Oct
11
2021
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Explaining the Shareholder Voting Process

By | Growing Wealth, Investing | No Comments

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

Shareholder voting rights are typically given to investors who own shares of common stock, not preferred stock. Investors with common stock are generally allowed one vote per share that they own. (Thus an investor who owns 1,000 shares of stock may have 1,000 votes to cast.) Some companies may grant just one vote total per shareholder.

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

What Are Stockholder Voting Rights?

First it helps to distinguish between the two main types of shareholders: those who own common stock and those who own preferred shares. As noted above, investors who own shares of common stock are typically granted voting rights, usually at one vote per share, which gives these investors some say over corporate decisions that could impact company performance.

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

There’s another wrinkle when it comes to understanding the voting rights of equity shareholders. In a privately held company, the corporation itself (along with state corporation laws) oversees and can restrict shareholder voting rights. In a publicly traded company, though, shareholder voting follows company rules but must also adhere to guidelines set by the Securities and Exchange Commission (SEC). These also must align with any rules specified by the exchange on which the company’s stock is listed for trading.

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

So, what do shareholders vote on?

The voting rights of equity shareholders don’t extend to issues concerning day-to-day operations or management issues, but they do include the right to vote on various corporate actions (see below). Given the one vote per share rule that’s generally followed, the more shares you own the more influence you can exert if you’re actively exercising your voting rights — which is why it’s important to pay close attention to critical issues where your vote might make a difference.

What Do Shareholders Vote On?

The management team of a company makes many decisions throughout the year, including hiring and firing, the allocation of budget, product development, and more. Certain issues are then approved during the annual shareholder meeting, and can have a significant impact on a company’s bottom line, strategy, and overall profitability.

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

•   Electing directors to the board

•   Approving a merger or acquisition

•   Approving a stock compensation plan

•   Executive salaries and benefits

•   Major shifts in company goals

•   Fundamental corporate structure changes

•   Approving stock splits

•   Dividend payments

Decisions that might benefit a company’s management may not be in the best interest of investors, so shareholder voting offers a channel whereby investors can weigh in.

For example, a company may choose to use a defense tactic called a “poison pill” to prevent a takeover by another company. They might do this because company management may be against the acquisition, even if it could result in a significant increase in stock value for investors.

As you’re considering which stocks to invest in, you may want to look into the specifics of how shareholder voting works with each company.

There are some companies that don’t allow shareholders to call special meetings, and a supermajority vote is required to change some of the company’s bylaws.

What Happens at a Shareholder Meeting?

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

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

The agenda will probably be similar to the following:

Notice of Meeting

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

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

Minutes of Previous Meeting

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

Presentation of Financial Statements

The company will present current financial statements to the shareholders.

Ratification of Director Actions

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

Speeches

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

Open Floor for Shareholder Questions

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

Election of the Board of Directors and Other Votes

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

Extraordinary Matters

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

How Does the Voting Process Work?

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

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

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

In Person

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

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

According to some statutes, if a group of shareholders representing more than 10% of a company’s capital requests a meeting — or a percentage specified in the company’s bylaws not to exceed 25% — members of the board are required to call a special meeting.

By Mail

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

By Phone

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

Over the Internet

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

What Are Proxy Requirements?

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

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

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

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

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

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

How Do You Know When to Vote?

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

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

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

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

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

The Takeaway

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

Those with preferred stock do not typically have the right to vote on company matters, but they get dividend payouts, which common stockholders generally don’t.

In the majority of cases, shareholder voting isn’t like the one-person-one-vote policy that guides our political system in the U.S. The more company shares you own, the more you might be able to influence company policy and strategy by casting those votes at the annual company meeting. Although day-to-day issues are generally handled by management, shareholders can influence significant corporate decisions, from changes to corporate structure to executive compensation.

Now that you know more about this compelling aspect of being a stockholder, you might be inclined to open a SoFi Invest® account and buy shares in a company you care about, or would like to be more involved with.

SoFi puts all of your investment information in one easy-to-use platform. There are no SoFi management fees, and you don’t need much money to get started buying stocks. You can even buy partial shares. If you have questions, the SoFi team can offer complimentary, personalized investment advice.

Ready to start trading? Download the SoFi app today.


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

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11
2021
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What Is Asset Management?

By | Financial Independence, invest, Investing, Terminology | Comments Off on What Is Asset Management?

As investors begin to acquire assets — from stocks and bonds to alternative investments and real estate — some may wish they had a bit of help managing them. Asset management is a service provided by an individual or financial institution, in which they direct and invest a client’s financial assets on their behalf in exchange for a fee. For example, you may work with an asset management firm to manage your accounts.

Understanding what financial asset management is and the role it can play in managing your portfolio can help you decide whether it is a service that’s right for you, or whether another type of financial professional is a better fit.

Asset Management Basics

What is asset management? If this is a new concept, here’s a simple asset management definition: It simply means paying a professional to oversee your financial assets. This can include bank accounts as well as investment accounts.

Traditionally, asset management companies screen out smaller investors by requiring high investment minimums. As a result, the clients they tend to work with are what is known as high-net-worth clients. These clients could be individuals, corporations, institutions like universities, or even government agencies.

Asset managers handle investments on their client’s behalf, working to deliver investment returns while aiming to mitigate risk. They choose which investments to buy, sell, or avoid entirely. And they make recommendations based on what they think will help their client’s portfolio grow safely.

In addition to trading traditional and alternative securities, such as stocks, bonds, real estate and private equity, asset managers may also offer services not usually available to private investors such as first access to initial public offerings (IPOs).

Asset managers may also allow their clients to take advantage of other less common investment strategies. For example, they may let an investor borrow against the securities in their portfolio if there are other investment opportunities that require quick cash.

They may also offer their clients other services like bundled insurance, which can be cheaper to buy through them than through another insurance company.

How Does Asset Management Work?

Asset managers often make investments based upon an individual or institutional client’s investment mandate. This mandate is a set of instructions for how the client wants their pool of assets to be managed and how much risk to take on. These mandates may include instructions on a client’s goals and priorities, what benchmarks may be used to measure success, and what types of investments should be prioritized or avoided. For example, an environmental organization might avoid stocks or funds that include petroleum companies, or a human rights organization might target funds that prioritize good corporate governance.

To make managing and monitoring their accounts easier, clients may consolidate all of their accounts — including checking accounts, savings accounts, money market accounts, and investment accounts — into one asset management account. These accounts provide one monthly statement to help clients keep track of their financial activities, and may provide other benefits such as automatic periodic investment.

Asset management accounts are relatively new: The government first allowed them just over 20 years ago. In 1999, the Gramm-Leach-Bliley Act overrode the Glass-Steagall Act of 1933, which banned firms from offering banking and securities services at the same time. The Gramm-Leach-Bliley Act permitted financial services firms to offer brokerage and banking services, and the asset management accounts were born.

How Much Does an Asset Manager Cost?

Investors should pay special attention to how an asset manager gets paid, as their compensation structures can be complicated. Before hiring an asset manager, an investor should feel comfortable asking for a copy of their fee structure. Individual Advisory Representatives (IAR), which most asset managers are, are required by the Securities and Exchange Commission (SEC) to file a Form ADV that includes information such as the manager’s investment style and assets they manage, among other things.

Many asset managers charge an annual fee based on a percentage of the value of an account. These fees may change depending on the size of the portfolio. For example, large portfolios may be charged lower fees than smaller portfolios. Alternatively, some asset managers may offer tiered-fee systems that assign different fees to different asset levels within a portfolio. For example, managers may charge one fee for the first $250,000 in a portfolio and a slightly smaller fee for the next $250,000 to $1 million, and so on.

Asset managers may also earn fees on other products or services they offer, such as insurance policies. Other asset management firms are fee-only, meaning they don’t collect commissions on specific products, and only make money from the management fees they charge their clients. A fee structure like this may make investors feel more confident that their asset manager is choosing investments and products that are appropriate to their investment strategy, rather than choosing products because they carry higher commissions.

Some asset management accounts come with account minimums and related fees. Smaller investors may have trouble meeting the opening balance amount or keeping enough in their account to avoid fees.

Importance of Asset Management

Financial asset management is important on several levels for both individual investors as well as business entities. For example, asset management makes it easier to keep track of assets in a centralized way. If you run a business, maintaining accounts at an asset management bank could help with tracking cash flow. If you’re an individual investor, asset management can help you see at a glance how much you have to invest at any given time or how your investments are performing.

Asset management also plays a part in maximizing financial assets and capitalizing on opportunities. A dedicated asset manager can help develop an investment strategy that’s designed to produce a target level of returns for their client, while still maintaining a risk profile that’s tailored to the client’s needs and preferences.

It’s possible to develop both short- and long-term strategies for financial asset management. The asset manager would establish these strategies based on the risk tolerance, time horizon, and investment goals of the investor they’re working with.

Benefits of Asset Management

Asset management can be attractive to investors, business owners, and other entities that want to benefit from professional financial guidance. For example, your asset manager may be able to review your portfolio and develop a plan for maximizing its tax efficiency. Or if you’re interested in a specific objective, such as generating current income through dividend investments, your asset manager may be able to guide you in your investment decision-making to achieve that goal.

Financial asset management may also yield cost savings. While you may pay a fee to an asset manager for their services, that fee may be justified if they’re able to help you reduce other investment fees. For example, if you’re investing in a mutual fund that has a steep expense ratio and produces average returns at best, an asset manager may be able to help you replace it with a mutual fund that has a lower expense ratio and a stronger return profile.

It’s important to keep in mind that asset management isn’t the same as wealth management. Asset managers typically target specific activities, such as choosing an asset allocation for your portfolio or finding ways to minimize investment taxes. Wealth managers, on the other hand, may take a broader view of your financial situation. For example, in addition to helping you with investment decisions, wealth managers may also be concerned with:

•  Estate planning

•  Insurance planning

•  Tax planning

•  Charitable giving

•  Retirement planning

•  College planning

Asset management is concentrated on specific assets while wealth management is more comprehensive in its approach to building and preserving wealth over time.

Asset Management Accounts

Asset management accounts function like a checking or savings account, but with features of investment accounts. You may find them offered at asset management banks or through traditional and online brokerages. Asset management accounts can also be referred to as “sweep” or “cash” management accounts.

Depending on where you open an asset management account, it may include these features and benefits:

•  Ability to link to your brokerage account for convenient transfers

•  Automatic “sweeps” (transfers) of funds from your brokerage account to your asset management account

•  Interest earned on deposits

•  Check-writing abilities

•  Access to funds via a debit or ATM card

•  Combined statement for brokerage and checking transactions

Asset management accounts may also have fewer fees compared to traditional checking or savings accounts. And they may enjoy enhanced FDIC coverage limits. An asset management account should make it as easy as possible to move funds between your spending account and your investment account.

Developing Asset Management Strategies

If you’re considering working with an asset management bank or firm, it’s important to understand how financial asset management strategies work. While every asset manager is different, they may consider some of the same metrics when developing a plan for managing client assets. Those metrics can include the investor’s:

•  Current age

•  Risk tolerance

•  Time horizon for investing

•  Current portfolio allocation

•  Goals and objectives

Asset managers may also take into consideration an investor’s values as well. For example, you may be interested in ESG strategies that promote positive environmental, social and governance practices. Your asset manager could help you to develop an asset allocation that includes green companies or companies that support social justice. Or you may want to exclude certain industries or stock market sectors altogether, which is something else an asset manager could discuss with you.

Alternatives to Asset Managers

You don’t have to be a high-net-worth individual to access some form of asset management. Some financial firms may offer asset management to some clients through a private client division while offering other clients access to pooled investments, such as mutual funds.

Smaller investors — and any investors — looking for help with their portfolios do have other options besides asset managers. These are some of the more common ways to get help putting together and monitoring an investment portfolio.

Managed Funds

Actively managed mutual funds, index funds, and exchange-traded funds (ETFs) are structures in which investors’ money is pooled and then managed in a single account by asset managers. While there are some funds that focus on specific ideals or are focused on producing income to an individual’s needs, the managers don’t work for individual investors specifically. The funds do, however, offer some benefits of active management. Any investor can buy shares of these funds through a broker or with the help of a financial advisor.

Actively managed funds are led by a team of well-trained experts who are trying to outperform the market. This expertise can come at a price, and actively managed funds may come with higher fees. When you invest in mutual funds, for example, you can expect to be charged a sales load — a percentage of the dollar amount invested — by brokers and the mutual fund company when you buy or sell the fund. Front-end loads are paid by the investor up front when they purchase shares of a fund. So if a mutual fund has a load fee of 5% and an investor buys $10,000 worth of shares, $500 will be taken out of the account to pay brokers and distributors.

Back-end fees are paid when an investor sells shares. These fees are usually calculated based on the initial investment and not on the final value of the shares at the time of the sale.

Passively managed funds closely mirror a market index, such as the S&P 500. These funds hold the same securities contained in the index and tend to stray very little from that pattern. As a result, the fund is essentially on auto-pilot and requires very little human intervention.

One low-cost option for investors who want to take a hands-off approach to their portfolios are online investment platforms, some of which use algorithms to build and manage client portfolios.

Registered Investment Advisors (RIAs)

A registered investment advisor (RIA) is an individual or firm who gives investment advice, but may outsource asset management to third-party firms.

RIAs must register with the SEC or another state-level authority. They have a fiduciary duty to their clients, which means they are legally obligated to act in their clients’ best interests. In other words, RIAs must provide investment advice because it is best for their client — and not because it’s beneficial or more profitable to them. The advice they give must be as accurate as possible based on the information available, and RIAs must consider cost and efficiency when making investments on their clients’ behalf.

Not all financial professionals are held to this same standard. Stock brokers for example, are held to a suitability standard rather than a fiduciary standard, meaning the recommendations they make to clients must be suitable to their client’s needs. This differs slightly from the fiduciary standard an investment advisory is held to, which means that the advisor is bound to act in the client’s best interest.

RIAs may suggest investments to their clients for which they receive monetary compensation, such as a commission, as long as the product is in the client’s best interest and the RIA discloses the conflict of interest.

When registering as an RIA, advisors must disclose the investment styles and strategies that they use, how much money they manage in total, their fee structure, past disciplinary actions, conflicts with clients, and any potential conflicts of interest.

Broker Dealers

Broker-dealers are individuals or companies who are licenced to sell securities and other investments. In effect, they are middlemen who buy and sell on behalf of clients. They don’t help investors build their portfolios, or develop an allocation and diversification strategy. However, an investor can turn to a broker-dealer when they want to execute a trade.

Other Financial Advisors

Sometimes, an investor might seek general financial advice that doesn’t necessarily have to do with managing their assets. If those instances, a certified financial planner (CFP®) might be someone to consider. CFPs can make recommendations about asset allocation, investment accounts, and tax strategy, for example. And they can help an individual put together long-term investment plans to save for major financial goals, such as retirement or sending kids to college.

CFPs are credentialed by the CFP Board, and to earn their stripes they must meet rigorous training requirements and pass the CFP exam. The CFP board holds its members to a fiduciary standard, so as with RIAs, the advice they give must be in their clients’ best interest.

The Takeaway

Though asset managers typically work with high-net-worth clients, there are a number of different options any investor has — including wealth managers, RIAs, and CFPs — when it comes to finding a professional service or individual to manage their investment portfolio. For any investor, it helps to consider one’s income bracket, specific needs, and tolerance for fees, when deciding where to turn for professional guidance.

SoFi Invest® can help anyone from seasoned investors to eager beginners get started building a diversified portfolio today. Members can trade stocks and ETFs, choosing to take a hands-on, active approach to building their portfolio—or letting SoFi take the reins to build an automated portfolio for you.

Learn more about SoFi Invest and how it can help grow wealth.

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.
SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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.
IPOs: Investing early in IPO stock involves substantial risk of loss. The decision to invest should always be made as part of a comprehensive financial plan taking individual circumstances and risk appetites into account.
Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

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Should I Use a Dividend Reinvestment Plan?

Should I Use a Dividend Reinvestment Plan?

By | Growing Wealth, Investing | No Comments

A dividend reinvestment plan, or DRIP, allows investors to reinvest the cash dividends they receive from their stocks into more shares, or fractional shares, of that stock.

Hundreds of companies, funds, and brokerages offer DRIPs to shareholders. Although some stock exchanges offer automatic dividend reinvestment, this is different from a formal DRIP. Reinvesting dividends through a DRIP may come with a discount on share prices or no commissions.

Of course, it’s possible to simply keep the cash dividends to spend or save, or use them to buy shares of a different stock. In order to decide what’s best for your financial plan, it helps to know the pros and cons of a dividend reinvestment plan and how it works.

What’s a Dividend?

First, some basics about dividends themselves. A dividend is a payment made from a company to its shareholders (people who own shares of their company’s stock).

Dividends are often drawn from a company’s earnings and paid to shareholders on an annual or quarterly basis. While they’re typically paid in cash via direct deposit or a check, in some cases a company might elect to pay dividends via additional shares. Either way, dividends are subject to tax.

Not all stocks pay dividends, though. Growth stocks, for example, are less likely to offer a dividend, as these companies typically reinvest all of their profits in further growth.

If you buy a dividend-paying stock and want to qualify for a dividend payout, you must own the stock before its ex dividend date. This is a date set by the company that determines which shareholders are eligible to receive an upcoming dividend payment.

Recommended: How Does a Dividend Work?

Dividends Paid on Per-Share Basis

Dividends are paid on a per share basis. Dividend per share (DPS) represents the total amount of dividends per individual outstanding share of stock in a company.

There are two ways to calculate dividend per share:

Total dividends paid/Shares outstanding = Dividend per share

OR

Earnings per share (EPS) x Dividend payout ratio = Dividend per share

In this second formula, earnings per share is a company’s net profit divided by the number of outstanding shares. This is a key metric that’s used to assess a company’s profitability.

Dividend payout ratio (DPR) reflects the total amount of dividends that are paid out to shareholders, relative to a company’s net income. This metric can tell you at a glance what percentage of its profits a company pays to investors as dividends versus reinvesting in growth.

What Is Dividend Reinvestment?

Dividend reinvestment typically means using the dividends you receive to purchase additional shares of stock in the same company (although technically you can reinvest in any company’s stock). So if you’re asking, Should I reinvest dividends? what you may want to know is whether you should use your dividends to buy more of the same stock.

Here’s how it works. If you own 20 shares of a stock that has a current trading value of $100 per share, and the company announces that it will pay $10 in dividends per share of stock, then the company would pay you $200 in dividends that year.

If you choose to reinvest the dividends, you would own 22 shares of that stock ($200 in dividends/$100 of current trading value = two new shares of stock added to your original 20). If the stock price was $200, you’d be able to purchase a single share; if it was $50, you could theoretically reinvest and own an additional four shares.

If instead you want cash, then you’d receive $200 to spend or save, and you’d still have the initial 20 shares of the stock.

When you initially buy a share of dividend-paying stock, you typically have the option of choosing whether you’ll want to reinvest your dividends automatically. Let’s look at how those plans work.

Dividend Reinvestment Plans

Depending on which stocks you invest in, you may have the option to enroll in a Dividend Reinvestment Plan or DRIP. This type of plan, offered by about 650 companies and 500 closed-end funds, allows you to automatically reinvest dividends as they’re paid out into additional shares of stock.

So should you reinvest dividends with a DRIP?

Pros of Dividend Reinvestment Plans

You may have heard that Albert Einstein once said that the most powerful force in the universe was compound interest. The story may be apocryphal, but it’s true that one of the best reasons to reinvest your dividends is that it helps to position you for potentially greater long-term returns, thanks to the power of compounding.

Generally, if a company pays out the same level of dividends each year — whether that’s 2%, 3% or another amount — and you take your dividends in cash, then you’ll keep getting the same amount in dividends each year (assuming you don’t buy any additional shares).

But if you take your dividends and reinvest them through a DRIP, then you’ll have more shares of stock next year, and then more the year after that — which means that the dollar amount of the dividends (at least in our example where the payout percentage is the same each year) will keep rising. Over a period of time, the amount you would receive during subsequent payouts could increase significantly.

An important caveat: Real-life situations aren’t often as straightforward as this example, of course. For one thing, stock prices aren’t likely to stay exactly the same for an extended period of time.

Plus, there’s no guarantee that dividends will be paid out each period; and, even if they are, there is no way to know for sure how much they’ll be. The performance of the company and the general economy can have a significant impact on company profitability and, therefore, typically affect dividends given to shareholders.

From a long-term historical perspective, though, stocks have provided financial growth and, when dividends are reinvested, the effect of compounding can provide significant benefits.

There are more benefits associated with DRIPs:

•  You may get a discount: Discounts on DRIP shares can be anywhere from 1% to 10%. Investors can also purchase fractional shares through DRIPS. This is useful because dividend payments may not be enough to buy an entire share of the stock.

•  Zero Commission: Most DRIP programs can allow you to buy new shares without paying commission fees. However, many brokerages offer zero-commission trading outside of DRIPs these days.

•  Fractional Shares: DRIPs may allow you to reinvest into fractional shares, rather than whole shares that may be at a pricier level than you wish to purchase.

•  Dollar-cost averaging: This is a common strategy investors use to manage price volatility. You invest the same amount of money on a regular cadence (every week, month, quarter) no matter what the price of the asset is. This is generally smarter than trying to time the market.

Cons of Dividend Reinvestment Plans

Dividend reinvestment plans also come with some potential negatives.

•  The cash is tied up. First, reinvesting dividends obviously puts that money out of reach. That can be a downside if you want or need the money for, say, home improvements, a tuition bill, or an upcoming vacation.

•  Risk exposure. You should also keep potential risk factors in mind. For example, you may have concerns about the stock market in general, or about the particular company where you’re a shareholder, and reinvesting your cash into more equities may seem unwise. Or you may need to rebalance your portfolio. If you’ve been reinvesting your dividends, and the stock portion of your portfolio has grown, using a DRIP could inadvertently put your allocation further out of whack.

•  No flexibility. Another factor to consider is that when your dividends are automatically reinvested through a DRIP, they will go right back into the company that issued the dividend, giving you no choice as to where to put those funds. Perhaps you’d simply rather buy stock from another company.

•  Less liquidity. Also, when you use a DRIP and later wish to sell those shares, you must sell them back to the company. DRIP shares cannot be sold on exchanges.

Cash vs. Reinvested Dividends

Should I reinvest dividends or take cash instead? How you approach this question can depend on several things, including:

•  Short term financial goals

•  Long term financial goals

•  Income needs

Accepting the cash value of your dividends can provide you with ongoing income. That may be important to you if you’re looking for a way to supplement your paychecks during your working years, or other income sources if you’re already retired.

As mentioned earlier, you could use that cash income to further a number of goals. For instance, you might use cash dividend payouts to pay off debt, fund home improvements or put your kids through college. Or you may use it to help pay for long-term care during your later years.

You might consider a cash option for dividends rather than reinvesting dividends if you’re already building sufficient wealth for retirement in your portfolio. That way you can free up the cash now to enjoy it or address other current priorities.

Cash may also be more attractive if you’re comfortable with your current portfolio configuration and don’t want to purchase additional shares of the dividend stocks you already own.

On the other hand, reinvesting dividends automatically through a DRIP could help you to increase your savings for retirement. This assumes, of course, that your investments perform well and that the stocks you own don’t decrease or eliminate their dividend payout over time. Choosing Dividend Aristocrats or Dividend Kings could help to hedge against the possibility of dividend cuts.

Dividend Aristocrats represent a select group of companies that have increased their dividend payout year over year for at least 25 consecutive years. The Dividend Kings are an even more elite group of companies that have increased dividend payouts year over year for 50 consecutive years or more.

Tax Consequences of Dividends

One thing to keep in mind is that dividends — whether you cash them out or reinvest them — are not free money. There may be tax consequences when you receive dividends because if the amount is significant enough, you might need to pay income taxes on what you’ve earned.

Each year, you’ll receive a tax form called a 1099-DIV for each investment that paid you dividends, and these forms will help you to determine how much you owe in taxes on those earnings.

Dividends are considered taxable whether you take them in cash or reinvest them — even though when you reinvest, the money isn’t currently available for you to spend.

The exception to that rule is for funds invested in retirement accounts, such as an online IRA, as the money invested in these accounts is tax-deferred. If you have received or believe you may receive dividends this year, it can make sense to get professional tax advice to see how you can minimize your tax liability.

Should You Reinvest Dividends?

Reinvesting dividends through a dividend reinvestment plan is partly a short-term decision, and mostly a long-term one.

If you need the cash from the dividend payouts in the near term, or have doubts about the market or the company you’d be reinvesting in (or you’d rather purchase another stock), you may not want to use a DRIP.

If on the other hand you don’t have an immediate need for the cash, and you can see the value of compounding the growth of your shares in the company over the long haul, reinvesting dividends makes sense. And using a DRIP, which may offer some cost savings, could be a smart way to go.

The Takeaway

In general there is a strong case to be made for reinvesting dividends as a growth play, and using a dividend reinvestment plan (or DRIP) is an automatic feature investors can use to take their dividend payouts and use them to purchase more shares of the company’s stock.

As appealing as that sounds, though, it’s important to kick the tires, as it were, and consider all the usual scenarios before you decide to surrender your cash dividends to an automatic reinvestment plan. While there is the potential for compound growth, and it’s likely that using a DRIP will allow you to purchase shares at a discount and with no transaction fees, these dividend reinvestment plans are limiting. You are locked into that company’s stock during a certain market period and even if you decided to sell, you wouldn’t be able to sell DRIP shares on any exchange but back to the company.

Before you can truly decide whether to use a DRIP, it may help to have some dividend-paying stocks. When you open an online investment account with SoFi Invest® a whole world of stock investing is open to you, and you can explore dividend-paying stocks, fractional shares, and more. Becoming a SoFi member also gives you access to complimentary financial advisory services.

For a limited time, opening an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is sign up, play the claw game, and find out how much you won.

Ready to start building your portfolio? Download the SoFi Invest app today.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Advisory services are offered through SoFi Wealth, LLC an SEC-registered Investment adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .
Claw Promotion: For the full terms and conditions of SoFi’s Claw Promotion, click here. Probability of a customer receiving $1,000 is 0.028%.

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Safe Harbor 401k Plan: What Is It? Is It for You?

By | Growing Wealth, Investing, Preparing for Retirement | Comments Off on Safe Harbor 401k Plan: What Is It? Is It for You?

Safe harbor 401(k) plans enable companies to sidestep the annual IRS testing that comes with traditional 401(k) plans, in part by providing a contribution to all employees’ retirement accounts that vests immediately.

Typically a perk used to attract top talent, safe harbor 401(k) plans are a way for highly compensated employees, like company executives and owners, to save more than a traditional 401(k) plan would normally allow.

With traditional 401(k) plans, contributions from highly compensated employees can’t comprise more than 2% of the average of all other employee contributions, in addition to other restrictions. However, with safe harbor 401(k) plans, those limits don’t apply.

Keep reading to learn more about safe harbor rules, why companies use these plans, along with the benefits, drawbacks, and relevant deadlines.

Recommended: What is a 401K Plan and How Does it Work?

Safe Harbor 401(k) Plans Defined

A 401(k) safe harbor plan behaves much the same way a traditional 401(k) plan does — but with a twist. In both cases, eligible employees can use the plan to deposit pre-tax funds for their retirement and employers can contribute matching funds.

But with an ordinary 401(k) retirement plan, companies must submit to annual nondiscrimination regulatory testing by the IRS to ensure that the company plan doesn’t treat highly compensated employees (HCEs) — generally defined as earning at least $130,000 a year or owning 5% or more of the business — more favorably than others.

But the testing process is complex and onerous, as we’ll cover below in the section on safe harbor 401(k) rules.

An alternative is to set up a safe harbor 401(k) plan with a safe harbor match. This allows a company to skip the annual IRS testing — and avoid imposing restrictions on employee saving — by providing the same 401(k) contributions to all employees, regardless of title, salary, or even years spent at the company. And those funds must vest immediately.

This is an important benefit, because in many cases, employer contributions to ordinary 401(k) plans vest over time, requiring employees to stay with the company for some years in order to get the full value of the employer match. Often, if you leave before the employer contributions or match have vested, you may forfeit them.

For smaller companies, it may be worth making the extra safe harbor match contributions in order to avoid the time and expense of the IRS’s annual nondiscrimination testing. For larger companies, giving all employees the same percentage contribution could be expensive. But the upside is that highly paid employees can then make much larger 401(k) contributions without running afoul of IRS rules, a real perk for company leaders. In addition, 401(k) safe harbor plans are typically less expensive to set up than traditional plans.

What Are Nondiscrimination Tests, and How Do They Affect Your 401(k) Plan?

To understand the benefit of safe harbor plans, it helps to see what employers with traditional 401(k) plans are up against in terms of following IRS rules and submitting to the annual nondiscrimination tests. To confirm there is no compensation discrimination, the company must conduct Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), and Top Heavy tests.

If the company fails one of the tests, it could mean considerable administrative hassle, plus the expense of making corrections, and potentially even refunding 401(k) contributions.

Before explaining the details of each test, here’s how the IRS defines highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

To be a HCE:

• The employee must own more than 5% of the company at any time during the current or preceding year (directly or through family attribution).

• The employee is paid over $130,000 in compensation from the employer during the current or previous year. The plan can limit these employees to the top 20% of employees who make the most money.

Employees who don’t fit these criteria are considered non-highly compensated. The nondiscrimination tests are designed to assess whether top employees are saving substantially more than the rank-and-file staffers.

• The Actual Deferral Percentage (ADP) test measures how much income highly paid employees contribute to their 401(k), versus staff employees.

• The Actual Contribution Percentage (ACP) test compares employer retirement contributions to HCEs versus the contributions to everyone else.

According to the IRS, the terms of the ADP test — which compares the amounts different employees are saving in their 401(k)s — are met if the ADP for highly compensated employees (HCE) doesn’t exceed the greater of:

• 125% of the deferral percentage for ordinary, i.e., non-highly compensated employees (NHCEs)

Or the lesser of:

• 200% of the deferral percentage for the NHCEs

• or the deferral percentage for the NHCEs plus 2%.

The ACP test is met if the deferral percentage for highly compensated employees doesn’t exceed the greater of:

• 125% of the deferral percentage for the NHCEs,

Or the lesser of:

• 200% of the deferral percentage for the group of NHCEs

• or the deferral percentage for the NHCEs plus 2%.

Last, the top-heavy test measures the value of the assets in all company 401(k) accounts, total. If the 401(k) balances of “key employees” account for more than 60% of total plan assets, the 401(k) would fail the top heavy test. The IRS defines key employees somewhat differently than highly compensated employees, although both groups are similar in that they earn more than ordinary staff.

As you can see, maintaining a traditional 401(k) plan, and meeting these requirements each year, can be a burden for some companies. Fortunately, it’s possible to set up a safe harbor 401(k) plan, avoid the annual nondiscrimination tests, and provide additional 401(k) savings for employees.

Requirements for a Safe Harbor 401(k)

To fulfill the safe harbor 401(k) requirements, the employer must make qualifying 401(k) contributions (a.k.a. the safe harbor match) that vest immediately. The company contributes to employees’ retirement accounts in one of three ways:

• Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan, regardless of whether the employee contributes.

• Basic: The company offers 100% matching for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for the following 2% of an employee’s contributions.

• Enhanced: The company offers a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

Safe Harbor Contribution Limits

Just like traditional 401(k) plans, the maximum employee contribution limit for a safe harbor plan is $19,500 per year. If you are over 50, you would be eligible for an additional $6,500 catch-up contribution, if your plan allows it.

But in a safe harbor plan, a company owner can reserve the maximum $19,500 (in 2021) for their plan contribution and also boost contribution payments to valued team members up to an individual profit-sharing maximum amount of 100% of their compensation, or $58,000 ($64,500 for those over age 50) — whichever is less.

Regular employees are allowed the standard maximum contribution limit of $19,500, plus anyone over age 50 can contribute an extra “catch-up” amount of $6,500. Those are the same maximum contribution ceilings as regular 401(k) plans.

Benefits of Offering a Safe Harbor 401(k) Plan

By creating a safe harbor 401(k) plan, a business owner can potentially attract and maintain highly skilled employees. Employees are attracted to higher retirement plan contributions and the ability to optimize retirement plan contribution amounts, ensuring more money for long-term retirement savings.

Plus, a safe harbor 401(k) plan can also help business owners save money on the compliance end of the spectrum. For example, companies save on regulatory costs by avoiding the costs of preparing for a nondiscrimination test (and the staff hours and training that goes with it).

There are some additional upsides to offering a safe harbor 401(k) retirement plan, for higher paid employees and regular staff too.

• Playing catch up. If a company owner, or high-level managers, historically haven’t stowed enough money away in a company retirement plan, a safe harbor 401(k) plan can help them catch up. The same may be true, although to a lesser degree, for regular employees.

• The spread of profit. Suppose a company has a steady and robust revenue stream and is managed efficiently. In that case, company owners may feel comfortable “spreading the wealth” with not only high-profile talent but rank-and-file employees, too.

• Encourage retirement savings. Suppose a company is seeing weak contribution activity from its rank-and-file employees. In that case, it may feel more comfortable going the safe harbor route and at least guaranteeing minimum 401(k) contributions to employees while rewarding higher-value employees with more lucrative 401(k) plan contributions.

Potential Drawbacks of a Safe Harbor 401(k) Plan

Safe harbor 401(k) plans have their downsides, too.

• Expense. The matching contribution requirements can add up to a hefty expense, depending on employee salaries. And because employees are vested immediately, there’s no incentive to stay with the company for a certain period.

• Termination fees. If a company introduces a safe harbor 401(k) plan, it must commit to it for one calendar year, no matter how the plan is performing internally. Even after a year, 401(k) plan providers (which administer and manage the retirement plans) usually charge a termination fee if a company decides to pull the plug on its safe harbor plan after one year.

Filing Deadlines for a Safe Harbor 401(k) Plan

Companies that opt for a safe harbor 401(k) plan have to adhere to strict compliance filing deadlines. These are the dates worth knowing.

October 1: That’s the deadline for filing for a safe harbor 401(k) for the current calendar year. This deadline meets the government criteria of a company needing to have a safe harbor 401(k) in operation for at least three months in a 12 month period, for the first year operating a safe harbor plan.

November 1: For companies with a safe harbor plan already in place, November 1st represents the last date a business can change the structure of a safe harbor plan. Regulators stipulate the November 1 deadline date for plan changes so notices can be transmitted to employees by December 1, giving them time to prepare for the next calendar year.

December 1: By this date, all companies — whether they’re rolling out a brand new safe harbor plan or are administering an existing one — must issue a formal notice to employees that a safe harbor 401(k) will be offered to company staffers.

January 1: The date that all safe harbor 401(k) plans are activated.

For companies that currently have no 401(k) plan at all, they can roll out either a traditional 401(k) plan or a safe harbor 401(k) plan at any point in the year, for that calendar year.

The Takeaway

Companies that don’t want the regulatory obligations of a traditional 401(k) plan, and want to prioritize talent acquisition and retention may want to consider safe harbor 401(k) plans.

These plans allow an employer to bestow extra retirement benefits on high-value employees, making an overall compensation package more desirable. But a business owner needs to weigh the pros and cons of a safe harbor 401(k) plan because, in some cases, it can be expensive for a company to maintain.

For business owners who aren’t sure which retirement plan is suitable for their company and their employees, it can be helpful to do some research. With SoFi Invest®, you can also open an online retirement account to gain access to more resources, including complimentary access to financial advisors.

Planning for retirement? Learn how working with a financial planner can help you reach your goals.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Advisory services are offered through SoFi Wealth, LLC an SEC-registered Investment adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .
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What Are Vanilla Options? Definition & Examples

What Are Vanilla Options? Definition & Examples

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Are Vanilla Options? Definition & Examples

Once you’ve started investing, you may want to learn about different assets beyond stocks and bonds. Among the alternative assets you might consider, are options, and vanilla options are a great way to get started with this type of investment.

Options give investors the — you guessed it — option to purchase or sell a stock at a certain price over a certain period. Options are derivative financial instruments, which means they are based on an underlying asset. Vanilla options are the most basic type of option contract, and they’re often standardized and traded on exchanges.

Vanilla Option Definition

Vanilla options, in contrast to exotic options, which have customization features, have simple and straightforward terms of the strike price, or the price for which an investor buys or sells a stock, and the period in which they can exercise their option. The last day that an investor may exercise an option is known as the expiry date.

How Do Vanilla Trades Work?

Let’s look at how options trading works with vanilla trading.

Each option has a strike price. If that price for purchase is lower than the market value of the stock, investors call that option “in the money.”

Investors pay a premium to own an option. This premium reflects several factors, including:

• How close the strike price is to the market price

• The stock’s volatility

• How length of time before the option expires

Investors don’t have to wait until the option expires to complete the trade, and they are typically under no obligation to exercise the option.

Recommended: Popular Options Trading Terminology to Know

What are the Different Types of Vanilla Options?

When it comes to options for vanilla stock options, there are two types, calls and puts.

Calls

A vanilla call option gives an investor the option to buy an asset at a certain price within a certain period. A call option is a bit like a down payment; the investor pays the premium so that, later, they can buy the stock at a good price and profit from it.

However, an investor can pay the premium and never exercise the option. If they decided not to exercise it, they would either lose what they paid for the premium, or they could sell the call option to someone else before it expires.

Puts

In contrast, a put option allows an investor to sell an asset at a fixed price within a certain time period. If a stock tanks in value over the period that option is exercisable, the investor can still sell it for the put price and not lose as much of his investment. But if the stock’s value goes higher than the put price in the market, the vanilla options are worthless because the investor could sell it at the market price and realize more of a profit.

Characteristics of Vanilla Options

Like all investments, vanilla options include a level of risk and volatility. But they can also provide the opportunity for profit.

Premiums

Whether you are interested in a vanilla call or put, you will pay a premium, in addition to what you would pay to purchase the stock with a call. The premium isn’t refundable, so if you don’t exercise the option, you’ve lost what you paid for the premium.

Volatility

The volatility of an option determines its price. The higher the volatility of the option, the higher the premium because there is more opportunity for profits (as well as the risk of loss).

One way to reduce volatility is to use an options trading straddle where you buy a put and call option simultaneously.

Risk Level

Like most other types of investments, options are not without risk. If a stock is lower in price on the market than a call option, the option is worthless. And if a stock has a higher price on the market, the put option won’t net more return on investment.

However, a vanilla option may be less risky than buying a stock outright, since the only thing you’re guaranteed to spend is the premium.

Pros and Cons of Vanilla Options Trading

Trading vanilla options can have potentially great returns…or large losses. Here are the pros and cons.

Pros

 Cons
Minimizes risk; no obligation to exercise Risky; may lose premium investment and more
Option to control more shares than buying them outright May be complex to understand
May offer large returns Fluctuations in market may render option worthless

Pros

Options may be less risky than buying a stock outright, since you’re only buying the option to purchase or sell a stock at a certain price. The premium is all you invest initially.

Typically you can purchase more shares through options than you could buying them on the market, so if you’re looking for larger investment opportunities, options could provide them.

And while they’re volatile, there is the potential for larger returns.

Cons

That being said, you don’t always see large returns. You can lose your entire investment if the option is out of the money when it expires.

Options can be complicated or confusing for new investors. Not only should you fully understand the risks you take with this investment tool, but you also should understand options taxation.

Examples of Vanilla Options

If you’re considering vanilla options as part of your options trading strategy, here are a few examples to illustrate how they work for both calls and puts.

Example of a Vanilla Put Option

A put is a bit like insurance in case your stock you’re holding goes down in value. It’s one way that investors might short a stock. Here’s an example.

Let’s say you own 100 shares of a stock that is currently trading at $25 per share. You buy a put option at a premium of $1 per share that expires in two months at a strike price of $25. So in total, you paid $100 for a premium for 100 shares.

In a month, the stock price drops to $18 per share. This is a good time to exercise that premium because your strike price allows you to sell the shares for $25 rather than $18. You wouldn’t gain any money because you’re essentially selling the stocks for what you paid for them ($25), and you would even lose a little (that $1 per share premium), but the alternative would be to lose even more if you waited and the price dropped more or you didn’t have the option.

Example of a Vanilla Call Option

A call option allows you to purchase a stock at a certain price within a specified time period. Bullish investors who expect a stock to go up in price typically purchase call options.

For our example, let’s say you’re interested in a stock that trades at $53, and you can buy a call option for this stock within one month to purchase the stock at $55 per share. The option is for 100 shares of this stock.

The premium for this option is $0.15 per share. So you would pay $15 for the premium. You aren’t obligated to purchase the stock. If the stock trades at more than $55.15 (option price plus premium), you can realize a profit.

Let’s say in two weeks, that stock is trading at $59. It is, as they say, “in the money.” Now would be a great time to exercise your option because you can realize $3.85 per share and $385 for 100 shares. You can sell the shares immediately to cash in on that profit or hold onto it to see if the stock price continues to rise.

The Takeaway

Vanilla stock options are a way to diversify your investment portfolio and increase your investing savvy. While SoFi does not offer options trading, it does allow you to build a portfolio of stocks, exchange-traded funds, and even IPOs or cryptocurrency. You can get started by opening an account on the SoFi Invest brokerage network.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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Terms and Conditions Apply. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or other eligible status and and meet SoFi's underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, evaluation of your creditworthiness, years of professional experience, income, and a variety of other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Financial Protection and Innovation under the California Financing Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org)

✝ To check the rates and terms you qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

* SoFi Lending $10 Check Your Rate on a Personal Loan or Student Loan Refinance Promotion (“Promotion”): The Promotion is offered by SoFi Lending Corp. or an affiliate (dba SoFi). SoFi reserves the right to change or terminate this Promotion at any time with or without notice to you. No purchase necessary to participate. Additional terms and conditions may apply. Promotion is void where prohibited by state law.

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