Investing Archives | Page 47 of 221

Nov

2023

What Is Dividend Yield?

By AJ Smith | Growing Wealth, invest, Investing, Terminology | Comments Off

Key Points

• Dividend yield is the ratio of a stock’s annual dividend payments to its current stock price, expressed as a percentage.

• Dividend yield can help investors compare companies and determine which ones may be better investments for generating income.

• Dividend yield fluctuates based on changes in stock price, so a higher yield doesn’t always indicate better value.

• Calculating dividend yield involves dividing the annual dividend per share by the stock’s current price.

• Other factors to consider when evaluating dividend stocks include dividend growth history, dividend payout ratio, company debt, and overall financial health.

What Is Dividend Yield?

A stock’s dividend yield is how much the company annually pays out in dividends to shareholders, relative to its stock price. The dividend yield is a ratio (dividend/price) expressed as a percentage, and is distinct from the dividend itself.

Dividend payments are expressed as a dollar amount, and supplement the return a stock produces over the course of a year. For an investor interested in total return, learning how to calculate dividend yield for different companies can help to decide which company may be a better investment.

But bear in mind that a stock’s dividend yield will tend to fluctuate because it’s based on the stock’s price, which rises and falls. That’s why a higher dividend yield may not be a sign of better value.

Keep reading to understand how to calculate dividend yield, and how to use it as a metric in your investment choices.

How Does Dividend Yield Differ From Dividends?

• Dividends are a portion of a company’s earnings paid to investors and expressed as a dollar amount. Dividends are typically paid out each quarter (although semi-annual and monthly payouts are common). Not all companies pay dividends.

• Dividend yield refers to a stock’s annual dividend payments divided by the stock’s current price, and expressed as a percentage. Dividend yield is one way of assessing a company’s earning potential.

How to Calculate Dividend Yield

Calculating the dividend yield of an investment is useful for investors who want to compare companies and the dividends they pay. For investors looking for investments to help supplement their cash flow, or even to possibly live off dividend income, a higher dividend yield on a stock would be more attractive than a lower one.

What Is the Dividend Yield Formula?

The dividend yield formula is more of a basic calculation than a formula: Dividend yield is calculated by taking the annual dividend paid per share, and dividing it by the stock’s current price:

Annual dividend / stock price = Dividend yield (%)

How to Calculate Annual Dividends

Investors can calculate the annual dividend of a given company by looking at its annual report, or its quarterly report, finding the dividend payout per quarter, and multiplying that number by four. For a stock with fluctuating dividend payments, it may make sense to take the four most recent quarterly dividends to arrive at the trailing annual dividend.

It’s important to consider how often dividends are paid out. If dividends are paid monthly vs. quarterly, you want to add up the last 12 months of dividends.

This is especially important because some companies pay uneven dividends, with the higher payouts toward the end of the year, for example. So you wouldn’t want to simply add up the last few dividend payments without checking to make sure the total represents an accurate annual dividend amount.

Example of Dividend Yield

If Company A’s stock trades at $70 today, and the company’s annual dividend is $2 per share, the dividend yield is 2.85% ($2 / $70 = 0.0285).

Compare that to Company B, which is trading at $40, also with an annual dividend of $2 per share. The dividend yield of Company B would be 5% ($2 / $40 = 0.05).

In theory, the higher yield of Company B may look more appealing. But investors can’t determine a stock’s worth by yield alone.

Dividend Yield: Pros and Cons

Pros	Cons
Can help with company valuation.	Dividend yield can indicate a more established, but slower-growing company.
May indicate how much income investors can expect.	Higher yield may mask deeper problems.
	Yield doesn’t tell investors the type of dividend (ordinary vs. qualified), which can impact taxes.

For investors, there are some advantages and disadvantages to using dividend yield as a metric that helps inform investment choices.

Pros

• From a valuation perspective, dividend yield can be a useful point of comparison. If a company’s dividend yield is substantially different from its industry peers, or from the company’s own typical levels, that can be an indicator of whether the company is trading at the right valuation.

• For many investors, the primary reason to invest in dividend stocks is for income. In that respect, dividend yield can be an important metric. But dividend yield can change as the underlying stock price changes. So when using dividend yield as a way to evaluate income, it’s important to be aware of company fundamentals that provide assurance as to company stability and consistency of the dividend payout.

Cons

• Sometimes a higher dividend yield can indicate slower growth. Companies with higher dividends are often larger, more established businesses. But that could also mean that dividend-generous companies are not growing very quickly because they’re not reinvesting their earnings.

Smaller companies with aggressive growth targets are less likely to offer dividends, but rather spend their excess capital on expansion. Thus, investors focused solely on dividend income could miss out on some faster-growing opportunities.

• A high dividend yield could indicate a troubled company. Because of how dividend yield is calculated, the yield is higher as the stock price falls, so it’s important to evaluate whether there has been a downward price trend. Often, when a company is in trouble, one of the first things it is likely to reduce or eliminate is that dividend.

• Investors need to look beyond yield to the type of dividend they might get. And investor might be getting high dividend payouts, but if they’re ordinary dividends vs. qualified dividends they’ll be taxed at a higher rate. Ordinary dividends are taxed as income; qualified dividends are taxed at the lower capital gains rate, which typically ranges from 0% to 20%. If you have tax questions about your investments, be sure to consult with a tax professional.

The Difference Between Dividend Yield and Dividend Rate

As noted earlier, a dividend is a way for a company to distribute some of its earnings among shareholders. Dividends can be paid monthly, quarterly, semi-annually, or even annually (although quarterly payouts tend to be common in the U.S.). Dividends are expressed as dollar amounts. The dividend rate is the annual amount of the company’s dividend per share.

A company that pays $1 per share, quarterly, has an annual dividend rate of $4 per share.

The difference between this straight-up dollar amount and a company’s dividend yield is that the latter is a ratio. The dividend yield is the company’s annual dividend divided by the current stock price, and expressed as a percentage.

What Is a Good Dividend Yield?

dividend yield of sp500 vs dividend aristocrats

Two companies with the same high yields are not created equally. While dividend yield is an important number for investors to know when determining the annual cash flow they can expect from their investments, there are deeper indicators that investors may want to investigate to see if a dividend-paying stock will continue to pay in the future.

A History of Dividend Growth

When researching dividend stocks, one place to start is by asking if the stock has a history of dividend growth. A regularly increasing dividend is an indication of earnings growth and typically a good indicator of a company’s overall financial health.

The Dividend Aristocracy

There is a group of S&P 500 stocks called Dividend Aristocrats, which have increased the dividends they pay for at least 25 consecutive years. Every year the list changes, as companies raise and lower their dividends.

Currently, there are 65 companies that meet the basic criteria of increasing their dividend for a quarter century straight. They include big names in energy, industrial production, real estate, defense contractors, and more. For investors looking for steady dividends, this list may be a good place to start.

Dividend Payout Ratio (DPR)

Investors can calculate the dividend payout ratio by dividing the total dividends paid in a year by the company’s net income. By looking at this ratio over a period of years, investors can learn to differentiate among the dividend stocks in their portfolios.

A company with a relatively low DPR is paying dividends, while still investing heavily in the growth of its business. If a company’s DPR is rising, that’s a sign the company’s leadership likely sees more value in rewarding shareholders than in expanding. If its DPR is shrinking, it’s a sign that management sees an abundance of new opportunities abounding. In extreme cases, where a company’s DPR is 100% or higher, it’s unlikely that the company will be around for much longer.

Other Indicators of Company Health

Other factors to consider include the company’s debt load, credit rating, and the cash it keeps on hand to manage unexpected shocks. And as with every equity investment, it’s important to look at the company’s competitive position in its sector, the growth prospects of that sector as a whole, and how it fits into an investor’s overall plan. Those factors will ultimately determine the company’s ability to continue paying its dividend.

The Takeaway

Dividend yield is a simple calculation: You divide the annual dividend paid per share by the stock’s current price. Dividend yield is expressed as a percentage, versus the dividend (or dividend rate) which is given as a dollar amount.

A company that pays a $1 per share dividend, has a dividend rate of $4 per year. If the share price is $100/share, the dividend yield is 4% ($4 / $100 = 0.04).

The dividend yield formula can be a valuable tool for investors, and not just ones who are seeking cash flow from their investments. Dividend yield can help assess a company’s valuation relative to its peers, but there are other factors to consider when researching stocks that pay out dividends. A history of dividend growth and a good dividend payout ratio (DPR), as well as the company’s debt load, cash on hand, and credit rating can help form an overall picture of a company’s health and probability of paying out higher dividends in the future.

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Nov

2023

Buying Stocks Without a Broker

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Buying stocks without a broker can be done, typically through the use of a self-administered brokerage service, or one of a couple of different types of investing plans. Buying stocks may help you get started on the path to building wealth. And just like hiring professional movers can help make relocating less stressful, purchasing stocks through a broker can make the process of diversifying your portfolio easier.

That, however, can involve paying commissions and fees to trade stocks and other securities. Potential investors who are trying to curb investment costs might wonder how to buy stocks online without a broker being involved.

Key Points

• Buying stocks without a broker is possible through online brokerage accounts, dividend reinvestment plans, and direct stock purchase plans.

• Full-service brokers may offer additional services like trading advice and personalized investment strategies.

• Direct stock purchase plans allow investors to buy shares directly from the company, while dividend reinvestment plans reinvest dividends to purchase more stock.

• Online brokerage accounts often offer convenience, lower fees, and the ability to customize investment strategies.

• Each option has its pros and cons, and investors should consider their preferences and goals before choosing a method.

How Can I Buy Stocks Without a Broker?

It is possible to buy stocks without a broker. In fact, there are three alternatives to using a full-service broker: opening an online brokerage account, investing in a dividend reinvestment plan, and investing in a direct stock purchase plan. So, the short answer is yes, you can buy stocks without a broker.

But it may be useful to understand why some investors do choose to use a broker when making stock purchases.

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Benefits of Using a Broker to Buy Stocks

As their name implies, stockbrokers can help broker trades of stocks and other securities on behalf of their clients. In return, they may earn commissions for making those trades. But that’s just one thing a full-service broker can do. A stockbroker’s role may also involve:

• Offering trading advice to clients based on their experience with the stock exchange and education.

• Giving their clients additional tips and suggestions, like what investments they should buy and sell or when it makes sense to do so.

• Building relationships with their clients to better understand and inform individual investment strategies.

A stockbroker’s salary is largely dependent on commissions, which means they’ve got to be pretty good at what they do to make a living. Investors can benefit from the education, training, and experience a stockbroker accumulates over the course of their career.

That being said, for most stockbrokers, their payment comes from your trades, which means a client has to pay their stockbroker every time they buy, sell, and trade. For some, the knowledge of a stockbroker is worth the cost of doing business. For others, the idea of DIY investing is more appealing. It all depends on personal preference.

💡 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.

How to Buy Stocks Online Without a Broker

DIY investors have several options for buying stocks without brokers online. Here’s a closer look at how each one works.

Direct Stock Purchase Plans

Direct Stock Purchase Plans (DSPPs) allow investors to purchase shares of company stock directly from the company itself. Specifically, trades are completed through a transfer agent.That means you could buy stocks without a broker, full-service or online, to complete the transaction.

DSPPs can be offered by companies that are publicly traded on a stock exchange, though not all publicly traded companies offer DSPPs. Each company can determine what minimum investment to require for initial and subsequent stock purchases.

Direct Stock Purchase Plans

Pros of Buying DSPPs

Buying DSPPs comes with its own unique set of advantages:

• Passive investing: Many DSPPs plans allow an investor to invest a set amount on some kind of recurring basis — sort of a “set it and forget it” strategy.

• Lower fees: DSPPs often charge little or no commissions or fees, once the account is set up.

• An investor might get a discount: Depending on the company a person invests in, they might be offered a slight discount, between 1% and 10%, for investing directly.

Cons of Buying DSPPs

While DSPPs have benefits, there are some drawbacks as well:

• Higher upfront costs: There is typically a cost associated with starting a DSPP account, and DSPPs typically require a $250 to $500 initial investment, with no option of purchasing fractional shares.

• It’s another account: DSPPs are held with individual corporations. So if an investor has DSPP holdings with multiple companies, each will live on the company’s individual platform.

• They’re typically long-term investments: DSPPs don’t offer the same flexibility and speed of an online broker. For that reason, they’re typically considered more appropriate for a long term investment.

Dividend Reinvestment Plans

Dividend Reinvestment Plans (DRiPs), share many similarities to DSPPs — in fact, some DSPPs offer DRiP programs. With a DRiP, investors can still buy stock directly from the publicly traded company, but they can also reinvest the dividends earned on the stock directly back into the company to purchase additional stock.

Dividend Reinvestment Plans

Pros of DRiP Programs

In addition to the benefits of DSPPs, DRiPs have a few to offer on their own if you’d like buy stock without a broker:

• Automated, compounded growth: Reinvesting dividends is not dissimilar to compound interest. DRiPs allow investors to continually reinvest and grow, without having to add funds.

• Fee-free reinvestment, even in fractional shares: Investing the dividends comes fee-free. Investors are also usually offered the opportunity to buy fractions of a share.

Cons of DRiP Programs

DRiPs share many of the same drawbacks as DSPPs, but also have a few specific to them:

• Limited selection: Not all companies that offer DSPPs offer DRiPs, which means you’re selecting from a smaller pool.

• Dividends are still taxable: Although the cash is automatically reinvested in a DRiP, investors will still be taxed on the gains. That means they may want to have liquidity elsewhere to pay the tax.

Online Brokerage Account

Online brokerage accounts offer the convenience of being able to buy stocks online without a traditional full-service broker (and the typical traditional broker fees). Think of it as the difference between dining at a full-service restaurant versus a self-serve buffet.

After opening an account with an online brokerage,an investor can tell their broker what they want to buy, and how much of it. Then the broker completes the order.

Depending on the online broker, there may be low or no fees associated with making a trade.

Online Brokerage Accounts

Pros of Investing with an Online Broker

It might sound pretty easy, but online investing has both pros and cons. Here are a few of the advantages:

• Low fees: When it comes to online investing, people can typically expect to pay lower fees. Many online firms do not charge commissions.

• DIY investing: There’s a lot of freedom that can come with an online brokerage account. An investor gets to choose, creating a customized plan.

• On-demand investing: As long as the markets are open, an investor can ask for trades through their digital brokerage account.

Cons of Investing with an Online Broker

Depending on an investor’s personality and preferences, there may be a few drawbacks to using an online broker:

• It’s all on the investor. Online investing can give investors a lot of choice and freedom, but without the expertise of qualified financial professionals, some investors might be left to research and form a strategy on their own. For some, this might feel stressful.

• It’s for the long term. Since online investing is on-demand, a person can sell whenever they like. That can be a challenge for an investor if patience isn’t their strong suit.

The Takeaway

It’s possible to buy stocks without a full-time broker. For instance, investors can use an online brokerage account to trade stocks on their own, or invest using different types of investment plans. But there can be pros and cons to each.

While there are some advantages to using a traditional full-service broker to purchase stocks, you don’t necessarily need one in order to invest. However, if you don’t feel comfortable doing it yourself, you can speak with a financial professional for guidance.

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Nov

2023

What Is a Dead Cat Bounce and How Can You Spot It?

By Ashley Kilroy | Growing Wealth, invest, Investing | Comments Off

A “dead cat bounce” is a colorful way of describing an unexpected price jump that occurs after a long, slow decline — and typically just before another price drop.

A dead cat bounce carries that morbid name because the price spike in a particular stock or market sector isn’t “live” (i.e. it’s not a real rebound), and characteristically it doesn’t last.

The danger can be that the apparent rebound creates false value, or optimism. That said, some investors may be able to take advantage of a dead cat bounce to create a short position. Unfortunately, it’s hard to identify a dead cat bounce until after the fact.

Nonetheless, investors may want to know some of the signs of this price pattern, as it can help them gauge certain market movements.

Key Points

• A dead cat bounce refers to a temporary price jump after a decline, often followed by another drop.

• It is difficult to identify a dead cat bounce in real-time, making it challenging for investors to take advantage of it.

• Dead cat bounces can occur in individual stocks, bonds, or entire markets.

• Investors should be cautious when interpreting price movements and consider other factors before making investment decisions.

• Active investors may use technical analysis and market indicators to help identify potential dead cat bounces.

What Is a Dead Cat Bounce?

The meaning of “dead cat bounce” comes from a bleak saying among traders that even a dead cat will bounce if it’s dropped from a high enough height.

Thus, when a security or market experiences a steady decline, and then appears to bounce back, only to decline again — it’s known as a dead cat bounce. The “recovery” doesn’t have a rhyme or reason; it’s merely part of a short-term market variation, perhaps driven by market sentiment or other economic factors.

Sometimes what appears to be a dead cat bounce can turn into a stock market crash.

A Dead Cat Bounce Is Specific

If you’re learning how to invest in stocks, bear in mind that a dead cat bounce is not used to describe the ups and downs of a typical trading day — it refers to a longer-term drop, rebound, and continued drop. The term wouldn’t apply to a security that’s continuing to grow in value. The revival must be brief, before the price continues to fall.

It’s also important to point out that this financial phenomenon can pertain to individual securities such as stocks or bonds, to stock trading as a whole, or to a market.

Why Identify a Dead Cat Bounce?

Even for experienced traders or short-term investors using sophisticated technical analysis, it can be difficult. Sometimes a rally is actually a rally; sometimes a drop indicates a bottom.

The point of trying to distinguish whether the rise in price will continue or reverse is because it can influence your strategy. If you have a short position, and you anticipate that a rally in stock price will end in a reversal, you may want to hold steady. If you think the rally will continue, you’ll want to exit a short position.

Example of a Dead Cat Bounce

To illustrate a dead cat bounce, let’s suppose company ABC trades for $70 on June 5, then drops in value to $50 per share over the next four months. Between Oct. 7 and Oct. 14, the price rises to $65 per share — but then starts to rapidly decline again on Oct. 15. Finally, ABC’s stock price settles at $30 per share on Oct. 16.

This pattern is how a dead cat bounce might appear in a real-life trading situation. The security quickly paused the decline for a swift revival, but the price recovery was temporary before it started falling again and eventually steadied at an even lower price.

History of Dead Cat Bounces

There are countless examples of the dead cat bounce pattern in stocks and other securities, as well as whole markets. One of the most recent affected the entire stock market during the Covid pandemic.

The U.S. stock market lost about 12% during one week in February 2020, and appeared to revive the following week with a 2% gain. But it turned out to be a false recovery, and the market dipped back down again until later that summer.

Why Does a Dead Cat Bounce Happen?

A dead cat bounce is often the result of investors believing the market or security in question has hit its low point and they try to buy in to ride the turnaround. It can also occur as a result of investors closing out short positions.

Since these trends aren’t driven by technical factors, that’s why the bounce is typically short-lived — usually lasting a couple of days, or maybe a couple of months on the outside.

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How to Spot A Dead Cat Bounce

Because a dead cat bounce is often an illusion of actual intrinsic value, investors may be tempted to jump on an investment opportunity before it makes sense to do so.

The following typical sequence of events may help an investor correctly identify a dead cat bounce as it might occur with a specific stock.

1. There is a gap down.

Typically the stock opens lower than the previous close, usually a significant amount like 5% (or perhaps 3% if the stock isn’t prone to volatility).

2. The security’s price steadily declines.

In a true dead cat bounce scenario, that initial gap down will be followed by a sustained decline.

3. The price sees a monetary gain for a short time.

At some point during the price drop, there will be a turnaround as the price appears to bounce back, close to its previous high.

4. A security’s price begins to regress again.

The rally is short, however, and the stock completes its dead cat bounce pattern with a final decline in price.

Dead Cat Bounce vs Other Patterns

How do you know whether the pattern you’re seeing is really a classic dead cat bounce versus other types of movements? Here are some clues.

Dead Cat Bounce or Rally?

One way to stay alert for a dead cat bounce with a particular stock is to consider whether the now-rising stock is still as weak as it was when its price was falling. If there’s no market indicator as to why the stock is rebounding, it might make sense to suspect a dead cat bounce.

Dead Cat Bounce or Lowest Price?

Since investors are looking for opportunities to profit, they try to find investment opportunities that allow them to buy low and sell high.

Therefore, when assessing investment opportunities, a successful investor might try to recognize emerging companies, and buy shares of their stock while the price is low and before other investors get wind of the lucrative company.

Since companies go through business cycles where stock prices fluctuate, pinpointing the lowest price point might be hard to determine. There’s no way to know if a dead cat bounce is happening, until the prices have resumed their descent.

Dead Cat Bounce or Bottom of a Bear Market?

Investors may also confuse a dead cat bounce for the actual bottom of a bear market. It’s not uncommon for stocks to significantly rebound after the bear market hits bottom.

History shows that the S&P 500 often sees substantial gains within the first few months of hitting bottom after a bear market. But these rallies have been sustained, and thus are not a dead cat bounce.

Investing Strategies to Avoid a Dead Cat Bounce

For investors who want a more hands-on investing approach — meaning active investing vs. passive — it’s generally better to use investing fundamentals to evaluate a security instead of attempting to time the market (and risk mistaking a dead cat bounce for an opportunity).

Investors who are just starting may want to consider building a portfolio of a dozen or so securities. Picking a few stocks allows investors to monitor performance while giving their portfolio a little diversification. This means the investor distributes their money across several different types of securities instead of investing all of their money in one security, which in turn can help to minimize risk.

Active investors could also consider selecting stocks across varying sectors to give their portfolio even more diversification instead of sticking to one niche.

Investors with restricted funds might consider investing in just a few stocks while offsetting risk by investing in mutual funds or exchange-traded funds (ETFs).

For investors who would prefer not to execute an active investing strategy alone, they can speak with a professional manager. Working with a professional manager may help the investors better navigate the intricacies of various market cycles.

Limitations in Identifying a Dead Cat Bounce

As noted several times here, a dead cat bounce can’t really be identified with 100% certainty until after the fact. While some traders may believe they can predict a dead cat bounce by using certain fundamental or technical analysis tools, it’s impossible to do so every single time.

If there were a way to accurately predict market movements or different patterns, people would always try to time the market. But there are no crystal balls in investing, as they say.

The Takeaway

With 20-20 hindsight, investors and analysts can clearly see that an individual security or market has experienced a steady drop in value, a brief rebound, and then a further drop — a phenomenon known as a dead cat bounce.

Unfortunately, though, it can be too hard for most investors to distinguish between a dead cat bounce and a bona fide rally, or the bottom of a given market or security’s price. Still, knowing what to look for may help investors make more informed choices, especially when it comes to making a choice around keeping or closing out a short position.

For investors who want to take an active role in investing, an online trading platform like SoFi Invest® offers the opportunity to manage your money the way you want. When you open an Active Invest account with SoFi, you can trade stocks you’re familiar with or explore different investment opportunities, including IPO shares, fractional shares, and more.

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Nov

2023

Introduction to Fixed Income Securities

By Matthew Zeitlin | Growing Wealth, invest, Investing | Comments Off

Fixed income securities are a vital pool of investments that are an important part of investors’ strategies, whether they’re institution or individual investors. And while the public is more likely to hear about the ups and downs of the stock market on the news, the fixed income security market is worth trillions, and of vital importance to the overall financial system.

Understanding fixed income securities, and how they fit into an investing strategy, can be critical for investors of all stripes.

Key Points

• Fixed income securities are an important part of investors’ strategies and overall are worth trillions of dollars in the financial system.

• Fixed income securities, like bonds, offer preset payments that do not change and have a set maturity date.

• Advantages of fixed income securities might include lower risks, guaranteed returns, and potential tax benefits, while downsides include lower potential returns and interest rate risks.

• Fixed income securities differ from other securities in terms of their predictable income stream and potential for price appreciation.

• Other similar investments include preferred stocks, money market funds, and certificates of deposit (CDs).

What are Fixed Income Securities?

To understand fixed income securities and investing in fixed income securities, it’s important to understand what “fixed income” means, and how that designation sets these financial securities apart from other investments that can be bought and sold.

“Fixed income” refers to the structure of the security itself: fixed income securities like bonds return a preset payment that legally can not change, known as the interest, and also the principal, which is returned at a set time in the future, known as “maturity.”

And like other types of securities, they have their upsides and downsides, and potentially, a place in an investor’s portfolio. With that in mind, too, it can be a good idea for investors to know how to buy bonds.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Pros and Cons of Fixed Income Securities

Here’s a quick rundown of the advantages and disadvantages of fixed income securities for investors.

Pros of Fixed Income Securities

Perhaps the biggest advantage of fixed income securities is that they are relatively low-risk, and experience less price volatility compared to equities. They can also offer more or less guaranteed returns through regular interest payments (stocks, by comparison, offer no such guarantees other than perhaps dividends), and some of them may offer tax benefits or advantages, too.

Cons of Fixed Income Securities

Fixed income securities can have their downsides, too. For most investors, there are lower potential returns to be derived from fixed income securities (lower risk and lower returns). Given that they tend to be less volatile, too, there can be fewer opportunities to sell them for a sizable return. They can also be subject to things like interest rate risks, which may not apply to other types of securities.

How Fixed Income Securities Differ from Other Securities

The payments (dividends, potentially) from a fixed-income security, like a bond, are likely known in advance. Investors know what they’re getting, in other words, and can more or less depend on a fixed income stream. The trade-off, though, is that many of those same securities do not typically have the same potential for price appreciation as stocks, as discussed.

It’s worth noting, too, that some bonds are “callable” (versus non-callable). Callable bonds can be riskier for some investors as the issuer can “call” it, requiring an investor to perhaps reinvest their money at a different rate. So, in that sense, callable bonds may not be quite as “fixed” as they seem.

Utilizing Bonds as a Fixed Income Security

Bonds are the heavy hitters of the fixed income world. Bonds are, in effect, investments in the debt of a government or a corporation, or sometimes consumer debts like mortgages or auto loans.

Think of bonds vs. stocks like this: Because of their predictable yield, bonds are generally more low-risk than stocks, which have a value that can fluctuate minute to minute.

There are a few different types of bonds, each of which have their own unique attributes. It’s also worth noting that some bonds can be “callable” — meaning, the issuer can choose to repay investors the face value of the bond before the maturity date arrives. In those cases, interest is not always guaranteed.

Corporate bonds

There are trillions of dollars worth of corporate bonds outstanding that run the gamut from very safe, low-yield bonds issued by huge companies to the riskier, higher-yield bonds, issued by companies whose prospects for future earnings are more uncertain.

High-yield bonds used to be called “junk bonds.” These are bonds issued to fund companies that often don’t have long track records of steady profits or have fallen on tough times recently and thus have to pay more for the privilege of borrowing money.

While these bonds are considerably more risky than bonds in the so-called “blue chip” market, they also provide more opportunities for profits, both because their value tends to sway and that they have higher coupon payments.

Typically the easiest way for an individual or retail investor to invest in corporate bonds is to use an investment product like an exchange-traded fund, what’s known as a “fixed income” or bond ETF, specifically for bonds.

Know, too, that there are a multitude of investment funds on the market, many of which may include or use bond investments.

Government bonds

While the corporate bond market is almost unfathomably big, it’s actually a smaller portion of the world of bonds. Government bonds are issued by governments or public agencies that issue debt to fund their activities, and pay it off with either tax payments or a stream of fees that governments have special access to.

Whenever you hear about the “national debt” of a country, you’re hearing about a set of outstanding bonds that a country uses to cover the gap between taxes and spending. This concerns the federal government in the U.S. There’s also debt issued by states and local governments, some of which offers tax advantages for investors, and debt issued by government-affiliated agencies, like Fannie Mae and Freddie Mac, the two housing finance corporations.

Debt issued by the federal government tends to have the lowest possible yield of any debt for its duration (meaning the time during which an investor gets the coupon payments), because it’s assumed by the market to be risk-free. (Think government savings bonds.) This is why corporations or institutional investors with a large amount of cash will sometimes buy government debt in order to earn something back but not risk their overall investment, compared to keeping it in cash.

💡 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.

Similar Investments to Fixed Income Securities

While bonds do most of the heavy lifting in the fixed income securities world, they’re not the only types of investments that behave in roughly the same way, or which can be used by investors to provide the same type of service in a portfolio. Here are some examples.

Dividend-paying or Preferred stocks

Preferred stocks may have fixed payouts like a bond and are given a “preference” over common stock, meaning that before dividends are paid to common stockholders, they need to be paid to preferred stockholders. Preferred stockholders are also prioritized when a company liquidates or goes out of business — the “senior debt,” aka bondholders, get paid out first, then the preferred stockholders, and finally the common stockholders get paid last.

Money market funds

Money market mutual funds are invested in short-term instruments, and investors can use them as a sort of buoy to try and maintain portfolio stability. These accounts typically invest in short-term debt investments that provide low yield but are low-risk as well. One way to think of a money market mutual fund is as a fixed income investment product that you can always sell out of and into at a stable price.

They can be used in a similar way to checking accounts but do not have the type of Federal Deposit Insurance Corporation (FDIC) insurance that bank products will have.

Certificates of Deposit (CDs)

One of the most well-known types of fixed income security, Certificates of deposit (CDs) may not seem like a “security” at all and are typically purchased through a bank, not a broker.

Unlike a bank account, however, CDs cannot be accessed for a set amount of time, which makes them more similar to traditional fixed income investments. Likewise, with a CD an investor gets a contractually obligated stream of payments that is predetermined when they purchase the security. It may be worth reading up the differences in bonds vs. CDs.

One unusual aspect of CDs is that they’re insured by the FDIC for up to $250,000, which can be attractive to some investors. They’re generally low-risk investments, too — but that lower risk tends to come with correspondingly low interest rates, making CDs a savings product more than an investment one.

Investing with SoFi

Fixed income securities like bonds, preferred stocks, money market accounts, and CDs offer steady payments and little to no income fluctuation. But with that low level of risk comes a generally low level of payoff. For investors who like knowing exactly what they’re getting, fixed income securities can be an asset to a portfolio.

The potential downside of investing in fixed income securities is lower potential returns, which may turn many investors off of them. However, depending on your investment strategy, they may play a huge role in your portfolio, too.

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

FAQ

Are fixed income securities debt or equity?

Fixed income securities are typically debt securities, which includes assets like bonds. Though they can sometimes be equities, like preferred stocks.

What are the risks of investing in fixed income securities?

The primary risks of investing in fixed income securities are increased chances for lower returns compared to other asset types, and risks associated with interest rate changes.

What is the difference between a bond and fixed income securities?

A bond is a type of fixed income security, so there isn’t really a difference – one is an umbrella term over the other.

Nov

2023

Understanding the Buy Low, Sell High Strategy

Buy Low, Sell High Strategy: An Investor’s Guide

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

When it comes to investing, there are certain rules of thumb that investors are often encouraged to follow. One of the most-repeated adages in investing is to “buy low, sell high.”

Buying low and selling high simply means purchasing securities at one price, then selling them later at a higher price. This bit of investing wisdom offers a relatively straightforward take on how to realize profits in the market. But figuring out how to buy low and sell high — and make this strategy work — is a bit more complicated. Timing the market is not a perfect science, and understanding that implementing a buy low, sell high strategy is more complicated than it sounds is critical to investor success.

Key Points

• Buy low, sell high is an investment strategy that involves purchasing securities at a lower price and selling them later at a higher price.

• Timing the market and implementing this strategy can be challenging, as market movements are unpredictable.

• Understanding stock market cycles and trends can help determine when to buy low and sell high.

• Technical indicators and moving averages can assist in identifying pricing trends and points of resistance.

• Investor biases and herd mentality can impact decision-making, so it’s important to make rational choices based on research and analysis.

What Does It Mean to “Buy Low, Sell High”?

“Buy low, sell high” is an investment philosophy that advocates buying stocks or other securities at a lower price than you can later sell them. This is the opposite of buying high and selling low, which effectively results in investors selling stocks at a loss.

When investors buy low and sell high, they may do so to maximize profits. For example, a day trader may purchase shares of XYZ stock at $10 in the morning, then turn around and sell them for $30 per share in the afternoon if the stock’s price increases. The result is a $20 profit per share, less trading fees or commissions.

Likewise, a buy and hold investor may purchase stocks, exchange-traded funds (ETFs), or mutual funds and hold onto them for years or even decades. The payoff comes if they sell those securities later for more than what they paid for them.

💡 Recommended: How to Know When to Sell a Stock

4 Tips on How to Buy Low and Sell High

The following tips may help investors develop a buy low, sell high strategy (or avoid the buy high, sell low trap).

1. Investing with the Business Cycle

Understanding stock market cycles and their correlation to the business cycle can help when determining how to buy low and sell high.

The business cycle is the rise and fall in economic activity that an economy experiences over time. If the business cycle is in an expansion phase and the economy is growing, for instance, then stock prices may be on the upswing as well. On the other hand, if it’s become apparent that economic growth has peaked, that could be a signal for stock price drops to come as an economy slows or enters into a recession.

But like most strategies that aim to buy low and sell high, investing with the business cycle can be challenging.

It’s also important to remember that security prices typically don’t move in a straight line up or down in lockstep with a specific phase of the business cycle. Instead, most securities experience a level of volatility, where prices move up or down (or both) in the short term before reverting to the mean.

2. Look at Stock Pricing Trends

Investors who want to buy low may find it helpful to pay attention to pricing trends or technical indicators. Tracking trends for individual securities, for a particular stock market sector, or the market as a whole can help investors get a sense of what kind of momentum is driving prices.

For instance, an investor wondering how low a stock price can go can look at technical indicator trends to identify significant pricing dips or rises in the stock’s history. This can make it easier to determine when a stock or security has reached its bottom, opening the door for buying opportunities. Conversely, investors can also use trends to evaluate when a stock has likely reached its high point, indicating that it’s prime time to sell.

3. Use Moving Averages

Moving averages are a commonly used indicator for technical analysis. A moving average represents the average price of a security over a set time period. So to find a simple moving average, for example, an investor would choose a time period to measure. Then they’d add up the stock’s closing price each day for that time period and divide it by the number of days.

The moving average formula can help compare stock pricing and determine points of resistance. In other words, they can tell investors where stock prices have topped out or bottomed out over time. Moving averages can smooth out occasional pricing blips that temporarily push stock prices up or down.

Comparing one moving average to another, such as the 50-day moving average to the 200-day moving average, can also help investors to spot sustainable up or down pricing trends. All this can help when deciding when to buy low or sell high.

4. Beware of Investor Bias

An investor bias is a pattern of behavior that influences reactions to a changing market. For example, noise trading happens when an investor makes a trade without considering the state of the market or timing. The investor may follow pricing trends but make trades without considering whether the time is right to buy or sell.

Investors who give in to biases may find themselves following a herd mentality when it comes to making trades. If news of a pending interest rate hike sparks fear in the markets, investors may start panic selling in droves. This can, in turn, cause stock prices to drop. On the other hand, irrational exuberance for a specific stock or type of security can push prices up, causing an unsustainable market bubble.

Investors who can refrain from being influenced by the crowd stand a better chance of making rational decisions about when to buy or when to sell to either maximize profits or minimize losses.

Pros and Cons of Buy Low, Sell High

A buy low, sell high strategy can work for investors, but while it’s a worthy goal, the implementation can be difficult. Investors who are too focused on timing the stock market can run into difficulties.

Benefits of Buy Low, Sell High

Buying low and selling high can yield these advantages to investors.

• Bargain-buying opportunities. If investor sentiment is causing fear and panic to take over the market and push stock prices down, that could open a door for buy low, sell high investors as they buy the dip. Individuals who ignore market panic could purchase stocks and other securities at a discount, only to benefit later once the market rebounds and prices begin to rise again.

• Potential for high returns. An investor skilled at spotting trendings and reading the market cycle could reap sizable profits using a buy low, sell high strategy. The wider the gap between a stock’s purchase and sale price, the higher the profit margin.

• Beat the market. A buy low, sell high approach could also help investors to beat the market if their portfolio performs better than expected. This might be preferable for active traders who forgo a passive or indexing approach to investing.

Disadvantages of Buy Low, Sell High

Attempting to buy low and sell high also holds some risks for investors.

• Timing the market is imperfect. There’s no way to time the market and which way stock prices will go at any given moment with 100% accuracy. So there’s still some risk for investors who jump the gun on when to buy or sell if stocks have yet to reach their respective lowest or highest points.

• Being left out of the market. Investors who want to buy low and sell high would not want to buy securities when the market is up. That practice, however, could lead to substantial time out of the market entirely, especially during bull markets.

• Biases can influence decision-making. Investment biases and herd mentality can wreak havoc in a portfolio if an investor allows it. Instead of buying low and selling at a profit later, investors may find themselves in a buy high, sell low cycle where they lose money on investments.

• Pricing doesn’t tell the whole story. While tracking stock pricing trends and moving averages can be useful, they don’t offer a complete picture of what drives pricing changes. For that reason, it’s important for investors also to consider other factors, such as consumer sentiment, the possibility of a merger, or geopolitical events, influencing stock prices.

Alternatives to Buy Low, Sell High

Buying low and selling high is not a foolproof way to match or beat the market’s performance. It’s easy to make mistakes and lose money when attempting to time the market unless, of course, you possess a crystal ball or psychic abilities.

There are, however, other ways to invest successfully without trying to get market timing right. Take dollar-cost averaging, for example. This strategy involves staying invested in the market continuously through its changing cycles. Instead of trying to time when to buy or sell, investors continue making new investments. Over time, the highs and lows in stock pricing average out.

A dividend reinvestment plan (DRIP) is another option. Investors who own dividend-paying stocks may have the opportunity to enroll in a DRIP. Instead of receiving dividend payouts as cash, they’re reinvesting into additional shares of the same stock. Similar to dollar-cost averaging, this approach could make it easier to ride out the ups and downs of the market over time and eliminate the stress of deciding when to buy or sell.

Investing with SoFi

While buying high and selling low may be a good investment strategy, it can be challenging to implement. Executing a buy low, sell high plan successfully means researching and doing due diligence to understand how the market works.

For investors who prefer a more hands-off investing approach, automated investing may be a better option. One way to get started is by opening an online brokerage account with SoFi Invest®. With SoFi automated investing, you can build wealth automatically with competitive fees.

Open an automated investing account and start investing for your future with as little as $1.

FAQ

Is buying low and selling high a good strategy?

Buying low and selling high is generally a good strategy as it allows you to take advantage of price movements in the market. However, there is no guarantee that this strategy will always be successful, and you may end up losing money if the market conditions are not favorable.

Is it illegal to buy low and sell high?

There is no law against buying low and selling high. Most investors make money by buying a security at a low price and then selling it later at a higher price.

Why do you sell high and buy low?

Many investors sell high and buy low because they want to take advantage of market conditions to realize a positive return. When the market is high, investors may sell an investment they purchased at a lower price to make a profit.

Photo credit: iStock/katleho Seisa