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Q: When will social security run out?

According to a 2020 projection from the Social Security Administration (SSA), workers who reach retirement age after 2034 are projected to receive 76% of scheduled benefits.

Jul

2023

When Will Social Security Run Out?

By Rebecca Lake | Investing, Preparing for Retirement | Comments Off

While it’s unlikely that Social Security will ever run out completely, current predictions are that benefits could be reduced by as much as 20% by 2034 — unless Congress intervenes.

Why is that?

Imagine the Social Security system as a bucket of water. Current workers pay Social Security tax that’s added to the bucket, while retired workers withdraw their benefits from the resources in the bucket.

Throughout Social Security’s almost 90-year history, there was always a surplus of funds. More people were paying into the system than were withdrawing from it.

Over time, for various reasons — including a smaller pool of younger workers and a longer-living pool of retirees — those excess resources have been slowly depleted. Given the demands on the system, it’s unclear how to keep Social Security functioning unless benefit payouts are cut, or the government takes some kind of action.

How Social Security Works

The American Association for Retired Persons (AARP) describes Social Security as a “pay-as-you-go” system, meaning that the contributions made by workers now (through the Social Security payroll tax) are actually used to pay the benefits of today’s retirees. Currently some 180 million workers pay into the system, which provides Social Security and Disability benefits for 66 million people.

When today’s workers retire, the idea is that they will receive benefits based on what the next generation contributes. Any money that’s left over goes into one of two Social Security trust funds.

According to the Social Security Trustees report published in March 2023, total costs of the OASI and DI Trust Funds (Old Age and Survivors Insurance, and Disability Insurance) the system began to outstrip total income in 2021, and the reserves of the OASI and DI Trust Funds declined by $22 billion in 2022 to $2.83 trillion.

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Understanding Social Security Tax

The amount each individual worker contributes to Social Security depends on their income. Employees who work for a traditional employer split the Social Security tax payment with their employer at 6.2% each up to $162,200 in annual salary, and self-employed workers are responsible for the entire 12.4%.

As employees contribute to the tax, they earn Social Security “credits” — with a max of four per year.

Those employees become eligible for benefits when they reach 40 credits, which equals roughly 10 working years, or they reach full retirement age. For Americans born in 1960 or later, that’s 67 years old.

At What Age Are You Eligible for Social Security?

Getting the most out of Social Security benefits becomes a numbers game as workers get close to retirement age, because workers are technically eligible at age 62. But for each month previous to full retirement age that someone starts drawing benefits, they’re reduced by one-half of one percent.

According to the SSA, that means if a worker’s full retirement age is 66 and 8 months and they start drawing Social Security at age 62, they’ll only get around 71.7% of their full benefit.

The benefits stop increasing at age 70, and the AARP reports that workers who are able to wait that long get the most return — full benefit plus delayed retirement credits — but individual decisions should be made on a number of factors, including employment outlook and health.

Recommended: When Can I Retire?

Social Security Trust Funds

After all the contributions have been paid in and benefits paid out, any remaining funds are divided up between two trust funds, divided up between the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund, where they earn interest in government-guaranteed Treasury bonds.

The larger of the two funds, the OASI, pays benefits to retired workers, their surviving spouses and eligible children, and covers administrative and other expenses. It’s the largest fund that takes care of retirees who don’t face special circumstances, and deposits are made daily. It’s been around since 1940.

The smaller DI Trust Fund handles monthly benefit payments to disabled workers and their spouses and children until they’re eligible for full benefits through the OASI.

Even though both funds are a part of the overall federal budget, they’re handled separately and the SSA isn’t allowed to pay out more than what’s in the trust fund.

Recommended: Top 5 Social Security Myths

Risk of Social Security Running Out

Media headlines in recent years have highlighted concerns over a potential Social Security funding shortfall. But it’s important to separate fact from fiction when understanding how Social Security works.

Myth 1: There won’t be any money to pay benefits

As mentioned, the odds of Social Security running out of money completely are low. Remember, Social Security is pay as you go with today’s workers paying in funds that are used to provide retirement benefits for today’s retirees.

When you retire, your benefits would be paid by those still working. So unless the system itself is abolished, Social Security benefits would continue to exist and be funded by workers.

Reality: Social Security surplus funds may be exhausted

While workers pay into Social Security, the program also has a surplus of trust funds that it can use to pay benefits, as described earlier. The program has begun using those funds to pay some benefits as of 2021, with payroll taxes continuing to pay the majority of benefits to retirees.

While Social Security itself is unlikely to end, the trust funds may eventually be spent down to $0, which presents the possibility of a reduction in future benefits.

Myth 2: People who aren’t eligible for Social Security can receive it

Another concern about the possibility of Social Security running out stems from the mistaken belief that undocumented individuals can illegally claim Social Security benefits.

The idea is that some people might unfairly claim benefits they’re not entitled to, putting a burden on the system and reducing benefits for eligible workers.

Reality: Documentation is required to obtain benefits

A Social Security number or Individual Taxpayer Identification Number is required for the Social Security Administration to create a benefits record for a citizen or non-citizen who’s authorized to work in the U.S. Someone who has either could legally obtain benefits through Social Security since they’ve technically paid into the system.

Myth 3: The current system can’t support an aging population

As life expectancies increase and the birth rate declines, it’s natural to assume that living longer may affect Social Security’s ability to continue paying out benefits. Someone who’s 25 now, for example, may be wondering what year will Social Security run out and how will it time up with my retirement?

Reality: Social Security can adapt

While there’s little the government can do to change the demographic makeup of the population, lawmakers can be proactive in proposing changes to Social Security. That includes measures that can help to preserve benefits for as many workers as possible while minimizing the odds of running out of funding.

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Problems With Social Security

Because benefit payouts are tied to the SSA’s reserve balance, it begs a question for many working Americans — what happens when that balance hits zero? The SSA itself acknowledges that benefits will likely only be available in full until 2035. That’s just 11 years away.

Reasons for the depletion of fund reserves are attributed to a number of challenges, including a rise in program costs. Cost-of-living adjustments, or COLA, have been steadily increasing. Life expectancy for Americans has grown longer, while the number of workers hasn’t kept pace with the number of retirees.

How to Avoid Social Security Running Out

Lawmakers, financial experts, and retirement advocates are starting to float ideas for how to save the program. To date, the two ideas that have been floated include raising the Social Security tax or reducing the benefit — two options that are likely to be unpopular with both workers and retirees.

There are many details on how to implement those two ideas. Some business publications say that the deficit could be eliminated with a combination of both that aggregate to 2.84% of payroll — that equals less than 3 cents for each dollar earned, and it would be split by workers and employers.

Another proposed fix, called the Social Security 2100 Act, would make a number of changes to the current system, such as changing the formula for COLA to use a Consumer Price Index for the Elderly (versus its current price index for wage earners).

It would also involve setting the new minimum benefit at 25% above the poverty line. Advocates say the result would be like getting a 2% raise of the average benefit.

History of Early Social Security

The need to secure a financial future for ourselves and our loved ones isn’t new — or uniquely American. Across the pond, the English passed a series of “Poor Laws” around 1600 intended to ensure that the state provided for the welfare of its poorest citizens.

Americans were quick to embrace the idea that the country should take care of its people, but at first it wasn’t society at large. In 1862, for example, a post Civil War-era program offered pensions to disabled Civil War soldiers, and widows and children of the deceased.

Around the late 1800s, some private companies were starting to offer pension plans too. The first company to offer a real pension plan was the Alfred Dolge Company, which made pianos and organs. They took 1% of an employee’s salary and put it into a pension plan, and then added 6% interest per year.

In 1935, President Franklin D. Roosevelt signed into law the Social Security Act. The government then started collecting Social Security taxes two years later. Then on January 31, 1940, the first monthly retirement check of $22.54 was issued to Ida May Fuller in Ludlow, Vermont.

This Isn’t the First Social Security Shortfall

The retirement en masse of America’s Baby Boomers and parallel decline in birth rate is taking the blame for Social Security’s current problems. But this isn’t the first time the fund has been in trouble.

When the program first began phasing in, for example, workers were contributing but no one was retiring yet, so the fund grew a nice little surplus. Congress, seeing those nice big numbers, were generous with increasing benefits every time they had the chance.

When the 1970s rolled around, however, and those workers reached retirement age, that upward momentum came to a screeching halt. On top of that, a flaw in the program’s COLA formula caused benefits to double-index, or increase at twice the rate of inflation rather than matching it.

It became such a mess that task forces were created, the error got its own name “The Notch Issue,” and instead of making changes to Social Security during even years, because increases and expansions were good for election campaigns, Congress made changes on odd-numbered years.

Social Security Amendments of 1983

Amendments in 1983 addressed the financing problems to the Social Security system. These changes were the last major ones to the program and were based on recommendations from a commission chaired by Alan Greenspan.

The Greenspan Commission adjusted benefits and taxes. The resulting reforms have generated surpluses and the buildup of a trust fund. However, many experts project that the retirement of the baby boomers, along with other demographic factors, will exhaust the trust.

What Can I Do About Social Security?

The SSA allows contributors to keep track of their Social Security accounts online, work with retirement and benefits estimation tools, and even apply for retirement benefits online.

Perhaps the two most important tools in the journey toward retirement are education and planning — knowing where you are, where you want to be, and what you need. Understanding the ins and outs of the ideal retirement age, whether that’s through Social Security or private retirement savings plans, and how to avoid penalties can help form a solid plan.

Aside from government benefits, one of the easiest steps for traditionally employed workers is to take full advantage of their employer’s 401(k) matching plans. These are programs in which the employer can match what you contribute to the 401(k).

If your employer doesn’t offer a 401(k) or matching plan, consider setting up an IRA or Roth IRA. Regular IRAs are tax-deductible like 401(k)s, meaning you’re not taxed until your withdrawal in retirement. Meanwhile, contributions to Roth IRAs are not tax-deductible, but you can withdraw money tax-free in retirement.

The Takeaway

Without fixes, the cash reserves of the SSA will become depleted and workers who reach full retirement age after 2034 will likely receive a reduced benefit amount.

It can be a scary proposition for some, but knowing that the deadline is approaching is a huge advantage in that members of the workforce who have time to take measures to counter the expected shortfall by saving more and adjusting their financial plans.

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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.
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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.

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.

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

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Jul

2023

Ways to Build Wealth at Any Age

By Ashley Kilroy | Growing Wealth, Investing | No Comments

Whether you want a worry-free retirement or a custom-built home, your financial goals are worthy investments. And building wealth is likely a foundational goal for most people, as it can help them achieve most, if not all of their financial goals.

There are some tried and true ways to save money and build wealth at any age — whether you use those funds for immediate purchases, long-term goals such as retirement, or estate planning for after you’re gone. The key is to start as soon as possible, rather than wait until “the right time.”

Set Short- and Long-Term Goals

The first step in building wealth is to set short and long-term goals you can revisit throughout your journey.

Short-term goals focus on achieving more immediate results, such as funding next summer’s trip or buying a new car. In contrast, long-term goals might require several years or more of preparation. For example, you may want to collect enough to pay off your mortgage or send your kid to college expenses. Creating realistic goals at the start gives you direction, so make them as specific as possible.

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Create a Budget

Once you know your goals, drafting a monthly budget becomes more manageable. Document up to three months’ worth of expenses and then break the list down into fixed costs, variable costs, necessary costs and discretionary costs. You probably can’t stop paying your utilities, but you will likely find places to save in your discretionary category (think restaurant meals, or entertainment expenses). Dedicate a portion of that discretionary spending to your goal’s fund regularly.

Taking stock of your financial situation gives you a clearer understanding of where you are, where you’re going to go, and how you’re going to get there.

Pay Off Debt

To dedicate more money toward building wealth and saving for your goals, you’ll likely need to pay off some debt first. You can use your discretionary income as a tool for minimizing your debt load. If you have multiple debts, consider using a debt repayment method, such as the avalanche method or the snowball method, to accelerate the process.

Debt Repayment: The Avalanche Method

The avalanche method prioritizes high-interest debts by ranking the interest rates from greatest to least. Then, regularly pay the minimum on each of your debts, and put any leftover funds towards the one with the highest interest rate. Once you pay that off, continue on to the second-highest debt. Follow that pattern to minimize the interest you’re paying as you become debt-free.

Debt Repayment: Snowball Method

Alternatively, the snowball method is another debt repayment strategy. It’s essentially the opposite of the avalanche approach. List your debts from smallest principal to largest, ignoring the interest rates. Then, regularly dedicate enough funds to each to avoid penalties, and put any extra money toward the smallest debt.

After the smallest debt is paid, redirect your attention to the next largest debt, and so on. As the number of individual debts shrink, you’ll have more money to apply towards the larger debts. You may still have interests to worry about but picking off the debts one by one can impart a sense of forward movement and accomplishment.

Start Investing

If you haven’t already, find out what if any employer-sponsored retirement savings plans are available to you, such as a 401(k). These qualified retirement plans offer tax advantages and typically allow you to direct a portion of your paycheck to your account, putting your savings on autopilot. If your workplace does not offer any retirement accounts, consider opening an IRA or a brokerage account to build an investment portfolio.

Generally, investing for retirement when you’re young means you can take on more risks. While a diversified portfolio is a standard strategy, younger investors might have a portfolio that’s heavier on equities early, since they may help you capitalize on long-term growth. As you get older and closer to retirement, your risk profile may change and your portfolio will need a rebalancing to incorporate more fixed-income investments.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

How to Increase Your Income and Save More

You might be getting by on your current income, but if you had the chance to boost it, wouldn’t you? With an extra-positive cash flow, you could tackle debt, save more, and achieve your goals sooner. Here are a few ways to make that happen.

Ask for a Raise

Asking for a salary increase is one solution for improving your cash flow. All it takes is one good conversation, a positive work record — and a bit of courage and confidence. Speak to your peers and read up on how to conduct yourself when asking. Going in with a plan will save you anxiety and help you get your points across clearly.

Seek Other Investment Opportunities

When investment opportunities pop up, take advantage of the ones that speak to you whenever possible. Some may be easier to break into, like real estate, one of the world’s largest asset classes. Other options include gold and silver, which you can invest in physically or through ETFs. For investors willing to take on a higher-risk opportunity, investing in startups may be appealing. It all comes down to what investment will best serve your personal short- and long-term goals.

Start a Side Gig

Additional work is also great to bulk up your resume and create new connections. It seems like everyone is starting up a side hustle these days. From online shops to freelancing, the opportunities are endless. All you have to do is determine your marketable skills and how to advertise them. There might be local opportunities, or you can create a profile online on side hustle-oriented websites.

Cut Expenses

Sometimes it’s not about finding new currents of money, but about creating a larger pool with the money already coming in. Take a second pass at your list of discretionary expenses to pinpoint a few more areas you could cut back on without feeling the impact in your day-to-day life.

One good example: Automatically renewed subscriptions for streaming services and local businesses, like gyms, are convenient. But think about how frequently you use the service. If the answer is “not often,” you’re not getting your money’s worth — and you may want to negotiate a lower fee, or cut the subscription altogether.

How to Build Wealth at Every Stage of Life

While it’s good to have a general strategy in place for building wealth and increasing cash flow, different stages in your life may require you to focus on different things. Taking advantage of the opportunities each decade brings you will help you financially adjust and build a stable lifestyle.

In Your 20s

You may be right out of school and trying to navigate the job market, but don’t wait to start working towards your long-term financial goals. The sooner you start, the sooner you’re likely to reach your goals.

Create an Emergency Fund

Generally, an emergency fund should include about three to six months’ worth of living expenses. Although that sounds like a lot, you’ll be grateful for the cushion if you should lose your job, or crash your car, or have a medical emergency. Unexpected things happen all the time, and an emergency fund will protect you while you get things back up and running. It will also keep you from having to touch other savings accounts, like a retirement account.

Eliminate High-Interest Debt

Your student loans aren’t going anywhere, so pay them off as soon as possible. The same goes for any other high-interest debt you might have incurred, such as with a credit card. Paying off growing interest rates will bog down your ability to save.

However, don’t be afraid to use your credit cards. Your 20s are the perfect time to build credit, which will be vital to certain goals, like purchasing a house. Use them strategically and pay them off immediately to build an upstanding credit history.

In Your 30s

Your 30s may bring some stability into your life, whether it’s regular work, a partner, and/or kids. However, the costs you’re facing are likely growing with you. Focus on money moves that will benefit you long-term.

Plan for College Expenses

If you have children, saving for their education is a big step. Use opportunities like a 529 account to help provide the funding. A 529 plan is a tax-advantaged savings plan you can use to pay for future tuition and related costs. That said, many people who’ve been there, and done that, may advise against prioritizing your kids’ education over your retirement.

Pad the Nest Egg

By some popular estimates, by age 30 you should have at least one year’s worth of your annual salary saved for your retirement — and twice that by 35. Incrementally increasing the amount you put towards your savings will help boost that number as well.

In Your 40s and Beyond

By 40, conventional wisdom holds that you should be well on your way to a growing nest egg with three times your annual salary saved up. At this stage, you may also have other assets to your name, such as property. If you have kids, they might be nearing college age, and retirement might not seem quite as far away as it once did.

Protect Your Wealth

It’s always smart to protect your assets and yourself. Make sure you have insurance covering both your estate and yourself (through health and life insurance). Insurance can take a burden off of your family’s shoulders in case anything happens to you.

Capitalize on Make-Up Contributions

A make-up, or catch-up, contribution, is an additional payment that anyone over age 50 can make to their 401(k) or IRAs retirement savings account. If you’re in a financial position to contribute these extra funds, it can help bulk up those savings to help prepare for retirement.

For 2023, the maximum allowable catch-up contribution to 401(k) plans is $7,500. The IRA annual contribution limit for 2023 is $6,500, with those 50 and above allowed to contribute another $1,000 a year. In total, anyone over 50 can put $7,500 into their IRA annually.

Wait to Take Social Security

Did you know you could receive a higher Social Security benefit if you wait to claim your benefits? Those who hold off collecting Social Security until age 67 get 108% of their benefits, and those who wait until the age of 70 can receive 132% of their monthly benefit. On the other hand, if you begin taking benefits early, at age 62, you’ll receive 25% less in monthly benefits.

Shift Your Asset Allocation

Investors should periodically revisit their portfolio and reassess their investments and risk level. As you get closer to retirement, you may decide to allocate a larger part of your portfolio to safer choices like bonds and other fixed-income.

The Takeaway

Building wealth at any age starts with a frank look at your current income and expenditures, a detailed list of short-term and long-range goals — and a little follow-through based on where you are in life.

Some ways to start building wealth are to take on a side gig or side hustle, find ways to cut expenses and increase savings rates, and to start investing. There are numerous ways to do any of these, and it may take some experimenting to see what works for you.

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Jul

2023

What Is the Federal Reserve?

By Amanda Holden | invest, Investing, Terminology | No Comments

The Federal Reserve is the U.S. central bank system. The Fed implements monetary policy in order to stabilize the economy, monitor interest rates, and keep unemployment low. It is the most powerful economic institution in the country, and one of the most important in the world.

You’ve probably heard a lot about the Fed thanks to higher-than-normal inflation in 2022 and 2023. Notably, the Fed raised interest rates rapidly in these two years, using a series of small increases designed to tamp down inflation.

The Federal Reserve System does far more than manage inflationary pressures, however. That’s just a start.

Why Was the Federal Reserve Created?

Throughout the 19th century, there was no central bank in the U.S., and the banking system was fraught with bank failures and “bank runs,” where depositors would rush to banks to withdraw all of their money. To create a safer and more stable bank system, President Woodrow Wilson signed the 1913 Federal Reserve Act.

The Fed is actually an intricate system that consists of several different parts. These are the three bodies of the Fed:

The Federal Reserve Board of Governors

There are seven Federal Reserve board members that oversee the Federal Reserve System. This includes the chairman and vice chairman. Jerome Powell has been chair of the Fed since 2018. Before him, the chairman of the Federal Reserve was Janet Yellen.

The Board of Governors, which is made up of seven governors, is based in D.C. and reports to Congress. Board members are appointed by the U.S. president and serve staggered 14-year terms (so the entire board isn’t replaced in a single year). The chairman and vice chairman serve four-year terms and may be reappointed at the end of their term.

Federal Reserve Branches

There are 12 Federal Reserve districts in major cities throughout the country that act as the operating arms of the Federal Reserve.

You wouldn’t walk into a Federal Reserve bank and open up a checking account, though. Rather, Federal Reserve banks work with other institutions, such as banks and credit unions, and the U.S. Treasury. They provide services like holding deposits for banks, processing payments, and issuing and redeeming government securities.

The Federal Open Market Committee (FOMC)

The committee comprises all members of the Board of Governors and five rotating Reserve Bank presidents. Although not all Reserve Bank presidents vote, all participate in policy discussions.

The FOMC meets eight times a year to review economic trends and vote on new monetary policy measures. During these meetings, the committee will set a federal funds rate. The FOMC may also take steps to control the money supply.

What Does the Federal Reserve Do?

The Federal Reserve has several primary functions:

Setting Monetary Policy

One of the primary roles of the FOMC is to set monetary policy. With monetary policy, there are typically two primary goals: Maximum employment and stable inflation.

Often, we hear about monetary policy in terms of the setting of the federal funds rate. This is the rate at which banks charge each other on an overnight basis.

A bank might need to borrow money from another bank in order to meet the Fed’s minimum reserve requirement, or how much cash the bank has available in its reserves.

Recommended: What Is Fractional Reserve Banking?

The federal funds rate as set by the FOMC may influence other interest rates. In this way, the federal funds rate can be used as a tool to encourage or restrict borrowing. For example, the Fed may attempt to fight inflation by raising the federal funds rate. Conversely, the Fed may lower that same rate in an attempt to ward off a recession.

But this isn’t the only monetary policy that the FOMC is engaged in. According to the Federal Reserve, its main tool for controlling the money supply is “open market operations,” which is the buying and selling of government securities, like treasury bills. They may do this in conjunction with a rate change or other strategies.

Regulating Banks

To ensure the safety and solvency of the nation’s banking and financial system, the Fed regulates banks and other financial services institutions. This is done not only for the protection of the consumer but to promote stability within the banking system.

The Board of Governors typically sets guidelines for member banks through policy regulation and supervision. The Reserve Banks then examine member banks to ensure that they comply with existing laws and regulations. Often, new guidelines are created because of legislation that has been passed through Congress.

Overseeing Payment Systems

The Fed provides financial services to the U.S. government, major financial institutions, and foreign official institutions. The Fed acts as the depository institution for the U.S. Treasury — essentially, the Treasury’s checking account.

The Fed also plays a major role in operating and overseeing the nation’s payment systems. In addition to making sure there is enough currency in circulation, the Fed clears millions of checks and processes electronic payments. Social Security checks and the payrolls of government institutions are processed by the Fed.

Limiting Risk

At the end of the day, the Federal Reserve wants to control risks to the economy and financial markets (such as the stock market) as best they can. They utilize a number of measures, including those discussed above, in order to best achieve this stability.

How Does the Federal Reserve Affect You?

Although you might not always feel it, the Federal Reserve enacts policies and makes decisions that affect the lives of everyday Americans.

Although the Fed does not set rates like mortgage rates and credit card interest rates, those rates can shift as the Fed Funds rate does.

An increase or decrease in interest rates can affect consumers in plenty of ways. If overall rates increase, then it becomes more expensive to be a borrower. Variable interest rates may rise, and any new debt will be issued at higher rates.

The rates at which money is flowing freely throughout an economy may also have rippling impacts. For example, when rates are low and access to money is cheap, businesses may borrow money in order to invest in development or expand operations. If there is too much money in circulation, inflation may increase. This could cause the prices of everyday goods, like groceries, to increase as well.

The Takeaway

One of the Fed’s goals is an economy with full employment. If they are not able to succeed using the tools at their disposal, people may lose jobs, and unemployment may increase. This could also have effects throughout the greater economy, such as decreased consumer spending and overall slowed economic growth.

Keeping an eye on what the Fed does and why they’re doing it can provide valuable information for investors. Issues like unemployment and inflation can affect the markets, which in turn can have an impact on your financial plans.

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

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.

SOIN0523104

Jul

2023

How to Open a Brokerage Account

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

When you open a brokerage account with a brokerage firm, you transfer money into the account that you can use to start investing. While some brokerage accounts may set an account minimum, there is typically no limit to how much you can deposit or when you can withdraw your money.

With a brokerage account, investors can invest in a variety of securities, including stocks, bonds, ETFs, and more. There are many brokerages, but the steps to open a brokerage account are similar among most of them.

How Do I Open a Brokerage Account?

There are a few simple steps to opening a brokerage account. We’ll dive deep into each one below.

1. Choose a brokerage provider.

2. Sign up for an account.

3. Transfer money.

4. Start trading.

Step 1: Choose a Brokerage Provider

There are several types of brokerage accounts, and the type you choose will depend on what you’re trying to accomplish.

• Full-service brokerage firms not only allow clients to trade securities, they may also offer financial consulting and other services—though the price may be steep, compared to the other options here.

• Discount brokerage firms typically charge lower fees than full-service, but as a result clients don’t have access to additional financial consulting or planning services.

• Online brokerage firms are typically online-only, allowing clients to sign up, transfer money, and make trades through their website. These firms typically offer the lowest fees.

The accounts above are known as cash accounts: You must buy securities with funds you put in your account ahead of time. You may also encounter other more complicated types of brokerage accounts known as margin accounts, which allow you to borrow money from your brokerage to make investments, using your case account as collateral. These accounts tend to be for sophisticated investors willing to shoulder the risk that investments bought with borrowed funds will lose value.

Before working with an individual investment advisor or a firm and opening a cash or margin account, it can be a good idea to run a check on their background. The Financial Industry Regulatory Authority (FINRA) offers online broker checks where you can enter a broker’s name, or the name of a firm, to learn whether a broker is registered to sell securities, offer investment advice, or both. And you can learn about a broker’s employment history, regulatory actions, and whether there are past or current arbitrations and complaints.

Step 2: Sign Up for a Brokerage Account

Most brokers of all kinds allow you to open and access your brokerage account online. When you open the account, you will likely be asked to provide your Social Security number or taxpayer identification number, your address, date of birth, driver’s license or passport information, employment status, annual income and net worth. You may also be asked about your investment goals and risk tolerance.

For the most part, they should not charge you a fee for opening an account. While some may require account minimums, others allow you to open an account with no minimum deposit.

There is no limit on the number of brokerage accounts you can open, and you may be able to hold multiple accounts with multiple brokerage firms.

Step 3: Transfer Money

You will need to fund your new brokerage account before you can purchase any types of securities. You can deposit money in a brokerage account like you would in a traditional bank account.

Step 4: Start Trading

Many brokerage firms will offer a way for you to earn interest on uninvested funds so that your money continues to work for you even when not invested in the market.

💡 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.

How Do Brokerage Accounts Work?

The brokerage firm with which you hold your account maintains the account and acts as the custodian for the assets you hold. In other words, the custodian provides a space for investors to use their account in the way that it was intended.

However, you own the investments in the account and can buy and sell them as you wish. The brokerage firm acts as a middleman between you and the markets, matching you with buyers and sellers, and executing trades based on your instructions.

For example, if you place an order with your brokerage to buy a certain number of shares of stock, the brokerage will match you with a seller looking to sell those shares and make the trade for you.

What’s the Difference Between Brokerage Accounts and Retirement Accounts?

Brokerage accounts are also known as taxable accounts, because profits on sales of securities inside the account are potentially subject to capital gains taxes. Generally speaking, these accounts offer no tax advantages for investors.

Retirement accounts, on the other hand, offer a number of tax advantages that may make them preferable to taxable accounts if you’re planning to save for retirement. Retirement accounts place limits on how much money you can contribute and when you can withdraw funds.

If retirement planning is your main concern, you may consider saving as much as you can in both a 401(k) if your employer offers one, and a traditional or Roth IRA. If you have funds left over, you may choose to invest those in your taxable brokerage account.

💡 Quick Tip: How much does it cost to set up an IRA? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

Is My Money Safe in a Brokerage Account?

The money and securities held in a brokerage account are insured by the Securities Investor Protection Corporation (SIPC) . The SIPC protects against the loss of cash and securities held at failing brokerage firms. If your brokerage firm goes bankrupt, the SIPC covers $500,000 worth of losses, including $250,000 in cash losses.

The SIPC only provides protection for the custody function of a brokerage firm. In other words, they work to restore the cash and securities that were in a customer’s account when the brokerage started its liquidation proceedings. The organization does not protect against declines in value of the securities you hold, nor does it protect against receiving and acting upon bad investment advice.

It is important that any investor realizes and accepts that investment comes with a certain amount of risk. While security prices may gain in value, it is also possible that you could lose some or all of your investment.

The Takeaway

Opening a brokerage account is a simple process that allows you to invest in securities. Effectively, you’re depositing money at a brokerage, which will allow you to buy investments such as stocks, bonds, or ETFs. There are numerous brokerages out there, and different types of brokerage accounts.

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

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

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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Jul

2023

A Guide to Delta Neutral Trading Strategies

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing | Comments Off

The typical options investor is trying to leverage options trading to speculate on directional moves in the prices of underlying assets. However, there are more sophisticated traders who would like to profit from other characteristics of options.

To pursue these trading strategies, investors need to minimize the effect of price changes and create portfolios that profit from and are more sensitive to these other factors. Delta neutral approaches allow investors to create these portfolios.

What Is Delta?

Delta is one of the Option Greeks and measures how much an option will change in price, given a $1 change in the price of the underlying asset. By definition, the delta of the underlying asset is always 1.

What Does Delta Neutral Mean?

Delta neutral means that a position’s value will not change when there are small market price changes. By holding a combination of assets and options, or combinations of various call and put options, a trader can create a portfolio with an overall delta of zero (in actual practice, very close to zero).

Traders use delta neutral strategies to minimize the effect of price changes while aiming to profit from shifts in implied volatility, the time decay of options, or simply to hedge against price movements.

How Does Delta Neutral Function?

A portfolio’s overall delta is determined by the sum of the deltas of its individual positions. Let’s take a closer look at the delta in options and securities.

Basic Mechanics

A trader holding shares (“going long”) benefits one-for-one from increases in the stock price. The delta for long shares is 1.

Investors short a stock will experience losses one-for-one as the share price rises, but they will benefit in the same amount when it falls. The delta for short shares is -1.

In the options trading world, a long call option has a delta of 0 to 1, while a long put option has a delta of –1 to 0.

Deep in the money long call options are most likely to feature a delta near 1. Deep out of the money long call options will have a delta near 0. At the money long call options typically have a delta near 0.5.

Deep in the money long put options typically have deltas near -1. Deep out of the money long puts have deltas near 0 and at the money long puts have deltas near -0.5.

Deltas values are for each individual security held and need to be adjusted based on your actual holdings. If you own 200 shares of stock, the delta for this position is 200. If you own an at the money call options contract, the delta for this position would be 100 x 0.5 or 50 due to options representing 100 shares of the underlying asset.

If you are writing (“going short”) options, the deltas values are reversed. If you write a call option with a delta of 0.75, then the delta for the position would be -75. Similarly, the delta for shares sold short is -1 per share.

The investor must also be aware that any delta neutral portfolio will only be neutral over a range of asset prices. An option’s delta is always in flux as it moves in and out of the money. A portfolio must be constantly adjusted to maintain delta neutrality – many delta neutral trades must be executed.

An Example of Delta-Neutral in Use

A trader might employ a delta neutral trading strategy when they are long shares of stock but are concerned about a near-term pullback in its price. Assume the trader owns 100 shares of XYZ stock at $100 per share. A long stock position has a delta of 1. Multiplied by 100 shares, the position has a total delta of 100.

The goal of a delta neutral strategy is to use a combination of calls and puts to bring the portfolio’s net delta to 0. One possibility is to purchase at the money put options that have a delta of -0.5. Two of these put option contracts have a total delta of -100 (-0.5 multiplied by 200 options). Recall that an options contract represents 100 shares of stock.

Here, the $100 strike is the delta neutral strike. As the underlying price moves away from $100, the delta of the portfolio will move.

Combining the deltas of 100 shares together with 2 long put option contracts with a -0.5 delta yields a delta neutral portfolio.

Stock position delta = 100 shares x delta of 1 = 100

Long put position delta = 2 contracts x 100 shares/option x delta of -0.5 = -100

Portfolio delta = stock position delta + long put position delta

Portfolio delta = 100 + -100 = 0 or delta neutral

The net position is protected from losses by being long put options while still having exposure to upside from the long stock position. Of course, there is a cost to purchasing put options.

A diagram might help illustrate what is delta neutral.

Profit & Loss Diagram Using the Above Example (Not Including the Put Option Cost)

Profiting From Delta-Neutral Trading

It is possible to profit from changes other than price movements in the underlying stock. For example, an options trader can use delta neutral strategies to benefit from declining or rising volatility. Vega is the Options Greek that tells a trader how much the price of an option will move in response to changes in volatility.

Delta neutral strategies can also be used to profit from time decay or – as in the earlier example – to hedge an existing long stock position. Writing options allows you to benefit from the effect of time decay, but there is a risk of assignment. If the underlying stock price moves significantly, the contracts could be assigned to you.

Shorting Vega

Shorting vega is a more advanced options trading strategy. A delta neutral approach can be used to benefit from collapsing volatility.

You might look to short volatility after a period of extreme movements in the market or a single stock. The key is to short vega when implied volatility is still high and you expect it to come back down.

When implied volatility is high, you pay a significant premium to be long options. You can take advantage of expensive options when implied volatility is high by selling options while still being delta neutral. The risk is that implied volatility levels continue to jump, which can lead to losses on a short vega play.

Waiting for Collapse in Volatility

A short vega position relies on the implied volatility on the underlying security to drop in order to turn a profit. It might take patience for implied volatility to drop to historical norms. To remain delta neutral, other positions might have to be put on to mitigate the risk of a change in the underlying stock price.

Pros and Cons of Delta Neutral Positions

Some of the pros of crafting a delta neutral portfolio have been highlighted, but there are downsides as well. Having to closely monitor your portfolio can be a burden, while trading costs mount as you constantly layer on or reduce hedges to keep near delta neutral.

Pros	Cons
Profit from variables other than the price movement of the underlying asset	Requires frequent trades, which could be costly, to maintain a delta near 0
Traders hold stock for the long run while protecting against near-term declines	Deltas are constantly changing resulting in being over- or under-hedged

Delta Neutral Straddle

A delta neutral straddle uses a combination of puts and calls to keep the position’s delta near zero while having exposure to volatility changes.

For example, if XYZ stock trades at $100, and it’s at the money call has a delta of 0.5 and it’s at the money put has a delta of -0.5, you can buy the put and call with the goal of selling them after implied volatility jumps. With this delta neutral long straddle strategy, your delta is effectively 0 but you are long volatility.

A delta neutral short straddle is an options trade that seeks to profit from minimal changes in the underlying stock price and a large drop in implied volatility. So, the reverse of a long straddle can be used when you believe implied volatility will drop.

Other options trading strategies used to profit from changes in volatility and time decay are calendar spreads, diagonal spreads, iron butterflies, iron condors, among others.

The Takeaway

Building and maintaining a delta neutral portfolio can be a challenging task, but profiting from time decay and changes in volatility can make it worthwhile and profitable.

Delta neutral trading can also hedge your portfolio from short-term declines while continuing to hold stock for the long-term.

Qualified investors who are ready to try their hand at options trading, despite the risks involved, might consider checking out SoFi’s options trading platform. The platform’s user-friendly design allows investors to trade through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors.

With SoFi, user-friendly options trading is finally here.

FAQ

How do you make money with a delta neutral strategy?

You profit from a delta neutral option strategy when there are changes in a stock’s variables other than its share price. Changes in implied volatility create opportunities to go long or short volatility while being agnostic to the stock price’s change. You can also benefit from time decay by selling options while being delta neutral.

What is a delta neutral strike?

A delta neutral strike marks the price at which a portfolio is precisely delta neutral. In practice, it is more of a theoretical price rather than an exact level. When the underlying asset price moves up or down from the delta neutral strike, its delta will stray from zero; it will take additional hedging trades to get back to delta neutral.

How can you calculate the value of your delta neutral position?

To calculate your position’s delta, simply multiply each security’s delta by your position size. For example, one call option contract with a delta of 0.75 has a delta of 75 (0.75 x 100 options per contract). While being long 100 shares of stock with a delta of 1 has a delta of 100 (1 x 100 shares).

You combine the deltas of all positions in your portfolio to determine your overall delta. At that point, you can trade options to make your portfolio delta neutral.

Photo credit: iStock/Delmaine Donson

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.

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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