend to have lower associated risks, guaranteed returns, and maybe even tax benefits — but that’s balanced out by lower potential returns, and other types of risk. With that in mind, it may be a good idea to look at fixed-income investments right out of the gate for relatively conservative investment options.

Evaluating Risk in Investments

It’s not necessarily easy to evaluate an investment’s relative risk or risks. But investors can likely do well by learning about the types of risks that an investment may be associated with, and how those risks can line up with their strategy or portfolio.

Key Principles for Secure Investments

Perhaps the most important method involved in discerning how risky an investment is the specific type of risks it introduces to a portfolio.

Investors who choose products and strategies to avoid market volatility leave themselves open to a variety of risks. When researching less-risky investments, it’s important to consider how different risk factors may affect them. Here are some of the most common types of risk you might encounter when building a diversified portfolio.

•   Inflation risk. This is the risk that your purchasing power can erode over time as inflation increases.

•   Interest rate risk. Fluctuating interest rates can influence returns for less-risky investment options such as bonds.

•   Liquidity risk. Liquidity risk refers to how easy (or difficult) it is to liquidate assets for cash if needed.

•   Tax risk. Task risk can influence an asset’s return, depending on how it’s taxed.

•   Legislative risk. Changes to investing or tax regulations could affect an investment’s return profile.

•   Global risk. Certain investments may be more sensitive to changing geopolitical events or fluctuations in foreign markets.

•   Reinvestment risk. This risk refers to the possibility of not being able to replace an investment with one that has a similar rate of return.

Risk vs Return: Finding the Balance

There’s a reason the sayings “nothing ventured, nothing gained” and “no risk, no reward” have been around so long. But having some knowledge of where various investments fall on that range of risks — as well as the types of risks to which a particular investment could be exposed — may help investors find the returns they need while still holding on to some sense of control.

Netting bigger potential rewards often means taking on more risk, investors may benefit from understanding the degree of risk they’re comfortable with and capable of enduring. That’s why it’s important to research every asset they add to their portfolio — or get help from a professional advisor when choosing between the riskiest and least-risky options.


💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

Lower-risk Investment Options in 2024

Among lower-risk investments on the market in 2024, here is a sampling of what investors might want to choose from, or research further.

High-yield Savings Accounts

Typically offered via online banks, high-yield savings accounts pay a higher interest rate than other types of deposit accounts. That said, since current interest rates are extremely low, these accounts are providing scant returns.

High-Yield Savings Accounts Pros

•   You’re unlikely to lose your principal in a savings account.

•   High-yield savings accounts are FDIC insured, so you won’t lose your deposit if your bank closes.

•   Savings accounts are highly liquid, meaning you can access your money quickly at any time.
High-Yield Savings Accounts Cons

•   Since interest rates on these accounts are lower than inflation, your money could lose purchasing power over time.

•   High-yield savings accounts offer a lower rate of return compared to other conservative investments or those with moderately higher risk.

•   Some banks place limits on the number of withdrawals that you can make from a savings account each month.

Recommended: Breaking Down the Different Types of Savings Accounts

Bonds and Treasury Securities

Investors typically consider savings bonds one of the least-risky investment options. Investors can purchase EE savings bonds (the most common type of savings bond) from the U.S. Treasury Department for half the face value and accrue interest monthly based on a fixed rate.

The interest rate is set for the first 20 years after purchase, and the Treasury guarantees an EE bond will be worth at least its face value when those 20 years have passed. After that, the Treasury resets the interest rate and extends the maturity by 10 more years.

Investors don’t have to hold onto a savings bond for the entire 30 years, but they do have to wait at least a year before redeeming it. And they’ll forfeit three months’ interest if they redeem a savings bond during the first five years after its purchase. The current rate for EE bonds is 0.10% annually. The return may be more conservative, but it’s also slow.

Further, Treasury securities (bills, notes, and bonds) provide funding for the government in exchange for a fixed interest rate. So, they are sold and backed by the “full faith and credit” of the U.S. government.

Because the government has the means to repay its investors (by printing more money or raising taxes), it’s highly unlikely it will default on these obligations, so investors get a practically guaranteed return of their principal and any interest they have coming, as long as they hold onto the security until its maturity date. For those reasons, Treasury securities land in the less-risky investments category.

Different types of government securities come with different lengths of maturity, and their interest rates reflect those term lengths. Treasury bonds have a higher interest rate in exchange for a longer term (30 years), but that lengthy term can be a drawback.

US Treasuries Pros:

•   Since they’re backed by the government, securities are among the least-risky investment options.

•   Varying maturity terms allow for flexibility when using securities to diversify a portfolio.

•   Interest is guaranteed if investors hold U.S. securities to maturity.

US Treasuries Cons:

•   Though conservative, you likely will not see sizable gains from this type of investment.

•   Once you buy a Treasury security the terms won’t change, even if newer bonds are paying higher rates.

•   Selling a bond before it matures could be difficult if there are bonds with more favorable terms on the market.

Certificates of Deposit (CDs)

A certificate of deposit account or CD is a time deposit account. These accounts require you to save money for a set time period, during which you can earn interest. Once the CD matures, you can withdraw your original deposit along with the interest earned. You can open CD accounts at brick-and-mortar banks and credit unions or online financial institutions.

CDs are similar to a savings account, and they’re FDIC-insured, which means the government will cover the depositor’s principal and interest (up to $250,000) if the bank or savings association issuing the CD fails. But unlike other bank accounts, savers must leave their money in the account for a designated period of time — usually from a few months to a few years. The longer the term, the higher the interest rate. And if savers take out the money early, they might have to pay a penalty (although there are some exceptions).

CD Pros:

•   Lower-risk as interest rates can be guaranteed for the CD’s maturity term.

•   FDIC coverage minimizes the risk of losing money if your bank closes.

•   The ability to earn interest on funds you don’t need to use for the near term.

CD Cons:

•   Withdrawing money from a CD before maturity can trigger an early withdrawal penalty.

•   When interest rates are low, CD interest earnings may not keep pace with inflation.

•   Some CDs may require larger minimum deposits to open.

Money Market Funds & Accounts

Money market funds are fixed income mutual funds that invest in short-term, lower-risk debt securities and cash equivalents. You may find them offered by banks though you’re more likely to encounter them at an online brokerage. They’re not to be confused with money market accounts, which are on demand deposit accounts also offered by banks and credit unions. Money market funds must comply with regulatory requirements regarding the quality, maturity, liquidity, and diversification of their investments, which can make them appealing to investors looking for a conservative and steady security that pays dividends.

But the less-risky and short-term nature of the investments within these funds means that returns are generally lower than those of stock and bond mutual funds with more risk exposure. That means they may not keep pace with inflation.

Money Market Fund Pros:

•   Money market funds are a conservative investment that carry less risk than traditional mutual funds or exchange-traded funds (ETFs).

•   Unlike CDs, savings bonds or U.S. Treasury securities, you’re not necessarily locked in to money market funds for a specific time period.

•   Money market funds can generate returns above high yield savings accounts or CDs.

Money Market Fund Cons:

•   A lower risk profile also means a lower return profile compared to other mutual funds or ETFs.

•   Risk doesn’t disappear entirely; you could still lose money.

•   Certain money market funds may offer greater liquidity than others.

Corporate Bonds

Corporate bonds may not be as conservative as CDs or government bonds, but investors generally consider them a lower risk than stocks. The term “investment grade” lets investors know a bond is a lower risk based on ratings received by either Standard & Poor’s or Moody’s. You can purchase corporate bonds through some online brokerage accounts.

Investors expect that a higher-quality investment-grade bond — rated AAA, AA+, AA, and AA- by Standard & Poor’s — will perform consistently and pay interest on a regular basis. Bonds rated A+, A, and A- also are considered stable, while those rated BBB+, BBB, and BB- may carry more risk but are still considered capable of living up to their debt obligations. Like other types of bonds, corporate bonds are susceptible to interest rate risk, and with a longer commitment, there’s typically more exposure to that risk.

Corporate Bond Pros:

•   Investors can earn interest from corporate bonds for reliable income.

•   May offer higher yields than other types of bonds, with longer terms generally producing higher yields.

•   Higher-grade bonds generally have a lower default risk, making them relatively less-risky investments with high returns.

Corporate Bond Cons:

•   Default risk could mean losing money if the bond issuer fails to uphold their end of the bargain.

•   Interest rate risk can negatively impact a corporate bond investor’s return profile.

•   Longer bonds may carry a higher degree of risk compared to bonds with shorter terms.

Preferred Stocks

Preferred stocks, or preferreds, may be an appealing option for conservative investors looking for a higher yield than CDs or treasuries have to offer. Preferreds are often referred to as a “hybrid” investment, because they trade like stocks but are like bonds in that they provide income. You can trade shares of preferred stock in some online brokerage accounts.

These investments generally pay quarterly dividends that you can use as income or reinvest for more potential growth. In a worst-case scenario, if a company can’t pay its preferred dividends for a while, the money owed accumulates as backpay. And when the company resumes payments, preferred shareholders get their accumulated dividends before those who own common stocks.

You can sell preferreds at any time, but they’re typically used as a long-term investment. Just as with corporate bonds, companies that are more financially stable will receive higher marks from credit ratings agencies, so investors can have some idea of what they’re getting into.

Still, the ins and outs of buying preferred shares can be complicated, so beginners may want to work with a financial professional who is experienced in this type of investment.

Preferred Stock Pros:

•   Preferred stock can offer consistent income in the form of dividends.

•   Preferred stock shareholders take priority for debt repayment in the event that the company goes bankrupt.

•   Investors can realize capital gains when selling preferred stock if shares have appreciated in value.

Preferred Stock Cons:

•   Companies that offer preferred stock can reduce or eliminate dividends so payouts are not necessarily always guaranteed.

•   Like other stocks, preferred stocks can be riskier investments than bonds or similar securities.

•   Preferred stock shareholders are not assigned voting rights.

Blue Chip Stocks

Stocks issued by big companies that have a reputation for performing well in good times and bad are typically known as blue chips. They aren’t immune from big losses, but they tend to handle market drops better than other stocks. You can purchase blue chip stocks through an online brokerage account.

These companies have a history of dependable growth and paying consistent dividends. Investors who want to do some research can get insight on blue chips by checking out the “Risk Factors” section of a company’s annual 10-K filing.

Companies must list their most significant risks, usually in order of importance. Some risks apply to the entire economy, some to that particular industry, and a few may be specific to that company.

Blue Chip Stock Pros:

•   Blue chip stocks are typically associated with stable companies, making them less susceptible to market volatility.

•   Some Blue chip stocks pay regular dividends

•   Blue chip stocks have the potential for long-term, steady growth which can allow investors to reap the benefits of capital appreciation.

Blue Chip Stock Cons:

•   Blue chip stocks are not entirely insulated against market volatility or its accompanying downside risk.

•   Blue chip stocks may have limited growth potential, as these are companies that are already well-established.

•   Investors interested in adding innovative companies to a portfolio may be disappointed by blue chips, as these are usually older companies with a set business model.

Investment Strategies for the Conservative Investor

An investor who takes a defensive posture, or attempts to stick to less risky investments is often referred to as “conservative” – which is different from a conservative political leaning. Conservative investing is, as noted, defensive, and seeks to preserve wealth by reducing risk in a portfolio.

The opposite of conservative investing is aggressive investing. Investors in one camp or another can and will use different strategies and assets that align with their risk tolerances and time horizons. Generally, a conservative investor is perhaps more likely to stick to a buy-and-hold strategy than, say, one that involves a lot of day-trading or options trading. That’s because, over time, a buy-and-hold strategy may prove less risky as the market tends to rise over time.

Balancing Your Portfolio with Lower-risk Investments

Along with a longer-term investment strategy, conservative investors may lean into less risky investments, which can include bonds, index funds, mutual funds, and more. They may still add some riskier investments or assets to the mix, in order to provide a little bit of additional growth potential, but the balance between the risk of some investments and the lower risk of others is what a conservative investor is aiming for.

How to Identify and Select Lower-risk Investments

Investors doing their best to seek out and choose relatively lower-risk investments for their portfolio will need to do their homework. That includes looking at some key metrics that may help discern how volatile an asset’s value could be.

A good place to start is by looking at an asset’s standard deviation, which can help determine the volatility associated with an investment. Experienced investors can go even deeper, looking at Sharpe ratios, Betas, and Alphas – which are fairly high-level metrics.

Due Diligence and Diversification

When deciding how much risk to take, investors typically consider several factors, including their age, personality, and purpose. Investors who can’t handle a lot of risk for any or all of those reasons may wish to lean toward those investments that are typically the most conservative.

But another way to help protect a portfolio is through diversification: choosing investments from different asset classes, in different sectors, and with different risk factors. For example, you may choose to invest in a mix of conservative investments such as bonds or U.S. Treasury securities alongside higher risk investments, such as individual stocks or cryptocurrency.

Having some lower-risk assets in a portfolio can minimize the impact of volatility in other assets. Typically, investors with a long time horizon (such as young investors saving for retirement) can take on more risk in their portfolios, while those with shorter-term goals may want a more conservative approach. Investors with a low tolerance for risk may prefer conservative investments during times of uncertainty.

Diversification can help to balance risk so you don’t have to make an either-or choice with regard to a risky investment or conservative investment. The various assets in your portfolio can counterbalance one another as the market moves through changing cycles.

Special Considerations for Lower-risk Investments in 2024

As noted throughout, there are some special considerations investors will want to make when looking at their lower-risk investment options.

For one, depending on market trends, returns on lower-risk investments may be disappointing to some investors. As discussed, assets with lower associated risks tend to be associated with lower growth or returns. Conversely, higher-risk investments may have higher associated gains. Think about the difference in how the value of a stock might increase compared to the value of a bond – assets accrue value in different ways and at different rates.

Another thing to think about is inflation, which is the tendency of money to lose value over time. One of the reasons that many people invest is to try and see their wealth grow faster than the rate of inflation (which is, traditionally, around 2% annually, but may be higher or lower). If they’re successful, their wealth grows, rather than erodes, over time.

There’s a lot to consider when trying to outpace inflation, including the balance of risks and rewards, as mentioned. But many investments that can offer relatively high yields or dividends (like certain bonds) can also be at risk of interest rate changes. During times of high inflation (as experienced in the U.S. and much of the world in 2021, 2022, and 2023), central banks may increase interest rates to slow the economy.

That change in interest rates may cause some investments to lose value. Again, this is a consideration many investors, especially in 2023 and 2024, should be aware of.

Next Steps for the Prudent Investor

For conservative investors, or even those who are merely looking to add a dimension of lower risk to their portfolios, there are a lot of potential strategies and investment types out there. But, again, there’s no single “correct” thing to do for every investor – you’ll need to give some serious thought to your risk tolerance, time horizon, overall financial goals, and weigh the pros and cons of conservative investing accordingly.

As for next steps? It may involve speaking with a financial professional for some guidance. It may also just entail taking a look at your existing holdings, looking for areas where you can mitigate risk, and rebalancing or reallocating your resources accordingly.

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.

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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2024

Ultimate Guide to Understanding Mutual Funds

By | Growing Wealth, invest, Investing | Comments Off on Ultimate Guide to Understanding Mutual Funds

Mutual funds are a type of investment vehicle that rope together numerous types of securities in one basket. They’re similar to exchange-traded funds, or ETFs, in that way, but there are some key differences. They can provide investors with an easy and turnkey way to build a diversified portfolio, often with a manager watching over the fund.

The ABCs of Mutual Funds

Mutual funds are funds, or a basket of different securities, that are packaged together and sold, in shares or fractional shares, to investors.

Mutual funds were designed for people to get started investing with small amounts of money. You can think of them as suitcases filled with different types of securities, such as stocks and bonds. Buying even one share of the fund immediately invests you in all the individual securities the fund holds.

The primary benefit of mutual funds is instant portfolio diversification. Say you invest in a mutual fund that holds stocks of every company in the S&P 500. If one company in the S&P 500 goes bankrupt, your fund might lose some value, but you most likely won’t lose everything. But if your whole investment was in that one company’s stock, you’d lose all or most of your money.

How Mutual Funds Work

A mutual fund itself is actually a company that pools investors’ resources and invests it on their behalf. They create a fund of many different investment types, and manage it on behalf of the group of investors.

Mutual funds can be managed actively or passively. Passively managed funds attempt to track an index, such as the Russell 2000 (an index of 2,000 small-cap U.S. companies). In other words, if one company leaves the index and another one joins, the fund sells and buys those company’s stocks accordingly. The risk and return of these funds is very similar to the index.

Actively managed mutual funds attempt to beat the performance of an index. The idea is that with careful investment selection, they will get higher returns than the index.

Different Types of Mutual Funds

There are numerous types of mutual funds that investors can choose to invest in.

Breaking Down Various Mutual Fund Types

Mutual funds can invest in stocks, bonds, real estate, commodities, and more. There are tens of thousands of mutual funds that cover every investing strategy you can imagine. Those can include asset class funds, sector funds, or target date funds, among many others.

Asset Class Funds

Asset classes are groups of similar assets that share similar risks, such as stocks, bonds, cash, or real estate. Some funds specialize in a particular type of investment or asset class — for example, large cap growth stocks or high yield bonds. These mutual funds assume that you or your adviser will choose the strategic mix of funds that’s right for you.

Sector or Industry Funds

Some funds will attempt to represent all or most of the stocks in a particular sector or industry. What’s the difference? Sectors are broader than industries — for example, oil is an industry, but energy is a sector that also includes coal, gas, wind, and solar companies. The stocks in each industry or sector share similar characteristics and risks.

Target Date Funds

A target date fund will provide you with a mix of asset classes (for example, 20% bonds and 80% stocks). They assume you will terminate the fund some year in the future, usually when you retire, and they shift to less risky investments as the target year approaches.

Target-date funds are intended to be a generic, low-cost solution to retirement saving and. They can be a good choice for a 401(k) investment if you don’t have the time or expertise to pick funds.


💡 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.

The Financial Mechanics of Mutual Funds

As mentioned, mutual funds pool money from a group of investors and invest it for them in various securities. That seems simple enough — but figuring out how to price shares is a bit more involved.

The Pricing Puzzle: Net Asset Value Explained

Mutual funds are companies, and investors purchase shares of the company. Share prices of mutual funds are also called net asset value, or NAV, and NAV corresponds to the net value of all the fund’s assets, with liabilities subtracted. Then, the number is divided by the number of shares outstanding.

In effect, investors can calculate share prices using the NAV formula if they wish.

Fee Structures: Costs Associated with Mutual Fund Investing

There are also costs associated with mutual funds. All mutual funds have some expenses, but they can vary a lot from one fund to another. It’s important to understand them, because fund expenses can have a big impact on your returns over time.

Another problem with actively managed funds is that they typically cost you more because funds are paying people who make investment decisions, and they are making more trades, which have transaction costs. As such, you may want to look out for operating expenses or transaction fees.

You won’t get a bill, but your returns on the fund will be reduced by the fund’s expenses. Some brokerage firms also charge commission for buying mutual funds.

The Pros and Cons of Investing in Mutual Funds

Like all investments, mutual funds have their pros and cons that investors should consider.

Benefits of Diversification and Professional Management

The two biggest pros or advantages of mutual funds are likely the built-in diversification that they offer investors, and professional management. The diversification element allows many investors to take a “set it and forget it” approach to their portfolio management, and many may find confidence knowing that professional fund managers are steering the ship.

Considering the Risks: No Guarantees and Potential for High Costs

Cons include the fact that there’s no guarantee in terms of returns (there never are when investing!), and the costs associated with mutual funds. As noted, mutual funds may incur additional costs compared to other investment types, depending on the individual fund. That may turn some investors off.

Taxes and Cash Drag: The Other Side of Mutual Funds

Taxes are another potential con for mutual funds, as investors will need to pay capital gains taxes on mutual fund payouts throughout the year — and they won’t have much control over that, either. And cash drag (or performance drag), which refers to the difference between returns between two investments when one incorporates trading costs, can be another thing for investors to think about.

Mutual Fund Investments and You

How can you determine if mutual funds are right for your strategy or portfolio? It may require some consideration of your goals, time horizon, and risk tolerance.

Are Mutual Funds Right for Your Portfolio?

There’s no way to say definitively that a certain investment or investment type, like mutual funds, are “right” for any given investor. But in a general sense, mutual funds may be a good choice if you’re a new or young investor, and looking to add some out-of-the-box investments to your portfolio. Again, mutual funds are typically already diversified, to a degree, and are managed by professionals.

Can You Cash Out Anytime? Understanding Liquidity

Mutual funds are not as liquid as stocks or other investments, but they are fairly liquid. That’s to say that if you want to cash out or sell your mutual fund holdings, a prospective trade will only execute once per day — after the stock markets close at 4pm ET. Conversely, stocks can trade any time during market hours.

Mutual Funds Compared to ETFs

Mutual funds are, in many ways, similar to other types of investments, like ETFs.

Mutual Funds vs ETFs: A Comparative Analysis

Mutual funds have been around since the 18th century, but exchange-traded funds, or ETFs, are relatively new, having debuted in the early 1990s. Traditional (old-school) mutual funds are issued by the fund sponsor when you buy them and redeemed when you sell them.

They are priced once a day, after the market closes, at the value of all the underlying securities in the fund divided by the number of fund shares — again, their net asset value (NAV).

Exchange Traded Funds (ETFs) trade on stock exchanges throughout the day. You buy them from and sell them to another investor — just like a stock.

Since the assets in the fund are constantly changing value throughout the day, and the fund price is set by market supply and demand, it might trade a little higher or lower than its NAV at different points in the day, but ETFs generally track their NAV very closely. Both traditional funds and ETFs can be actively or passively managed.

ETFs have two advantages — liquidity and cost. Even though you may pay a commission for buying or selling them—just like a stock, they generally have lower expenses that more than make up for it.

Since they can be bought or sold whenever the market is open, you don’t have to wait until the end of the day to buy or sell. This liquidity can be a big advantage on days when the market is way up or way down.

Understanding Fund Classes and What They Mean for Your Investment

There are some mutual funds that offer classes of shares, or different types of shares (similar to some stocks). The different classes of shares tend to correlate to the types of fees or expenses associated with them. Investors may find Class A, Class B, and Class C shares on the market for certain funds.

Class A shares tend to charge fees up front and have lower ongoing expenses, which may be attractive to long-term investors. Class B shares may have high exit fees and expense ratios. Class C shares tend to have mid-level expense ratios and small exit fees, and are often popular with the typical investor.

Getting Started with Mutual Funds

If you think mutual fund investing is a good option for your strategy, getting started can be relatively simple.

Steps to Your First Mutual Fund Investment

The first thing to do if you’re looking to invest in mutual funds is to sit down and do some homework. As discussed, there are myriad mutual funds out there, and they’re all different. You’ll want to pay close attention to what each fund offers, the costs associated with it, and the risks, too.

If you’ve found a mutual fund that you think is a good fit for your portfolio, you’ll want to choose a brokerage or platform that will allow you to buy shares of a given fund, or otherwise have an account that you can trade with, such as a retirement account.

From there, it’s more or less about placing an order and executing the trade. And, after that, managing and rebalancing your portfolio every so often.

Working With Financial Advisors: Finding Guidance in Mutual Fund Investing

As with all investments, if you feel that mutual fund investing has thrown you for a loop or is over your head, you can and maybe should reach out to a financial professional for guidance. Advisors of various types should be able to help you figure out which funds may be a good fit, describe their fees and risks, and help you make a wise selection that will help put you on track to reaching your financial goals.


💡 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.

The Takeaway

Mutual funds are companies that pool investors’ money, and then invest it in numerous types of securities on their behalf. Investors can purchase or invest in shares of mutual funds and add them to their portfolios. Mutual funds can be useful to new or beginner investors, as they offer built-in diversification, and active management.

They do have higher costs than other investments, though, which is something investors should consider. Further, there are thousands of mutual funds on the market, which may be overwhelming to some. If you’re interested in investing in mutual funds, it may be a good idea to speak with a financial professional for guidance.

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.

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