Investing Archives | Page 60 of 221

Sep

2023

Front-Running Explained

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Front running is when a broker trades a financial asset on the basis of non-public information that will influence the price of the asset in order to profit. In most cases front running is illegal because the broker is acting on information not available to the public markets, for their own gain.

Front running is somewhat different from insider trading, where an individual investor working at a company is able to place a trade based on proprietary information about that company. Insider trading is also illegal.

There is another definition of front running, however, that involves index funds. This type of front running is not illegal.

What Is Front Running?

In short, front running trading means that an investor buys or sells a security (a stock, bond, etc.) based on advance, non-public knowledge or information that they believe will affect its stock price. Because the information is not widely available, it gives the trader or investor an advantage over other traders and the market at large.

Based on this definition of front running, it’s easy to see how the practice — though illegal — earned its moniker. Traders, making moves based on privately held information, are getting out ahead of a price movement — they’re running out in front of the price change, in a very literal sense.

In addition to stocks, front running may also involve derivatives, such as options or futures.

Again, although front running is technically different from insider trading, the two are quite similar in practice, and both are illegal. Front running is forbidden by the SEC. It also runs afoul of the rules set forth by regulatory groups like the Financial Industry Regulatory Authority (FINRA).

If a trader has inside knowledge about a particular stock, and makes trades or changes their position based on that knowledge in order to profit based on their expectations derived from that knowledge, that’s generally considered a way of cheating the markets.

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

How Front Running Works

The definition of front running and how it works is pretty straightforward, and there are two main ways front running — also called tailgating — can occur.

• A broker or trader gets wind of a large upcoming trade from one of their institutional clients, and the size of the trade is sure to influence the price.

• Or the broker learns of a specific analyst report about a given security that’s likely going to impact the price.

In either case, the trader gains access to price-relevant information that’s not yet available to the public markets, and the broker is well aware that the upcoming trade will substantially impact the price of the asset. So before they place the trade, they might either buy, sell, or short the asset — depending on the nature of the information at hand — and make a profit as a result.

A Front Running Example

Let’s run through a hypothetical example of how one form of front running may work.

Say there’s a day trader working for a brokerage firm, and they manage a number of client’s portfolios. One of the broker’s clients calls up and asks them to sell 200,000 shares of Company A. The broker knows that this is a big order — big enough to affect Company A’s stock price immediately.

With the knowledge that the upcoming trade will likely cause the stock price to fall, the broker decides to sell some of his own shares of Company A before he places his client’s trade.

The broker makes the sale, then executes the client’s order (blurring the lines of the traditional payment for order flow). Company A’s stock price falls — and the broker has essentially avoided taking a loss in his own portfolio.

He may use the profit to invest in other assets, or buy the newly discounted shares of Company A, potentially increasing his long-term profits essentially by averaging down stocks.

The trader would’ve broken the law in this scenario, breached his fiduciary duties to his client, and also acted unethically.

Recommended: Understanding the Risks of Day Trading

Front Running in the Real World

There are many real-world examples of front running that have led to securities fraud, wire fraud, or other charges. Back in 2009, for instance, 14 Wall Street firms were hit with roughly $70 million in fines by the SEC for front running.

“The SEC charged the specialist firms for violating their fundamental obligation to serve public customer orders over their own proprietary interests by ‘trading ahead’ of customer orders, or ‘interpositioning’ the firms’ proprietary accounts between customer orders,” an SEC release read.

Further research into the topic of front running finds that when people (or firms) have insider knowledge that could benefit them in the markets, they’re likely to use it.

As for another real-world example of front running, there was a case in 2011 involving a large global bank, and some foreign exchange traders who found themselves in hot water. The two traders became privy to a pending order from a client, made some moves to get ahead of it, and ended up making their company money.

It was a $3.5 billion transaction, and by front running the trade, the traders were able to make more than $7 million. It’s not a happy ending, however, the people involved ended up sentenced to prison and ordered to pay hundreds of thousands of dollars in fines.

So, while front running does happen, there can be serious consequences if regulators catch wind of it.

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Is Front Running Legal?

No. In almost all cases, front running is illegal.

Are There Times When Front Running Is OK?

Yes, actually. Index front running is not illegal, and is actually fairly common among active investors.

As many investors are aware, index funds track market indexes like the S&P 500 or Dow Jones Industrial Average. These funds are designed to mirror the performance of a market index. And since market indexes are really nothing more than big amalgamations of stocks, they change quite often. Companies are frequently swapped in and out of the S&P 500 index, for instance.

When that happens, the change in an index’s constituents is generally announced to the public, before the swap actually takes place. If a company is being added to the S&P 500, that’s probably considered good news, and can make investors feel more confident in that company’s potential. Conversely, if a company is being dropped from an index, it may be a sign that things aren’t going so well.

That gives some traders an opening to take advantageous positions. Let’s say that an announcement is made that Firm X is being added to the Dow Jones Industrial Average, taking the place of another company. That’s big news for Firm X, and means that it’s likely Firm X’s stock price will go up.

Traders, if they have the right tools, may be able to quickly buy up Firm X shares the next day, and potentially, make a profit if things shake out as expected.

How is this different from regular front running? Because the information was available to the public — there was no secret, insider knowledge that helped traders gain an edge.

The Takeaway

Front-running is the illegal practice of taking non-public information that is likely to impact the price of a certain asset, then placing a trade ahead of that information becoming public in order to profit. Front running is similar to insider trading, although the latter generally involves an individual investor who profits from internal company information.

Fortunately, there are plenty of ways to profit in the markets without resorting to fraudulent activity like front running.

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

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

Why is front-running illegal?

Front running is illegal for a few reasons. First, it’s a form of cheating the market, by using non-public information for a gain. Second, in the case of institutional front running, it’s a violation of a broker’s fiduciary duty to a client.

How can I identify if my trades have been affected by front running?

Unfortunately, owing to the non-public nature of the information that typically leads to front-running, it’s very difficult for individual investors to determine whether or not their own trades have been impacted by a front-running event. Financial institutions have more tools at their disposal to detect incidents of front running.

Are there any technological solutions or tools available to detect and prevent front running?

Yes. With so many traders using remote terminals to place trades since the pandemic, trade surveillance technology and trade reconstruction tools are more important than ever. Fortunately, financial institutions have the resources to employ these tools, and other types of algorithms, to monitor the timing of different trades in order to identify front runners and front running.

Photo credit: iStock/Drazen_

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

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOIN0723105

Sep

2023

How and Why to Invest in Oil

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

Oil is valuable, and one of the most widely used and widely traded commodities in the world. Despite the growth of many forms of alternative energy, oil remains essential to the functioning of industry and transportation around the globe.

Given all the factors that go into oil prices, it’s no wonder that they can fluctuate dramatically, often on a daily basis. The price of oil has an impact on a wide range of industries, and ultimately on the prices that consumers pay at the pump, in the supermarket, and beyond. That also makes it attractive to investors.

Ways to Invest in Oil

For those who are interested in incorporating crude oil investing in their portfolio, there are many ways to get started.

Oil Company Stocks

In addition to the massive global names, there are other companies that specialize in different aspects of energy production, oil exploration, drilling, equipment, delivery and more. There are also smaller oil companies with vertical operations, but only in specific parts of the world. Each of those types of companies will perform differently depending on the many geopolitical, economic, technological, and other factors that drive the price of oil up and down.

Oil Funds

Not every investor has the time or interest to research a host of oil companies. For those investors, a better approach might be investing in a mutual fund or exchange-traded fund (ETF) that focuses on the oil sector, or more broadly on the energy sector.

Since thematic ETFs and mutual funds hold many securities, they offer investors a level of diversification within their portfolio.

Exchange-Traded Notes (ETNs)

Exchange-traded notes are a vehicle that invests directly in oil futures contracts. Investors like them because they offer easy access to oil futures, without some of the other factors that can affect the performance of oil companies, such as currency fluctuations and swings in the equity markets. Because they buy oil futures directly, ETNs can offer investors a more direct investment in the price of oil.

Derivatives

More sophisticated investors may also consider investing in the derivatives markets, buying futures, and options. Crude oil options trade on the New York Mercantile Exchange (NYMEX) and on the ICE exchange.

Alternative Investments

Investors interested in alternative investments might get exposure to oil by purchasing mineral rights or buying into Limited Partnerships (LPs) that invest throughout the sector.

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

Trends in Oil Investing

crude oil prices 2023-2024 vs inflation expectations

Oil prices plummeted in 2020, as pandemic-associated lockdowns drove U.S. oil prices into negative territory for the first time in history. In April 2020, investors bid the price for West Texas Intermediate (WTI) from $18 per barrel, down to roughly negative $37 a barrel.

Later that year, oil prices began to normalize. Demand returned in 2021, and oil prices shot back up in 2022, when they reached levels not seen in decades. In 2023, prices did fall a bit again — but the point is that prices are always on the move. Given the unpredictability of the global economy, too, it’s very difficult to determine how oil prices will perform going forward.

Forces That Drive Oil Prices

There are many factors that determine oil prices. That, in turn, can affect prices for gasoline and more. Here are some of the forces at play.

The Organization of Petroleum Exporting Countries (OPEC)

Another important contributor to oil prices is the Organization of Petroleum Exporting Countries (OPEC), a group of 13 oil-producing countries, including Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela.

Together, they’re responsible for nearly 80% of the planet’s oil supply. As an organization, OPEC meets regularly to set production levels. And its decisions can directly change the price of oil and gas. And while it has a massive influence on the price of oil, it doesn’t control the price.

Market Fundamentals

The global oil market is a force in its own right, as supply and demand tend to fluctuate sharply and unpredictably. There can be too much supply. Within OPEC, members don’t always follow through on the limits they agreed upon limits. There are also major oil suppliers, such as the United States, who are not OPEC members who may produce more oil than expected. That can cause high levels of supply relative to demand, which can drive down prices.

Production Costs

Oil in Canada’s oil sands or American shale reserves is far more labor-intensive and expensive to extract and refine than the oil in the Middle East. Those extraction costs contribute to the price of the oil, which can drive the oil prices higher or lower, depending on where the bulk of supply is coming from at any given time.

Natural Disasters

Oil prices are also susceptible to change as a result of natural disasters. Hurricanes, for example, regularly shut down oil production in the Gulf of Mexico, which can reduce the supply of oil and drive prices up.

International Relations

The headlines, especially international ones, can also drive oil prices. A significant amount of the world’s oil comes from the Middle East. Political instability in that region creates investor uncertainty, which can lead to price fluctuation. The same goes for countries like Russia, which produce a lot of oil, but as of 2023, are involved in geopolitical conflicts.

Economic Factors

While not always the case, recessions and economic turmoil can push oil prices lower.

The relative strength of the U.S. dollar also plays a role in the price of oil. The thinking is that a strong dollar allows American oil companies to buy more oil, and cut the cost to U.S. consumers, who buy 20% of the oil on the market.

However, while oil does not typically perform well during a recession, it does typically become more attractive to investors later in the business cycle.

The Takeaway

Oil is always in demand, and fluctuates a lot in price, which may make it attractive to many investors. But it’s a volatile investment, which can make investing in oil a risky endeavor. Given that many people are focused on renewable energy sources, too, investing in oil may not be as attractive as it once was.

The volatility of oil and its importance to the global economy makes it an important asset class for many investors. But again, it’s risky — so, whether you decide to invest in oil or oil-adjacent sectors and companies should be given considerable thought.

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.

Photo credit: iStock/kckate16

Sep

2023

What Are Capital Expenditures?

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

Capital expenditures, or CapEx, refers to the money a company spends or invests to promote its future growth. This is different from operating expenditures, which deal with the day-to-day costs of running a business. Both show up on a business accounting statement, and both matter for maintaining a healthy bottom line.

From an investment perspective, understanding capital expenditures and how a company spends its money can be useful for evaluating stocks when deciding where to invest. More specifically, the capital expenditure formula is often part of a fundamental analysis approach to gauge a company’s overall financial health and stability. Understanding how to calculate capital expenditures can be helpful when comparing stocks.

Capital Expenditures: Definition & Overview

Here’s a simple definition of capital expenditure: A capital expenditure is any amount of money that a company spends to further its growth.

Capital expenditures typically include the purchase, improvement, or maintenance of physical assets, though it can also refer to intangible assets, such as patents or trademarks. It includes assets that a company will own over more than one accounting period, many of which can depreciate in value over time.

Types of Capital Expenditures

The type of capital expenditures a company has depends on the industry it belongs to and the nature of its business. So, if you’re sector investing, the analyses may vary. Generally, capital expenditure examples can include:

• Land

• Buildings or warehouses

• Equipment

• Machinery

• Business vehicles

• Computer hardware and/or software

• Furniture or fixtures

• Patents

• Licenses

Capital expenditures are most often long-term investments that have a shared goal: to help promote or further business growth. For example, a manufacturing company may decide to upgrade its equipment to speed up production and increase efficiency. The return on that investment comes later, when the company increases its output and generates bigger profits.

Capital Expenditures vs. Operating Expenditures

In accounting, capital expenditures are separate from a company’s operating expenditures. An operating expenditure is money a company spends to maintain normal business operations.

Examples of operating expenditures include:

• Rent or lease payments for business property

• Utilities

• Insurance

• Employee payroll

• Inventory

• Marketing costs

• Office supplies

Bottom-up investors use both capital expenditures and operating expenditures to measure how a company spends its money, but it’s important to avoid confusing them. In a nutshell, capital expenditures represent long-term investments in assets that will be used in the future, while the operating expenditures represent short-term outlays.

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

How to Calculate Capital Expenditures

Companies calculate capital expenditures and include it on their cash flow statements under the section noted for investing activities. If you have access to a company’s cash flow statement or other key company financial information, you wouldn’t necessarily need to calculate capital expenditures because the relevant numbers would already be included.

But if you don’t have cash flow information available, or you simply want to do the math on your own, there’s a capital expenditures formula you can use. This formula is simple, though it does require that you have certain information about a company’s financial situation, including:

• Depreciation and amortization for capital expenditure assets

• Current period PP&E (Property, Plant & Equipment)

• Prior period PP&E

Property, Plant & Equipment refers to assets listed on a company’s balance sheet. In simpler terms, these are the assets that help generate revenue and profits for the business. So again, this can include things like equipment, machinery, vehicles, office equipment or land. Of those assets, land is the only one that typically doesn’t depreciate in value over time.

If you have these three pieces of information, you can then apply the capital expenditures formula. The formula looks like this:

CapEx = Current period PP&E – Prior period PP&E + Current period depreciation

Here’s how it works using hypothetical numbers. Say you’re evaluating a company that has a current period PP&E of $70,000, a prior period PP&E of $50,000 and $20,000 in current period depreciation. Your capital expenditures formula would look like this:

CapEx = $70,000 – $50,000 + $10,000
CapEx = $30,000

These calculations are relatively easy to do if you have all the relevant details from a company’s balance sheet. Once you can calculate capital expenditures, you can use the formula to evaluate investments.

Capital Expenditures and Fundamental Analysis

Fundamental analysis is one strategy for comparing investments and it’s typically used when investing for the long-term. With this type of analysis, the emphasis is on what makes a company financially healthy. This is something you may be interested in when trying to evaluate a stock appropriately and decide whether to invest in it.

A fundamental analysis approach considers a company’s assets and liabilities. But it also utilizes certain financial ratios that measure how money moves in and out of the company. Some of the most important ratios include:

• Price to earnings (P/E) ratio

• Earnings per share (EPS)

• Current ratio

• Quick ratio

• Return on equity (ROE)

• Book-to-value ratio

• Projected earnings growth (PEG)

All of these ratios measure a company’s value, which is important if you’re using a value investing approach. The goal there is to identify companies that have been undervalued by the market but have long-term growth potential. By investing in these companies and holding on to them, investors can benefit from price appreciation as they rise in value over time.

So where do capital expenditures fit in?

In terms of gauging a company’s value, capital expenditures offer insight into projected growth over the long-term. When a company regularly invests money in purchasing or upgrading assets, that can be a sign of financial strength and an eventual increase in value. On the other hand, a company pulling back on capital expenditures may hint at cash flow struggles that are impeding future growth.

One thing that’s important to keep in mind is that capital expenditures aren’t a foolproof indicator of a company’s long-term growth potential. It’s possible that a company may spend money with good intentions, only to have them backfire.

In an earlier example, we mentioned a manufacturing company purchasing new equipment to boost production. If that investment doesn’t pan out as expected–if, for example, the equipment requires constant maintenance and repairs that eat into profits or it falls short of expectations for increasing production speed–that could inhibit the company’s growth plans.

The Takeaway

Capital expenditures can be particularly helpful to investors if you favor a value investing approach or you lean toward buy-and-hold investing. Understanding how a company is investing in itself for the long-term can help you decide whether it makes sense as part of your portfolio.

Once you’re ready to invest, it’s important to choose the right tools for doing so. There are many out there, with numerous pros and cons. It’s a good idea to do your research when finding the right platform to invest, just like you would when researching specific investments.

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.

Photo credit: iStock/akinbostanci

SOIN0623026

Sep

2023

How Time-Weighted Rate of Return Measures Your Investment Gains

By Samuel Becker | Growing Wealth, invest, Investing | Comments Off

One of the most important and most common methods investors use to measure their returns is the time weighted rate of return formula. That’s because the time-weighted rate of return measures a compound rate of growth.

The time-weighted rate of return incorporates the impact of transactions such as portfolios rebalancing, contributions, and withdrawals. That leaves investors with a clearer picture of their portfolio’s overall performance.

What Is the Time-Weighted Rate of Return?

Starting with the basics, a return on investment (ROI) is a measure of how much money investments earn, or how much they’ve grown in value. Returns can be positive or negative (if a stock loses value following its purchase, for example). But obviously, investors make decisions with the goal of earning positive returns.

A rate of return, then, is a measure of the pace at which investments are accruing value, expressed as a percentage. The higher the rate of return, the better. Essentially, it’s a measure of a portfolio’s or investment’s performance over time. Rates of return can be calculated for certain time periods, such as a month or a year, and can be helpful when comparing different types of investments.

But investment portfolios are rarely static. Many investors make contributions or withdrawals to their portfolios on a regular basis. Many people contribute to their 401(k) with each paycheck, for example, or rebalance when market moves throw their asset allocation out of whack.

During these transactions, investors are buying and selling investments at different prices and times based on their investing strategy. That can make it more difficult and complicated to calculate a portfolio’s overall rate of return.

That’s where the time-weighted rate of return formula becomes useful. In short, the time-weighted rate of return formula takes into account a portfolio’s cash flows, and bakes in their effect on the portfolio’s overall returns. That gives investors a better, more accurate assessment of their portfolio’s performance.

That’s why the time-weighted rate of return calculation is, for many in the financial industry, the standard formula for gauging performance, over both the short- and the long-term.

💡 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.

The Time-Weighted Rate of Return Formula

The time-weighted rate of return formula can look intimidating for even seasoned investors, but it’s an important step in building and maintaining an investment portfolio. But like many other financial formulas, once the variables are identified, it’s a matter of plug-and-play to run through the calculation.

First, let’s take a look at the basic portfolio return calculation:

Basic portfolio return = (Current value of portfolio – initial value of portfolio) ÷ initial value

While this formula provides a value, it assumes that an investor made one investment and simply left their money in-place to grow. But again, investors tend to make numerous investments over several time periods, limiting this calculation’s ability to tell an investor much about their strategy’s effectiveness.

That’s where the time-weighted rate of return comes in. In essence, the time-weighted formula calculates returns for a number of different time periods — usually additional purchases, withdrawals, or sales of the investment.

It then “weights” each time period (assigns them all roughly equal importance, regardless of how much was invested or withdrawn during a given period). Then, the performance of each period is included in the formula to get an overall rate of return for a specified period.

Calculating the time-weighted rate of return over the course of a year, for instance, would include the performance from each individual month. And, yes, that’s a lot of math. Computers and software programs can help, but it’s also doable the old-fashioned way.

This is what the time-weighted rate of return formula looks like:

Time-weighted return = [(1 + RTP1)(1 + RTP2)(1 + RTPn)] – 1

There are variables needed to calculate the equation:

n = Number of time periods, or months
RTP = Return for time period (month) = (End value – initial value + cash flow) ÷ (initial value + cash flow)
RTPn = Return for the time period “n”, depending on how many time periods there are

Let’s break it down again, and assume we’re trying to calculate the time-weighted return over three months. That would involve calculating the return for each individual month, three in all. Then, multiplying those returns together — “weighting” them — to arrive at an overall, time-weighted return.

How to Calculate Time-Weighted Rate of Return

To run through an example, assume we want to calculate a three-month, time-weighted return. An investor invests $100 in their portfolio on January 31. On February 15, the portfolio has a value of $102, and the investor makes an additional deposit of $5. At the end of the three-month period on April 30, the portfolio contains $115.

For this calculation, we wouldn’t think of our time periods as merely months. Instead, the time periods would be split in two — one for when a new deposit was made. So, there was the initial $100 deposit that would constitute a time period that ends on February 15. Then a second time period, when the $5 deposit was made, which constitutes a second time period.

With this information, we can make the calculation. That includes calculating the return for each time period during our three-month stretch. So, for time period one, the basic formula looks like this:

Return for time period = (End value – initial value + cash flow) ÷ (initial value + cash flow)

Now, we plug in our variables and calculate. Remember, there was no additional cash flow during this first period, so that won’t be included in this first calculation.

Time period 1:
($102 – $100) ÷ $100 = 0.02, or 2%

Then, do the same to calculate time period two’s return:

Time period 2:
[$115 – ($102 + $5)] ÷ ($102 + $5) = 0.074, or 7.4%

Now, take the returns from these two time periods and use them in the time-weighted rate of return formula:

Time-weighted return = [(1 + RTP1)(1 + RTP2)(1 + RTPn) – 1

With the variables — remember to properly use percentages!

TWR = [(1 + 0.02) x (1 + 0.074)] – 1 = 0.95, or 9.5%

So, the time-weighted return over this three-month stretch (which included two time periods for our calculation), is 9.5%. If we had simply done a basic return calculation, we’d reach a different number:

Basic portfolio return = (Current value of portfolio – initial value of portfolio) ÷ initial value
$115 – $100 ÷ $100 = 0.15, or 15%

That 15% figure is too high, because it doesn’t account for cash flow. In this case, that was a $5 deposit made in mid-February. The basic return formula folds that into the overall return figure. The time-weighted calculation gives us a more accurate return percentage, and one that accounts for that mid-February deposit.

Other calculations

While the time-weighted rate of return is an important measurement, it’s not the only way to look at a portfolio’s returns. Some investors may also choose to evaluate a portfolio or investment based on its money-weighted rate of return. That calculation is similar to the time-weighted rate of return because it incorporates inflows and outflows, but it does not break the overall investment period into smaller intervals.

Another common measure is the compound annual growth rate, (CAGR), which measures an investment’s annual growth rate over time and does not include the impact of inflows and outflows.

The Takeaway

Having an accurate, timely view of a portfolio’s performance is critical for understanding current investments, planning future investments, and considering changes to your asset allocation. While other rate of return calculations can be useful, it’s important to understand their limitations.

The time-weighted rate of return formula is helpful because it takes into account the numerous inflows and outflows of money over various time periods. Armed with that insight, investors can adjust their strategy to try to increase their rate of return. That may mean reallocating or rebalancing their portfolio to include more aggressive investments or less risky securities.

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.

Photo credit: iStock/MicroStockHub

SOIN0623024

Sep

2023

What Are Stock Delistings and Why Do They Occur?

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

When a stock is delisted, that means it’s been removed from its exchange. All publicly traded stocks are listed on an exchange. In the United States, that typically means the New York Stock Exchange (NYSE) or the Nasdaq.

There are different reasons for delisting stock, it can occur voluntarily or involuntarily. Owning a delisted stock doesn’t mean you can no longer trade it, but it does change how trades take place. If you own a delisted stock, it’s important to understand what it may mean for your portfolio.

How Stock Listings Work

Before diving into stock delisting, it’s helpful to know more about how stocks get listed in the first place. Stock exchanges can either be physical or digital locations in which investors buy and sell stocks and other securities. The NYSE is an example of a physical exchange, while the Nasdaq is an electronic stock exchange.

To get listed on any stock exchange, companies must meet certain requirements. For example, Nasdaq-listed companies must meet specific guidelines relating to:

• Pre-tax earnings

• Cash flows

• Market capitalization

• Revenue

• Total assets

• Stockholder equity

• Minimum bid price

Companies must also pay a fee to be listed on the exchange. The NYSE has its own requirements that companies must meet to be listed.

Once a stock is listed, it can be traded by investors. But being listed on an exchange doesn’t guarantee the stock will remain there permanently. Stocks get added to and removed from exchanges fairly regularly.

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

What Does Delisting a Stock Mean?

When a stock is delisted, either the company itself or the exchange decides to remove the stock from the exchange.

Exchange-Initiated Stock Delisting

When an exchange delists a stock, it’s typically because it no longer meets the minimum requirements for listing or its failed to meet some regulatory requirement. Using Nasdaq-listed stocks as an example, a delisting can happen if a company’s pre-tax earnings, market capitalization, or minimum share price fall below the thresholds required by the exchange.

Exchanges set listing requirements to try and ensure that only high-quality companies are available to trade. Without stock listing requirements, it would be easier for financially unstable companies to find their way into the market. This could pose a risk to investors and the market as a whole.

In delisting stocks that don’t meet the basic requirements, exchanges can minimize that risk. When and if a company addresses the areas where it falls short, it can apply for relisting. Assuming it meets all the necessary requirements, it can once again trade on the exchange.

Exchanges typically give companies opportunities to rectify the situation before delisting stocks. For example, if a company is trading under the minimum bid price requirement, the exchange can send notice that this requirement isn’t being met and specify a deadline for improvement. That can help companies that experience temporary price dips only to have share prices rebound relatively quickly.

Company-Initiated Stock Delistings

A delisted stock can also reflect a decision on the part of the listed company. There are different reasons a company voluntarily delists itself. Scenarios include:

• A move from public to private ownership

• Merger with or acquisition by another company

• Bankruptcy filing

• Ceased operations

In some cases, a company may ask to be delisted as a preemptive measure if it’s aware that it’s in danger of being delisted by the exchange. For example, if the latest quarterly earnings report shows a steep decline in market capitalization below the minimum threshold, the company may move ahead with voluntary delisting.

What Happens If a Stock Is Delisted?

Once a stock has been delisted from its exchange, either voluntarily or involuntarily, it can still be traded. But trading activity now happens over-the-counter (OTC) versus through an exchange.

An over-the-counter trade is any trade that doesn’t take place on a stock exchange. Investors can trade both listed or delisted stock shares over-the-counter through alternative trading networks of market makers. The OTC Markets Group and the Financial Industry Regulation Authority (FINRA) are two groups that manage OTC trading activity.

Unless the company that issued a now-delisted stock cancels its shares for any reason, your investment doesn’t disappear. If you owned 500 shares of ABC company before it was delisted, for example, you’d still own 500 shares afterward. You could continue trading those shares, though you’d do so through an over-the-counter network.

What can change, however, is the value of those shares after the delisting. Again, this can depend on whether the exchange or the company initiated a delisting, and the reasoning behind the decision.

For example, if a stock is being delisted because the company is filing for bankruptcy its share price could plummet. That means when it’s time to sell them, you may end up doing so at a loss.

Even if a stock’s value doesn’t take a nosedive after delisting, it can still be a sign of financial trouble at the company. If you own delisted dividend-paying stocks, for instance, dividend payments may shrink or dry up altogether if the company begins making cutbacks to preserve capital or reduce expenses.

What to Do If a Stock You Own Is Delisted

If you own shares in a company that delists its stock, it’s important to consider how to manage that in your portfolio. Specifically, that means thinking about whether you want to hold on to your shares or sell them.

It helps to look at the bigger picture of why the reason for the delisting and what it might say about the company. If the company pulled its stock because a bankruptcy filing is in the works, then selling sooner rather than later might make sense to avoid a sharp drop in value.

Also, consider the ease with which you can later sell delisted stock if you decide to keep them. Some online brokerages allow you to trade over-the-counter but not all of them do. If you prefer to keep things as simple as possible when making trades, you may prefer to unload delisted stocks so you no longer have to deal with them.

Recommended: How to Open a New Brokerage Account

The Takeaway

When a stock becomes delisted, it’s removed from an exchange, either because it no longer met the requirements of the exchange, or because the company chose to delist for financial reasons. You can still trade a company after it’s delisted, but transactions occur over-the counter, rather than on an exchange.

Knowing about delisted stocks and companies can be helpful for investors of all types. It doesn’t necessarily mean that they need to invest in those companies, but broadening your knowledge about the markets is almost never a bad idea.

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.

Photo credit: iStock/wacomka

Front-Running Explained

What Is Front Running?

How Front Running Works

A Front Running Example

Front Running in the Real World

Is Front Running Legal?

Are There Times When Front Running Is OK?

The Takeaway

FAQ

Why is front-running illegal?

How can I identify if my trades have been affected by front running?

Are there any technological solutions or tools available to detect and prevent front running?

How and Why to Invest in Oil

Ways to Invest in Oil

Oil Company Stocks

Oil Funds

Exchange-Traded Notes (ETNs)

Derivatives

Alternative Investments

Trends in Oil Investing

Forces That Drive Oil Prices

The Organization of Petroleum Exporting Countries (OPEC)

Market Fundamentals

Production Costs

Natural Disasters

International Relations

Economic Factors

The Takeaway

What Are Capital Expenditures?

Capital Expenditures: Definition & Overview

Types of Capital Expenditures

Capital Expenditures vs. Operating Expenditures

How to Calculate Capital Expenditures

Capital Expenditures and Fundamental Analysis

The Takeaway

How Time-Weighted Rate of Return Measures Your Investment Gains

What Is the Time-Weighted Rate of Return?

The Time-Weighted Rate of Return Formula

How to Calculate Time-Weighted Rate of Return

Other calculations

The Takeaway

What Are Stock Delistings and Why Do They Occur?

How Stock Listings Work

What Does Delisting a Stock Mean?

Exchange-Initiated Stock Delisting

Company-Initiated Stock Delistings

What Happens If a Stock Is Delisted?

What to Do If a Stock You Own Is Delisted

The Takeaway

CATEGORIES

JOIN THE COMMUNITY

Student Loan Refinancing

Personal Loans

Online Investments

Other

Student Loan
Refinancing

Personal
Loans

Online
Investments