Investing is a powerful tool that allows you to put your money to work to help you reach future financial goals. But if you’re new to investing, you may be asking yourself what investment strategies should you pursue?
Here’s a guide to help you get started.
5 Popular Investment Strategies for Beginners
1. Asset Allocation
Once you’ve opened an investment account and you begin to build your portfolio, asset allocation is an important strategy to consider to help you balance potential risk and rewards. A typical portfolio might divide its assets among three main asset classes: stocks, bonds, and cash. Each asset class has its own risk and return profile, behaving a little bit differently under different market circumstances.
For example, stocks tend to offer the highest gains, but they are also the most volatile, presenting the most potential for losses. Bonds are generally considered to be less risky than stocks, while cash is typically more stable.
The proportion of each asset class you hold will depend on your goals, time horizon, and risk tolerance. Your goal is how much you aim to save. Your time horizon is the length of time you have before reaching your goals. And your risk tolerance is how much risk you’re willing to take to achieve your goals.
Your asset allocation can shift over time. For example, someone in their 30s saving for retirement has a long time horizon and may have a higher risk tolerance. As a result their portfolio may contain mostly stocks. As that person grows older and nears retirement, their portfolio may shift to contain more bonds and cash, which are typically less risky and less likely to lose value in the short-term.
💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.
2. Diversification
Another way to help manage risk in your portfolio is through diversification, building a portfolio with a mix of investments across assets to avoid putting all your eggs in one basket.
Here’s how it works: Imagine you had a portfolio consisting of stock from one company. If that stock does poorly your entire portfolio suffers.
Now imagine a portfolio consisting of many stocks, from companies of all sizes and sectors. Not only that, it also holds other investments, including bonds. If one stock suffers, it will have a much smaller effect on your overall portfolio, spreading out the risk of holding any one investment.
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3. Rebalancing
Your portfolio can change over time, shifting your assets allocation and diversification. For example, if there is a bull market and stocks outperform, you may discover that you now hold a greater portion of your portfolio in stocks than you had intended.
At this point, you may need to rebalance your portfolio to bring it back in line with your goals, time horizon, and risk tolerance. In the example above, you might decide to sell some stock or buy more bonds, for instance.
4. Buy and Hold Strategy for Investing
Market fluctuations are a natural part of the market cycle. However, investors may get nervous and be tempted to sell when prices drop. When they do, investors might lock in their losses and miss out on subsequent market rebounds.
Investors practicing buy-and-hold strategies tend to buy investments and hang on to them over the long term, regardless of short-term movements in the market. Doing so may help curb the tendency to panic sell, and it might also help minimize fees associated with trading.
Buy and hold might also affect an investor’s taxes. Holding a long-term investment vs. short-term one can make a big difference in terms of how much an individual pays in taxes.
If you profit from an investment after owning it for at least a year, it’s a long-term capital gain. Less than that is short-term. Capital gains tax rates can change, but generally, longer-term investments are taxed at a lower rate than short-term ones.
💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
5. Dollar-Cost Averaging
Dollar-cost averaging is a strategy in which individuals invest on a regular basis by making fixed investments on a regular schedule regardless of price.
For example, say an investor wants to invest $1,000 every quarter in an exchange-traded fund (ETF) that tracks the S&P 500. Each quarter, the price of that fund will likely vary — sometimes it will be up, sometimes it will be down. The amount of money the individual invests remains the same, so they are buying fewer shares when prices are high, and more shares when prices are low.
This strategy can help individuals avoid emotional investing. It’s also straightforward and can help investors stick to a plan, rather than trying to time the market.
The Takeaway
Investing is an ongoing process. Your life, goals, and financial needs will all change as your circumstances do. For example, may you get a raise at work, get married and have a child, or decide to retire early. Factors like these will change how much money you need to save and how you invest. Monitor your portfolio and make adjustments as needed.
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.
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.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Participating in a 401(k) through your employer can be a good way to contribute to and save for your retirement. One important thing to know is that there are limits on how much you can contribute each year and the amount typically changes, as per guidelines from the IRS.
Read on to find out about the 401(k) contribution limit for 2023 and 2024.
Overview of 401(k) Contribution Limits
The IRS reviews and often adjusts annual 401(k) contribution limits. The amount you can contribute to your 401(k) is increasing in 2024.
Changes in Contribution Limits for 2024
In 2024, you can contribute up to $23,000 in your 401(k). If you’re age 50 or older, you can contribute an additional $7,500 to your 401(k) plan for a grand total of $30,500 in annual contributions for 2024.
Yearly Contribution Limits Explained
The IRS reviews the annual contribution limits for 401(k)s, typically in the fall of each year, and adjusts them when necessary to account for inflation. The IRS changed the yearly 401(k) contribution limits (also known as elective deferral limits) for 2023 and 2024.
2023 Contribution Limits
For 2023, you can contribute up to $22,500 to your 401(k). Those age 50 and up may contribute additional catch-up contributions of $7,500 — for a total contribution limit of $30,000.
2024 Contribution Limits
For 2024, the IRS is raising the 401(k) contribution limit once again. You may contribute up to $23,000 to your 401(k) in 2024. However, the catch-up contribution limit for older employees is not changing in 2024; instead it will remain at the 2023 level. That means those age 50 and up may contribute an additional $7,500 to their 401(k) for 2024, for a total of $30,500.
💡 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.
Employer Contributions and Catch-Up Provisions
One of the factors that makes a 401(k) a good vehicle for saving for retirement is that an employer may also contribute to the plan on your behalf.
And for older employees, the opportunity to make catch-up contributions to help save for retirement can be especially helpful.
Understanding Employer Match Limits
Your employer can make matching contributions to your 401(k) in addition to the funds you contribute. Matching funds may be based on the amount you choose to contribute.
For example, your employer might offer matching funds if you contribute 5% or more of your salary, as an incentive to get you to save. It’s a good idea to save at least the minimum amount to receive an employer’s match. If you don’t, you could be giving up free money.
There is an overall limit on how much you and your employer can contribute to your 401(k) plan each year. The combined limit for employer plus employee contributions in 2023 cannot exceed 100% of your income or is $66,000, whichever is lower. The 2024 combined limit is 100% of your income or $69,000, whichever is lower.
Catch-Up Contributions for Older Investors
If you are over the age of 50, your retirement contribution limit increases. The 401(k) catch-up contribution lets you fill in gaps in your retirement savings as you get closer to retirement. In 2023 and 2024, you can make up to $7,500 in catch-up contributions.
Roth 401(k) vs Traditional 401(k) Limits
In addition to traditional 401(k)s, there are other types of employer-sponsored retirement accounts, such as a Roth 401(k). The main difference between a traditional 401(k) and a Roth 401(k) is that contributions to a Roth 401(k) are made after-tax, while contributions to a traditional 401(k) are made with pre-tax dollars. Money grows inside a Roth 401(k) account tax-free and is not subject to income tax when you withdraw it.
Like a traditional 401(k), a Roth 401(k) has contribution limits.
Understanding Roth 401(k) Limits
Employee contribution limits for Roth 401(k)s are $22,500 for 2023, and $23,000 for 2024, the same as traditional 401(k)s. Roth 401(k) catch-up contribution limits for those 50 and up are $7,500 in 2022 and 2023 — also the same as catch-up contribution limits for traditional 401(k)s.
Comparing Traditional 401(k) Limits
Here’s a side-by-side comparison of traditional 401(k) contribution limits for 2023 and 2024.
Traditional 401(k)
2023
2024
Employee contribution limit
$22,500
$23,000
Catch-up contribution limit
$7,500
$7,500
Combined employee and employer contribution limit
$66,000
$69,000
Managing Multiple 401(k) Plans
You may have multiple 401(k) plans, including some with previous employers. In that case, the same yearly contribution limits still apply.
Contribution Limits with Multiple Employers
Even if you have 401(k) plans with multiple employers, you must abide by the same annual contribution limits across all your plans. So, for 2023, the maximum you can contribute to all your 401(k) plans is $22,500, and for 2024, the maximum amount you can contribute is $23,000. You can split these total amounts across the different plans, or contribute them to just one plan.
After-Tax 401(k) Contribution Rules
Some 401(k) plans allow for after-tax contributions. What this means is that as long as you haven’t reached the maximum combined limit of your plan — which is $66,000 in 2023 — you can make after-tax contributions up to the maximum combined limit.
For instance, if you contribute $22,500 to your 401(k) in 2023, and your employer contributes $5,000 through an employer match, you can contribute an additional $38,500 in after-tax dollars, if your plan allows it, to reach the $66,000 maximum.
Excess Contributions and Their Implications
Figuring out how much you want to contribute to your 401(k) can be tricky. And you’re not allowed to go over the contribution limits or you may face penalties.
Handling Over-Contribution
If you contribute too much to your 401(k), you could be charged a 10% fine. You might also owe income tax on the excess amount.
Fortunately, many 401(k) plans have automatic cut-offs in place to help you avoid excess contributions. However, if you change jobs or you have more than one 401(k) plan, you might accidentally contribute too much. If you realize you’ve done this, you have until April 15 to request that the excess contributions be returned to you, along with any earnings those contributions made while they were in your 401(k). You can report excess contributions when you file your taxes using form 1099-R.
Strategies to Avoid Excess Contributions
To avoid making excess 401(k) contributions:
• Check the maximum contribution limits each year.
• If you get a raise, reassess your contribution amount to make sure you’re not exceeding it.
• If you have more than one 401(k) plan, review your contributions across all of your plans to make sure you’re not exceeding the maximum contribution limits.
Maximizing Your 401(k) Contributions
When you have a 401(k), you’ll want to get the most out of it to help you save for retirement. Here’s how.
Ideal Contribution Strategies
To maximize your 401(k):
• Start contributing to the plan as soon as you can. The earlier you start saving, the more time your money has to grow.
• Contribute at least enough to get the employer match on your 401(k). If you don’t, you are essentially passing up free money.
• Keep track of all your 401(k) plans to make sure you don‘t exceed the annual contribution limits. And if you have a 401(k) from a previous employer, you might want to do a 401(k) rollover to potentially get more out of the plan.
Balancing 401(k) with Other Retirement Plans
Along with your 401(k), you can open other types of retirement accounts to help you save for your golden years. For instance, consider opening a traditional IRA or a Roth IRA, which are both tax-advantaged plans. You can save up to $6,500 in 2023 (and $7,000 in 2024) in a traditional or Roth IRA, plus an extra $1,000 each year if you are over age 50 — and that’s in addition to what you can save in your 401(k).
Having more than one type of retirement plan could potentially help you reach your financial goals faster. Not only can you put away more money for your retirement, an IRA typically gives you more investing options that a 401(k) does, making it more flexible. It can also assist you with diversifying your portfolio to help manage risk and potentially help grow your retirement savings.
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
What is the maximum 401(k) contribution for 2023?
The maximum 401(k) contribution limit for 2023 is $22,500. Those aged 50 and up may contribute an additional $7,500 in 2023.
Are 401(k) contribution limits changing in 2024?
Yes, 401(k) contribution limits are changing in 2024. The 401(k) contribution limit in 2024 is $23,000. Individuals who are 50 and older can contribute an additional $7,500 to their 401(k) in 2024.
Can I contribute 100% of my salary to a 401(k)?
If you make less than $23,000 annually, you may be able to contribute 100% of your salary to a 401(k). However, your specific 401(k) plan may limit the amount you can contribute.
You should also note that there is an overall limit on how much you and your employer can contribute to your 401(k) plan each year. The combined limit for employer plus employee contribution in 2023 cannot exceed 100% of your income or is $66,000, whichever is lower. The 2024 combined limit is 100% of your income or $69,000, whichever is lower.
Is there a salary cap for 401(k) contributions?
Yes, there are income limit rules for 401(k) contributions. The amount of compensation eligible for 401(k) contributions in 2023 is $330,000. Anything above that amount of compensation is not eligible for contribution. What this means is that while you can contribute up to the maximum employee contribution, which is $22,500 in 2023, your employer can only match up to the income limit.
What happens if I exceed the 401(k) max?
If you contribute too much to your 401(k), you could be charged a 10% penalty. You might also owe income tax on the excess amount. If you realize you’ve exceeded the 401(k) maximum, you have until April 15 to request that the excess contributions be returned to you, along with any earnings the contributions made while they were in your 401(k). You can report excess contributions on form 1099-R when you file your taxes.
How much can I contribute to a 401(k) if I’m 50 years of age or older?
If you are 50 or older, you can contribute up to $30,000 in your 401(k) in 2023, and up to $30,500 in 2024. This includes an additional $7,500 each year in catch-up contributions.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
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.
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.
If you’re like many people who are socking away money in a 401(k) retirement plan (good work!), you probably know that early withdrawal of funds can take a financial toll. There are penalties that can be assessed, decreasing what you actually receive of those funds you saved.
But sometimes, life happens. Even though a 401(k) account is designed for retirement saving, you may need extra cash ASAP before you turn age 59½. Because money in your 401(k) account is not subject to federal income taxes until distribution, your 401(k) can lead to taxes as well as an early withdrawal penalty in this situation. Therefore, it may be worth exploring other options.
To answer the question, “what is the penalty for withdrawing from a 401(k)?” read on. You’ll learn:
• How a 401(k) works
• What is the 401(k) early withdrawal penalty
• How you can access cash without using funds from your 401(k) account.
How Does a 401(k) Work?
A 401(k) is an account designed to hold money and investments for retirement. Why does it have such a funky name? Well, it’s named after a line in the tax code that gives the 401(k) its special taxation guidelines. It can be a reminder that rules regarding 401(k) accounts are set by the IRS and generally have to do with taxation.
Essentially, the IRS allows investors to stash a certain amount of money away each year for retirement, without having to pay income taxes on those contributions.
Currently, that contribution maximum amount is $23,000 per year, with additional catch-up contributions of up to $7,500 allowed for those 50 and older. Additionally, the investments within the account are allowed to grow tax-free.
401(k) participants can’t avoid paying income taxes forever, though. When retirees go to pull out money in retirement, they must pay income taxes on the 401(k) amount withdrawn.
So, while you have to pay income taxes eventually, the idea is that maybe you’ll pay a lower effective tax rate as a retired person than as a working person. (Although, none of this is guaranteed because we can’t predict future tax rates.)
The IRS classifies 59½ as the age where a person can begin withdrawing from their 401(k). Before this age and without an exception, it is not possible to do a 401(k) withdrawal without penalty.
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What is the Penalty for Withdrawing from a 401(k)?
When a 401(k) account holder withdraws money from a 401(k) before age 59½, the IRS may charge a 10% penalty in addition to the ordinary income taxes assessed on the amount.
Unqualified withdrawals from a 401(k) are considered taxable income. Then, the 10% penalty is assessed on top of that. This could result in a hefty penalty.
Is a 401(k) Withdrawal Without Penalty Possible?
There are some exceptions to the 401(k) early withdrawal penalty rule. For example, an exception may be made in such circumstances as:
• A participant has a qualifying event such as a disability or medical expenses and must use 401(k) assets to make payments under a qualified domestic relations order
• Has separated from service during or after the year they reached age 55
• A distribution is made to a beneficiary after the death of the account owner.
Additionally, it may be possible to avoid the 401(k) withdrawal penalty through a method known as the Substantially Equal Periodic Payment (SEPP) rule. These are also called 72(t) distributions.
• To do this, the account owner must agree to withdraw money according to a specific schedule as defined by the IRS.
• The participant must do this for at least five years or until they have reached age 59½.
• Under the 72(t) distribution, a participant will systematically withdraw the total balance of their 401(k). While this is technically an option in some instances, it does mean taking money away from retirement. Consider this while making your ultimate decision.
💡 Quick Tip: In a climate where interest rates are rising, you’re likely better off with a fixed interest rate than a variable rate, even though the variable rate is initially lower. On the flip side, if rates are falling, you may be better off with a variable interest rate.
Alternatives to an Early 401(k) Withdrawal
Because of the steep penalty involved, you may feel inclined to shop around for some alternatives to early 401(k) withdrawal.
Borrowing from Your 401(k)
Participants can consider taking a loan from their active 401(k). The money is removed from the account and charged a rate of interest, which is ultimately paid back into the account. The interest rate is generally one or two points higher than the prime interest rate set by the IRS, but it can vary.
While this loan may come with a competitive interest rate that is repaid to the borrower themself and not a bank, there are some significant downsides.
• First, taking money from a 401(k) account removes that money from being invested in the market. A participant may miss out on the market’s upside and compound returns.
• Though a 401(k) loan might seem like an easy option now, it could put a person’s savings for retirement at risk. It is easy to imagine a scenario where the loan does not get repaid. If the loan is not repaid, the IRS could levy the 10% penalty on the distributed funds.
• Money that is repaid to a 401(k) is done with post-tax money. The money that is borrowed from the 401(k) would have been pre-tax money, so replacing it with money the borrower has already paid taxes on may make a 401(k) loan more expensive than it initially seems.
• If a person were to leave their company before the loan is repaid, the loan would need to be repaid by the time you file your taxes for that year or penalty and income tax could be due. Participants should proceed down this route with caution.
Withdrawing from a Roth IRA
A second option is to consider withdrawing funds from Roth IRA assets. Under IRS rules, any money that is contributed to a Roth IRA can be removed without penalty or taxes after 5 years.
Unlike with a 401(k), income taxes are paid on money that the account holder contributes to the account. Therefore, these funds aren’t taxed when the money is removed. (This only applies to contributions, not investment profits.)
Now, the downside to consider:
• Again, common advice states that removing money from any retirement account should generally be considered a last-resort option. The average person is already behind in saving for retirement, so even Roth IRA funds should only be considered after all other options are exhausted.
Access a Personal Loan
Another option to consider could be a personal loan. An unsecured personal loan can generally be used for any personal reason.
By using a personal loan, the participant is able to avoid a 401(k) early withdrawal penalty and leave all of the money invested within the account to grow uninterrupted.
Some other aspects to consider:
• A personal loan also puts the borrower on an amortized payback schedule that has a defined end-date. Having a defined payback period may be beneficial during debt repayment — it provides a goal, and it is clear how progress is made throughout the life of the loan.
• Compare the set amortization of a personal loan to the revolving debt of a credit card, where it can be quite tempting to add to the balance, even as the person is attempting to pay it off in full.
When charges are added to a credit card, the end-date can be pushed out further, especially in the event that the borrower is only making minimum payments. This is not the case with a personal loan where a lump-sum loan amount is disbursed and paid back within a set timeframe. You may want to consider using a personal loan calculator to compare costs.
The Takeaway
If you withdraw funds from your 401(k) retirement plan before age 59½, you will likely be subject to a 10% early withdrawal penalty as well as taxes. You may have other options available if you need funds, however, such as taking a loan against a 401(k), withdrawing from an IRA account, or securing a personal loan. With all of the above options, it is recommended to map out the cost of each and/or work with a tax advisor or financial advisor to help identify the best course.Ultimately, it will be up to you to research the best option given your needs.
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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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Forex margin trading is when foreign exchange traders borrow money from their brokers in order to make bigger trades than they would otherwise be able to based on their capital position. Like all margin trading, the risks of forex margin trading are higher, but the practice can also produce higher profits.
Traders who engage in forex margin trading are using leverage as part of their investing strategy.
What Is Forex Margin?
Forex margin is similar to the margin trading used in futures markets. Traders deposit money into a margin account as a good faith deposit, which allows them to open, hold and trade forex using leverage (with their account balance as collateral). This lets the traders control trades worth much more than they would otherwise.
Forex (also known as foreign exchange or FX) is a global trading market in which investors trade national currencies. Forex trading is the largest and most liquid market in the world. Currencies trade in what are called “pairs.” For example, the Euro (EUR) versus the United States dollar (USD) appears as the EUR/USD currency pair with the Euro being the base currency and the USD being the term currency.
Traders use the FX market to hedge against foreign currency and interest rate risk. Geopolitical risks are also managed while speculators take part alongside hedgers. The forex market is both a spot (cash) market and a derivatives market. Forwards, futures, currency swaps, and options trade in the FX market.
How Does Forex Margin Work?
Forex margin works by allowing a trader to hold large positions with a relatively small amount of collateral. When you trade with leverage, you amplify risk and return.
While there is no standard amount of margin in the forex market, it is common for traders to post 1% margin, which allows them to trade $100,000 of notional currency for every $1,000 posted.
For example, let’s say you want to trade forex on margin to speculate on the price of the EUR relative to the USD. You must open an FX trading account with a firm that offers this type of trading. Before trading, you must make a deposit into your margin account.
Let’s assume the broker requires 1% margin to trade EUR/USD. You seek to control $50,000 worth of that currency pair, so you post a deposit of $500. After opening the account and posting margin, you execute a buy order on the EUR/USD pair for $50,000 of notional currency at $1.20 per Euro.
If EUR/USD moves from $1.20 to $1.212, that 1% advance moves your position value from $50,000 to $50,500. Your unrealized profit is $500, or 100% of your initial deposit. If EUR/USD declines 1%, you have an unrealized loss of $500. You could face a margin call or a forced liquidation if prices move against you enough.
💡 Quick Tip: One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.
Forex Margin Requirements
Forex margin requirements vary by broker. Variables such as liquidity and volatility impact the amount of margin you need to trade FX. The less liquid the trading environment and the more volatile the currency pair, the higher your margin requirement will generally be. The broker wants you to be able to trade freely but must balance the credit (or default) risk of its customers. Trading with small margin amounts means you have high leverage.
Typical margin requirements range from 50% on the high end to 0.5% on the low end. Those figures correspond to 2:1 leverage and 200:1 leverage, respectively. Knowing your leverage ratio helps you grasp your account’s risk. Brokers determine forex margin requirements based on your credit profile and how much default risk they want to take on.
Forex Margin Terms
You’ll need to understand forex margin terms to navigate this volatile trading arena:
• Equity: Your account balance after adding current profits and subtracting current losses from your cash
• Margin Requirement: Your required deposit to trade with leverage
• Used margin: Margin set aside to keep existing trades active
• Free margin: Available margin to open new positions
• Margin level in forex: A measure of how well funded your account is. Divide your equity by used margin, then multiply that by 100 to find your margin level in forex.
• Leverage: The use of borrowed capital to enhance returns
• Pip: A measurement representing the smallest unit of value in a currency quote. Pip stands for “percentage in point.”
• Spread: The difference between the bid and ask prices
What Is Margin Level in Forex?
Your margin level in forex is the ratio between equity and used margin. It is a straightforward calculation expressed as a percentage. It is your account’s equity percentage multiplied by 100. If you’re trading a currency pair other than the currency in your account, you may have to also do a currency conversion to determine your forex margin in that denomination.
Margin Level = (Equity / Used Margin) x 100%
For example, if you have $5,000 of equity with $1,000 of margin, then your margin level is 500%. The lower the margin level in forex, the less free margin you have available to trade. If your margin level dips low enough, your broker might issue a margin call or an automatic stop out on your position.
While margin level minimums vary depending on the brokerage firm used, many brokers set a minimum margin level at 100%. That means if your equity is equal to or less than your margin used, you will not be able to open new trades.
Forex Margin Example
Let’s say you wish to go long the USD/JPY currency pair. Assume your account balance is $2,000 and you trade a notional value of $10,000. Also assume the margin requirement on this pair is 5%. Your required margin is the notional value multiplied by the margin requirement.
$500 = $10,000 x .05
Now compare the required margin (which is also your used margin) of $500 to your $2,000 of equity.
Your margin level is $2,000 / $500
400% = ($2,000 / $500) x 100%
Your margin level, 400%, is safely above the 100% minimum margin level in forex to avoid margin calls and automatic liquidation from your broker. You can also open new trades so long as your margin level remains above the 100% minimum.
Pros and Cons of Trading Forex on Margin
There are both benefits and drawbacks to using margin when trading currencies. Here’s a look at some of them.
Pros
Pros of using margin to trade forex include that it can enhance return potential, more buying power means access to many trading opportunities and currency pairs, and that the forex markets are open 24 hours a day, five and a half days a week. Depending on how you like to trade, that can be an attractive feature.
Cons
Some of the downsides of trading forex on margin are that trading with high leverage can quickly lead to big losses and margin calls, trading forex on margin creates more volatility, which can increase stress, and that forex markets are less regulated than some other markets. In short: there’s more risk to take into consideration.
💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
Is There a Difference Between Leverage and Margin in Forex?
Leverage and margin are similar concepts, but they’re different. One way to think of the differences is that a trader can use margin to increase their leverage. Margin is the tool, and leverage is the force behind the tool, which can be used to potentially increase returns (or losses).
The Takeaway
Currency trading is a liquid market that is open more hours per week than regular stock markets. Forex trading involves posting a margin deposit that allows traders to have exposure to large notional values of a currency. There are advantages and disadvantages to know as well as risks to consider.
If you do have the experience and the risk tolerance to try out trading on margin, you could increase your buying power, take advantage of more investment opportunities, and potentially increase your returns. But don’t forget the risks involved.
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FAQ
How much margin should you use for Forex trading?
It depends on your comfort level and risk tolerance. If you seek maximum risk, then you might be comfortable with a low margin amount. Those with a lower risk tolerance might prefer to trade with a higher margin deposit. You can typically have a leverage ratio anywhere from 1:1 to 500:1.
What is a bad margin level in Forex trading?
You want to have a forex trading margin level above 100%. A margin percentage any lower means you might not be able to open new trades.
Can you trade Forex without leverage?
Yes, you can trade forex without leverage by only trading with your margin deposit.
What is free margin in forex trading?
Free margin is the amount of money available to open new forex positions. It is your account’s equity after subtracting the margin used.
What is a good margin level in forex?
Generally, a good margin level in forex would be above 100%, but depending on how experienced of a trader you are, it can be much higher.
What does 5% margin mean in forex?
The margin percentage refers to how much cash a trader needs to put down to open a trade. So, if the requirement is 5% margin, a trader must put down 5% of the overall trade amount to open a position.
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Wouldn’t it be great if there were a super simple way to budget; say, no more than three figures you had to keep in mind to take control of your finances? That’s exactly what the 50/30/20 budget rule (aka the 50 30 20 rule) can do for you. It’s a simple and effective way to manage your money, allocating 50% of your take-home income to “musts,” 30% to “wants,” and 20% to saving for your future.
For anyone who has ever felt that budgeting was too complicated and headache-triggering to take on, this guideline can make things clear and easy.
What Is the 50/30/20 Rule?
The 50/30/20 budget or “rule” is a budgeting framework that can be relatively easy to create and implement. It’s one potential way to help keep your finances on track and help you work towards your goals.
The 50/30/20 numbers refer to percentages of your take-home income that you would allocate to three main categories: ”needs” or “musts” (essentials), “wants” (nonessentials), and saving (financial goals), respectively.
The primary goal of the 50/30/20 rule is to learn to prioritize saving money by making it a key part of your spending plan.
Everyone’s financial needs and goals are different, however. And, while these percentages can be a great starting point, you may find that you need to tweak these exact numbers to better suit your needs and current financial situation.
Where Did the 50/30/20 Rule Come From?
The 50/30/20 budget rule gained popularity when Sen. Elizabeth Warren explained it in her book, “All Your Worth: The Ultimate Lifetime Money Plan,” which was first published in 2005.
The simplicity of the concept (and the math) contributed to its appeal. The idea of dividing one’s money into three instantly understandable buckets proved to have staying power.
How the 50/30/20 Rule Works
In the 50/30/20 budget, you allocate your take-home (or after-tax) income into three main categories or buckets according to percentages.
Recommended: Check out the 50/30/20 calculator to see a breakdown of your money.
50% to “Needs”
These are things you cannot live without and the bills you cannot avoid paying. Consider them the “musts;” the items that you need to survive or that would leave you in a difficult situation if you didn’t pay them.
• Utilities, including electricity, WiFi, and water
• Car payments and/or other transportation expenses (say, to get to work)
• Groceries (but not that pricey takeout salad)
• Basic clothing (what you need to wear in daily life, at work, and/or to stay warm; not the latest style of jeans just because they’re cool)
• Insurance payments
• Healthcare costs
• Debt payment, such as the minimums on student loans and/or your credit card
The “needs” category does not include items that are extras, such as Netflix, dining out, and clothing beyond what you need for work. Those fall under the next category.
30% to “Wants”
Also known as personal, discretionary, or nonessential spending, these are the things you buy that you could technically live without. This includes:
• Dining out or takeout food
• Going to the movies, a show, or a concert
• Vacation/travel costs
• Streaming channel subscriptions (unless they are somehow vital for your work)
• New clothes, simply because you feel like buying them
• Electronics that are cool but not vital to your job
• Spa treatments
• Ubers or taxis instead of public transportation.
Wants are all the little extras and upgrades you spend money on that make life more fun.
20% to Savings
This is the money you save for future financial goals. This category often provides a means to financial security. This includes:
• Money put into an emergency fund
• Saving for a downpayment on a home
• IRA or other retirement contributions
• Extra payments to help pay off your loans sooner (minimum payments are part of the “needs” category).
Even though the budget is written as 50/30/20, the purpose of this system is to prioritize the saving aspect, this 20%. (It may be more appropriately named the 20/50/30 budget.) The goal here is to get people to save for tomorrow rather than just spend today.
The idea is to make space for the 20% without laboring over the rest. The minutiae of where your fun money is going ($5 for a latte here, $10 for an appetizer there) isn’t super important if you’re saving enough to meet your financial goals.
Another point to note: If you aren’t saving 20% of your income right now, that’s okay. The process of setting up the 50/30/20 budget will help you find out where your money is going so that you can make adjustments. After completing your budget breakdown, you can address the areas where you’d like to cut back.
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Benefits of the 50/30/20 Budget
The 50/30/20 rule may be a minimalist budget, but it can pack the same powerful benefits you would get with a more labor-intensive budget.
Some of the payoffs of setting up and following a 50/30/20 include:
• Knowing where you stand. As a popular adage goes, “what gets measured gets improved.” It can be hard to start spending less and saving more if you aren’t clear on how much and where you are currently spending.
• Identifying easy ways to cut back. As with any budgeting process, the 50/30/20 budget can reveal opportunities to cut back on spending. Simply going through the process – and seeing exactly where your money is going each month – can help to motivate you to make some relatively pain-free adjustments.
• Reducing financial stress. While building a budget may seem like a stress-inducing exercise, it can ultimately relieve a lot of financial worry. It can add structure and clarity to your spending. Instead of angsting over every purchase, you’ll have built-in boundaries that allow you to spend freely within your budget.
• Simplifying the budgeting process. By having fewer categories than a traditional monthly budget, the 50/30/20 rule of thumb can be easy to set up and to maintain. It can also be simple to track a 50/30/20 budget digitally.
• Achieving your savings goals. By making saving a priority and setting some money aside before you start spending, a 50/30/20 budget can help you work effectively towards your financial goals. Whether that’s creating an emergency fund, making a downpayment on a home, or going on a great vacation is your decision.
Tips for Implementing the 50/30/20 Budget
Want to give the 50/30/20 budget a try? If you decide to go this route, or you’re just looking for some budgeting basics, here are some steps you can take to get started.
Gathering Your Financial Records
To get started with any kind of budget, it’s helpful to collect the last three months or so of bank and credit card statements, pay stubs, receipts, and bills.
Calculating Your Monthly Income
You can use your statements to figure out exactly how much money you are bringing in each month after taxes are taken out. You can think of after-tax dollars as the pot of money you have to siphon into the three budget categories each month.
Setting a Savings Target
You may want to begin with the most important category, which is the 20% (savings). Since the goal for this budget is to turn the 20% into a nonnegotiable part of the plan, you’d calculate 20% of your monthly after-tax income and set that figure aside for things like debt repayment, cash savings, retirement investing, and any other financial goals that you have.
Even if you don’t feel it’s realistic for you to put 20% into saving right now, you might run the exercise assuming that you will. You’ll be able to tinker with the numbers later.
Calculating Essential Monthly Expenses
Next, you may want to make a list of all of your monthly essential or fixed expenses, such as rent/mortgage, utilities, groceries, and insurance.
Currently, do essential items absorb more than 50% of your take-home income each month? If so, what percentage do they comprise? And, is there any way to reduce any of these monthly expenses?
Building a Hypothetical Budget
After adding up savings and essentials, what is left over is what can be allocated towards discretionary spending, or the “wants” outline above.
It can be helpful to keep in mind that the 50/30/20 numbers are just a guideline. If the cost of living is high where you live, for example, it may not be feasible to keep essentials to 50% of your take-home income. In this case, you may need to reduce spending on wants.
Or, you may decide that at this point you can’t quite afford to put 20% into savings. There are variations on the 50/30/20 theme that accommodate these situations, such as the 70/20/10 rule, which acknowledges that for some people, a hefty 70% will be needed for the “musts” of life.
Once you see your numbers in black and white, you can play with the percentages and come up with a workable plan for roughly how much you can spend on nonessentials, or fun, each month.
Putting Your Plan into Action
Now that you have a basic guideline of how much money you will put into one type of savings account each month and how much cash you can spend each month on wants, it’s time to give your budget a try.
You may want to plan on tracking your spending for two to three months to start. You can do this by saving receipts and logging expenses according to the three categories at the end of the day. Or, you could use a budgeting app that makes it easy to track and categorize expenses.
Another tip: Try automating your finances and having money transferred from your checking account to your savings right after payday. That way, you won’t see the cash sitting in checking and think it’s there for the spending.
Making Some Tweaks
After tracking your spending for several months, you’ll probably have enough data to refine your original 50/30/20 budget. From there you can adjust the categories based on your actual spending, not just your projected spending.
You may also find that you need to adjust your spending. Discretionary spending is typically the easiest place to do some trimming.
You may decide you need to cook at home (rather than get takeout) a few more times a week, save on streaming services by dropping a channel you rarely watch, or ditch the gym membership and work out at home.
it may also be possible to pare back some of your fixed monthly expenses. Reducing utility bills, saving on gas, and, if possible, rent, could free up more money for fun spending.
After making some adjustments, you can execute your new and improved budget. You may want to continue to track spending in a method that works best for you until spending according to your budget becomes second nature.
The Takeaway
The 50/30/20 rule of thumb is a set of easy guidelines for how to plan your budget. Using them, you allocate your monthly after-tax income to the three categories: 50% to “needs,” 30% to “wants,” and 20% to saving for your financial goals.
Your percentages may need to be adjusted based on your personal circumstances and goals. But using this simple formula can be a good way to get a better handle on your finances, and to start working more effectively towards your goals.
You may find that technology can make sticking to a budget simpler. If you open a bank account online with SoFi, you’ll have features and perks that can help make the most of your money. Our Checking and Savings offers a competitive annual percentage yield (APY) and charges you no account fees. Plus you’ll spend and save in one convenient place, be able to track where your money goes, and use Vaults and Roundups to boost your savings.
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FAQ
Is the 50/30/20 rule a realistic goal?
For many people, the 50/30/20 rule is a realistic way to budget for essentials, discretionary expenses, and savings contributions. For others, it may not be realistic. If you are just starting your work life, earn a lower salary, live in an area where housing is very expensive, or have considerable debt to manage, you might do better with a different budget guideline.
Is the 50/30/20 rule weekly or monthly?
When budgeting, people typically work with their monthly expenses, since that is how housing costs, utilities, and other payments (say, student loans and credit card debt) are assessed. You could, however, apply the 50/30/20 guideline to your weekly spending and see how your finances are tracking.
What is the 60/30/10 rule budget?
The 60/30/10 budget is a different version of the 50/30/20 rule that can work well for super savers. It allocates 30% more for the “musts” of life and 10% for discretionary spending. The remaining 60% is for saving, investment, and paying off debt.
What is the 70/20/10 rule for money?
The 70/20/10 rule is a budgeting system that allocates 70% of one’s take-home income towards needs (minus debt) and “wants” (discretionary spending), 20% to saving and investing, and 10% towards debt repayment or donations.
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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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