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In general, economies are classified into two broad categories: developed economies and emerging economies. To answer the question, “what are emerging markets?” one first needs to understand developed markets.

Developed economies have higher standards of living, well-developed infrastructure, and more mature capital markets. Most developed market economies can be found in North America, Western Europe, and Australia.

Emerging market economies (EMEs), on the other hand, are those that are still in the process of becoming developed economies. Emerging markets are ones that are beginning to institute regulatory bodies, seeing rapid growth, and increasing amounts of money flowing through their stock markets.

EMEs make up the majority of the global economy—up to 80%, in fact. India, China, and Russia are just a few large countries that fall into this category.

What Are Emerging Markets?

In essence, an emerging market refers to an economy that has the potential to become a developed, advanced economy in the near future.

Investors tend to see these countries as potential cash cows because their economies resemble that of an established yet still young startup company. The infrastructure and blueprint for success has already been laid out, things just need a little more time before the economy can really take off.

If an investor selects an emerging market economy accurately, the payoff could potentially far exceed most investments in already advanced economies that have already experienced their most substantial stages of growth.

China is an interesting example of an emerging market. The country is quite advanced in many ways, with a large manufacturing base, plenty of technological innovation, and the largest population of any country in the world. China is the second-largest economy in the world by gross domestic product (GDP) and accounts for 16.38% of the entire global economy. So why is it considered an emerging market economy?

China has a few characteristics that are typical of an emerging market, in particular, having an economy that relies heavily on exports. India is another economy that is advanced in some ways, yet has a low per capita income that is typical of an emerging market.

Correctly identifying emerging markets isn’t exactly scientific. Not everyone agrees on which countries are emerging markets and which countries are not.

On the list are some large countries like China, Russia, Brazil, Korea, Mexico and others, in addition to smaller countries like Qatar, Poland, Peru, United Arab Emirates, and the Philippines.

Other financial institutions, like the International Monetary Fund, the S&P, Russell, and Dow Jones have their own lists that aim to help investors understand the question “what are emerging markets?”

How Investors Recognize Emerging Markets

While there are some differences among these lists, there is also a general theme. Certain indicators tend to be included time and again among those trying to differentiate emerging market economies from developed ones.

Here are seven tips for recognizing emerging markets, in addition to how to invest in emerging markets, the pros and cons, and why someone might want to invest in this area.

Fast-Paced Growth

An emerging market economy is one in a state of rapid expansion. There is perhaps no better time to be invested in the growth of a country than when it enters this phase.

At this point, an EME has laid much of the groundwork necessary for becoming a developed nation. Capital markets and regulatory bodies have been established, personal incomes are rising, innovation is flourishing, and GDP is climbing.

Lower Per Capita Income

The World Bank keeps a record of the gross national income (GNI) of many countries. For the fiscal year of 2021, lower-middle income economies are defined as having GNI per capita of between $1,036 and $4,045, while upper middle-income economies are defined as having GNI per capita between $4,046 and $12,535.

The vast majority of countries that are considered EMEs fall into the lower-middle and upper middle-income ranges. India, Pakistan, and the Philippines are lower-middle income, for example, while China, Brazil, and Mexico are upper-middle income. All of these countries are referred to as emerging markets despite the considerable differences in their economic progression.

Volatility

For EMEs, volatility is par for the course. Risk and volatility tend to go hand in hand, and both are common among emerging market investments.

Emerging market economies are often rife with conflict, political turmoil, economic upheaval, and booms and busts. Some of these countries might see violent revolutions, political coups, or become targets of sanctions by more powerful developed nations.

Any number of things could happen that threaten to throw an EME into disarray at a moment’s notice.

Political and Economic Instability

One of the reasons that developing economies can see a lot of volatility has to do with their inherent trend toward instability.

This can come from any source, including the type of situations mentioned in the last point.

Another potential point of conflict can come in the form of natural disasters, which can hit export-heavy nations hard. If a country relies on agricultural exports for a large portion of its trade, a tsunami, hurricane, or earthquake could derail a lot of related commerce.

Instability could result through either social unrest, economic devastation, political upheaval, or related factors.

Currency Crises

A currency crisis can sometimes be accompanied by a political crisis. When people lose faith in the leadership of a country, they might also lose faith in the currency of that country.

When this happens, a currency can enter freefall. When currencies lose value rapidly, prices for consumer goods start going up faster and faster.

The value of a country’s currency is an important factor to keep in mind when investing in emerging markets.

Sometimes it can look like stock prices are soaring, but in reality, the currency that those stocks have their values measured in is declining.

If a stock goes up by 50% in a month, but the national currency declines by 90% during the same period, investors will still see a net loss, although they might not recognize it as such until converting gains to their own native currency.

For example, Venezuelan stocks have soared against the Venezuelan Bolivar during the last five to ten years as the currency has entered hyperinflation, although those same stocks have collapsed in value against the US dollar.

Heavy Reliance on Exports

Emerging market economies tend to rely heavily on exports. That means their economies depend in large part on selling goods and services to other countries.

A developed nation might house all the needs of production within its own shores while also being home to a population with the income necessary to purchase those goods and services. Developing countries, however, must export the bulk of what they create.

Growth Potential

One of the biggest defining factors of an emerging market economy might be its potential for high growth.
These are countries that have shown a determination to join the developed world and have already laid most of the groundwork for achieving that.

So, the theory goes that if such a country were to continue progressing, its industry would flourish, its population would grow and earn higher incomes, and as a result related investments would outperform those in most other markets.

Why Invest in Emerging Markets?

Emerging markets are generally thought of as high-risk, high-reward investments.

They are also yet another way to diversify an investment portfolio. Having all of a portfolio invested in the assets of a single country puts an investor at the mercy of that country’s circumstances. If something goes wrong, like social unrest or revolution, a currency crisis, or widespread natural disasters, that might damage related investments.

Being invested in multiple countries can help mitigate the risk of something unexpected happening to any single economy.

The returns from emerging markets might also exceed those found elsewhere. If investors can capitalize on the high rate of growth in an emerging market at the right time and avoid any of the many potential mishaps, they stand to profit.

Over the period of 2000-2010, for example, the S&P 500 gave investors an annual return of -0.95%. At the same time, the MSCI Emerging Market Index returned 16% during that period.

Pros and Cons of Investing in Emerging Markets

Let’s recap some of the pros and cons associated with EME investments.

Pros

•  High profit potential: Selecting the right investments in EMEs at the right time can result in returns that might be greater than most other investments. Rapidly growing economies provide ample opportunity for profits.
•  Global diversification: Investing in EMEs provides a chance to hold assets that go beyond the borders of an investor’s home country.

This creates a kind of diversification that can’t be had any other way. Even if an unforeseen event should happen that contributes to slower domestic growth, it’s possible that investments elsewhere could exceed expectations.

Cons

•  High volatility: As a general rule, investments with higher liquidity and market capitalization tend to be less volatile because it takes larger capital inflows or outflows to move their prices.
EMEs tend to have smaller capital markets combined with many uncertainties, making them vulnerable to exceptional volatility.

•  High risk: With high volatility and uncertainty comes high risk. What’s more, that risk can’t always be quantified. The situation might be even more unpredictable than usual due to conflict, political turmoil, economic upheaval, and natural disasters.

All investments carry risk, but EMEs bring with them a host of fresh variables that can twist and turn in unexpected ways.

•  Low accessibility: While some emerging market funds do exist, it’s not always easy to gain access to these kinds of investments. There may not be a ticker symbol to select in a brokerage account, as is the case with most domestic securities.

While liquid capital markets are a characteristic of emerging markets, that liquidity still doesn’t match up to that of developed economies.

It may be necessary to consult with an investment advisor or pursue other means of deploying capital that may be undesirable to some investors.

The Takeaway

When contemplating how to invest in emerging markets, there is no one correct answer that works for every investor.

Emerging market Exchange-traded Funds (ETFs) might invest in different assets within a single country or spread their investments throughout multiple countries. The more countries included in a fund, the more diversification it will achieve. As usual, greater diversification can limit risks but also tends to limit rewards.

Bonds can also play a role in an emerging market portfolio. Many countries with developing economies have used the issuance of new debt to borrow money to build out their infrastructure. That means some emerging market economies could offer bonds with attractive yields.

Investors with low risk tolerance might choose to limit their exposure to emerging markets. Not only are related investments often volatile and high-risk, but the risk can be difficult to assess.

Whether playing it safe or taking a risk in emerging market stocks, SoFi Invest® has all the tools a new or experienced investor might need, including a cutting-edge trading platform and free financial advisors at your fingertips.

If you’re interested in learning more about emerging markets and other investment options, check out SoFi Invest.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
For additional disclosures related to the SoFi Invest platforms described above, please visit http://www.sofi.com/legal.
SOIN20155

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When you want to borrow money, perhaps for a car loan or home mortgage, you may research and compare rates among financial institutions to get the best deal. If so, you can be provided with interest rates and annual percentage rates (APRs) of current loan programs being offered by the institution.

If you want to save money, you might shop around for the best interest-bearing account. In that case, you’ll likely be given the interest rate for an account, along with the annual percentage yield (APY).

When given these numbers, you might think that there isn’t much of a difference, numerically speaking, between the interest rate and APY, or the interest rate and APR. Those differences, though, can be significant difference-makers when you want to maximize your money.

With a loan, the interest rate is a percentage charged by a lender for the use of money, with calculations based upon the loan’s principal. In the context of a savings account, a financial institution agrees to pay you a certain amount of interest based upon the money you have deposited in that institution.

Now, here’s more about how APRs and APYs are calculated, and much more!

High-Level Definitions

If you deposited money into an interest-bearing account, then you would earn an annual percentage yield on those dollars. The APY calculation takes into account the interest rate being offered, and then factors in any account fees and costs, as well as whether the financial institution offers simple interest or compounded interest—if the latter, then it also matters how often the financial institution compounds that interest—perhaps monthly or quarterly.

If the bank offers simple interest, then the interest is simply calculated on the principal balance. If, for example, you invested $10,000 at an interest rate of 1.5%, at the end of the year, you’d earn $150. Compound interest, meanwhile, is interest calculated on the principle, plus any accrued interest—so, when compound interest is paid, it includes interest paid on interest.

Switching gears, when you borrow money from an institution and are quoted an annual percentage rate, this figure factors in the interest rate charged, along with fees and costs, but compounded interest is not part of the APR calculation.

One of the key differences in how APY and APR are calculated, then, is that one takes compounded interest into account, while the other one doesn’t.

The APY Formula

Figuring what you could earn on, say, your savings or certificate of deposit using simple interest is a reasonably straightforward calculation. The APY, meanwhile, provides a picture of what you would earn on a deposit-based, interest-earning account over a period of one year.

The actual formula for APY calculation is as follows: (1 + r/n)ⁿ – 1.

The “r” stands for the interest rate being paid, while the “n” represents the number of compounding periods within a year. If, for example, the interest rate paid was 1.5%, then that’s what you’d use for the “r.” If interest is compounded quarterly, then “n” would equal four.

So, the frequency of interest compounding can cause savings accounts with the same interest rates to have different APYs. For example, if two different banks offered a CD with the same interest rates, and one of them compounded annually, that institution would have a lower APY than the institution that compounded quarterly, or daily.

The good news is that if you want to compare savings rates from one financial institution to another, you don’t need to perform these in-depth calculations. Each institution would need to provide you with the APY and you could simply compare the figures. And, here’s the heart of it all: the higher the APY, then the more quickly the money you deposit can grow.

More About the APR vs. APY

Like the APY, calculating interest on a loan is fairly straightforward, with the APR providing a better snapshot of the true cost of the loan to you on an annual basis. It may take into account the points you paid, for example, to get a mortgage loan, and/or other fees and loan-related costs.

However, here’s where APR calculations differ from APY ones. The APR does not take into account how often interest is compounded on a loan. And, the more often it’s compounded, the more you’ll ultimately pay back on your loan.

So, besides comparing APR to APR from different institutions, to get a better understanding of what would be a better deal, also ask how often interest compounding takes place at each one.

Here’s how an APR might be calculated: Fees and interest paid over the loan’s life would be divided by the original loan amount. Take that answer and then divide it by the number of days in the term of the loan. Multiply that number by 365, and then by 100. Ta-dah! That’s your APR.

Although that’s the basic calculation, there’s one more factor to consider—how APR is calculated can differ by loan type. Credit cards, for example, can have different APRs for purchases vs. for cash advances.

Summing Up the Main Differences

In short, here’s the answer to this question: “What is APY vs. APR?”:

•  APY calculates money paid to you on depository bank accounts such as savings and certificates of deposit. It factors in the interest rate, plus any fees, costs, and compounding interest frequency.
•  APR calculates the money you would owe to pay back loans, such as car loans and house mortgages. It factors in the interest rate, plus any fees and costs, but it does not take into account the impact of compounding interest.

When your goal is to maximize your dollars, a good foundational step can be to get the most interest on your savings dollars.

Types of High Interest Accounts for Savings

When you’re saving money, perhaps to buy a house or go on an ocean cruise, there are several types of interest-bearing accounts that may be the right choice for your goals, with different APYs, fees, ready access to cash, and withdrawal terms.

Traditional checking and savings accounts don’t usually fit the bill when you’re looking for a high-yield account, although there are interest-bearing ones that might fit your needs quite well. Other choices can include money market accounts, certificates of deposits, and other forms of investments.

With a money market account, your money is typically invested in a reasonably safe way, perhaps in government securities. If you don’t need regular access to this money, this could be a good choice, as there are often limits on how many withdrawals you can make monthly.

You typically need at least $1,000 to open a money market account—for higher investments, incentives might be offered.

Certificates of deposits (CDs) are investments with fixed maturity dates, ranging from one month to 20 years—typically, you can’t easily withdraw money before that date. Some CDs are traded on the market as securities. Others are offered by banks, and aren’t securities. Interest rates tend to be higher on longer-termed CDs than ones with shorter terms.

Some CDs require a minimum deposit, while others don’t. Some CDs don’t charge penalties for early withdrawals, but many do, so read the fine print. A penalty can put a real dent in any APY earned.

If you want easy access to your CD dollars, you might seek out one with fewer withdrawal restrictions, or invest in CDs at regular intervals, helping to ensure that one will mature when you need funds.

High Interest Checking Accounts

These are accounts designed to give you the flexibility of a traditional checking account, but with high-interest returns. Rates vary, but are typically much higher than savings accounts. Many of these accounts, unfortunately, come with fine print, perhaps limitations on monthly debit card usage, or on minimum balances required, or mandated bill-pay automation.

What you really want to look for in the fine print, though, is whether or not there’s a balance cap on your interest earnings. This would basically limit how much money you can earn at the high interest rate. For example, perhaps a bank would pay 3% on checking accounts, but you’d only earn that interest on the first $2,000.

What SoFi Money Offers

If you don’t want your interest-earning potential to come with a ceiling, you might want to look at SoFi Money®, a cash management account where you can spend, save, and earn all in one place. We work hard to give you high interest and charge zero account fees. With that in mind, our interest rate and fee structure is subject to change at any time.

You’ll have the ability to write and deposit checks and you can use a debit card, send and receive money, and use ATMs, with the added benefit of earning interest.

SoFi Money is a great way to spend and save. Get started today.

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SoFi Money®
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC . Neither SoFi nor its affiliates is a bank.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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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Exchange-traded funds (ETFs) are securities made up of any number of other securities—stocks or bonds most commonly. Some ETFs track a specific underlying index like the S&P 500 or the Nasdaq, but these funds can be structured to fit almost any investment needs.

ETFs generally fall into two categories: actively managed and passively managed.

Passively managed funds follow the principle of a “buy and hold” investment strategy. Rather than trying to beat the market, these funds simply track and index or invest in particular assets regardless of short-term market fluctuations.

Actively managed ETFs, by contrast, employ a portfolio manager or team of portfolio managers who personally track the investments held by a fund and make decisions to buy, hold, or sell, the assets held within it.

The goal of these portfolio managers is to outperform the broader market indexes. They often measure their success by using a certain index as their benchmark.

If their portfolios provide a higher return than those indexes, then the managers can claim success. If they return less than their benchmark index, then they did not beat the market, and their investors would have been better off with some kind of passive investment strategy.

How Actively Managed ETFs Work

Many of the most well-known ETFs are passively managed, meaning they intend to perform similarly to a particular index, asset, or group of securities. However, there are now two specific types of actively managed ETFs as well: transparent and semi-transparent funds.

Until late 2019, only transparent actively managed ETFs were allowed. These funds were required to disclose their holdings on a daily basis. Investors would then know exactly what was happening to their money.

Semi-transparent funds, by contrast, don’t have the same disclosure requirements. They either reveal the contents of their portfolio less often or communicate their true holdings by using various accounting methods like proxy securities or weightings.

The main reason investment managers want the option for this kind of ETF structure involves concealing their methods from competitors. The small percentage of active managers who outperform the market don’t want others to know how they did it.

From an investor’s perspective, the only noticeable difference between these two kinds of active ETFs would be the frequency with which they receive information disclosing the fund’s holdings. Both kinds of funds, and also passive funds, trade on exchanges at prices that change constantly during trading days.

Pros and Cons of Actively Managed ETFs

As with any investment vehicle, these funds have their benefits and disadvantages. Both the pros and cons tend to stem from the fact that a person or group manages the fund’s assets on a constant basis.

Pros

Higher Returns

The biggest advantage of an actively managed ETF is the potential for gains that could exceed those of the market at large. While very few investment management teams beat the market, those who do tend to produce outsized gains over a short period.

Greater Flexibility and Liquidity

Active ETFs could also provide greater flexibility amid market turbulence. When world events rattle financial markets, passive investors can’t do much other than go along for the ride.

A fund with active managers might be able to adjust to changing market conditions, however. Portfolio managers could be able to rebalance investments according to current trends, reducing losses, or even profiting from panics and selloffs.

Like passive ETFs, active funds also trade throughout the day (as opposed to some mutual funds who only have their price adjusted once daily), allowing investors the opportunity to do things like short shares of the fund or buy them on margin.

Professional Management

The premise of these funds relies entirely on the experience and capability of the fund’s management. Those who invest in actively managed ETFs don’t personally see these things happening. They will be reflected in the ETF’s share price and net asset value (NAV) , of course, and funds send out a prospectus periodically to update investors on new events and asset allocation changes.

Cons

High Expense Ratios

One of the biggest cons to holding shares of an actively managed ETF involves what’s known as the expense ratio.

All ETFs come with a cost—the costs associated with maintaining the investments of the fund. The portion of this cost that gets passed onto investors is calculated by dividing the sum of a fund’s costs by its total assets. This number, expressed as a percentage, is the fee that investors pay for the privilege of holding ETF shares.

Active funds tend to have higher expense ratios. The costs associated with paying a professional or entire team of professionals combined with the fees that result from additional buying/selling of investments adds up to a larger expense burden.

Each purchase or sale might come with a brokerage fee, especially if the securities are foreign-based. These costs exceed those of passive funds, resulting in higher expense ratios.

Higher Risk

While active ETFs could provide higher returns, most of them don’t. It’s a widely known fact in the investment world that the vast majority of managed funds (as well as most individual investors) do not outperform the market over the long-term.

So, while an active ETF may have the potential for greater returns, the risk can also be significant. The chances of choosing an active fund that fails to outperform the market are greater than the odds of choosing one that succeeds.

The responsibility to manage the risks and rewards of an actively managed ETF lies in the hands of a fund’s managers, not the retail investor buying shares. This might not sit well with investors who want to have control over their investments and the ability to choose when to buy or sell. Holding shares of this type of fund requires putting faith into those who manage the investments.

One of the risks inherent in this kind of investing, although remote, might be that fund managers choose to misallocate investor’s funds or otherwise engage in deceitful practices.

It’s not unheard of for financial regulatory enforcement agencies like the Securities and Exchange Commission (SEC) to catch people in the act of overtrading (placing excessive amounts of buy/sell orders), making misleading marketing claims regarding a fund’s past performance, or gambling with the funds that investors have entrusted to them.

Deviation from Net Asset Value

Another reason why investors might not like a fund being managed by someone else is the fact that this arrangement can lead to the ETFs share trading at a price that is higher or lower than the fund’s net asset value (NAV). In other words, sometimes the tradable shares don’t accurately reflect the price of the assets the fund actually holds. This can happen with passive ETFs as well, but the deviation in active funds can be much higher due in part to the other factors discussed above.

In addition, even if the fund outperforms, that might not be reflected in the share price. The individual investment holdings of the fund might do well, but investors holding shares could see little to no profits due to the high expense ratios and potential deviation from NAV.

Investing in Actively Managed ETFs

It begins with choosing a fund that fits an investor’s wants and needs and then finding an exchange where that security can be traded. Once an investor opens an account at their chosen brokerage, they can begin buying shares or fractional shares of actively managed ETFs.

Historically, brokerages have required investors to buy a minimum of one share of any security, so the minimum investment will most often be the current price of one share of the ETF plus any commissions and fees (most brokerages eliminated fees for buying or selling shares of domestic stocks and ETFs in 2019).

Some newer brokerages now offer fractional shares, however, which allow for investors to purchase quantities of stock smaller than one share. This option may appeal to those looking to get started investing with a small amount of money.

It’s important to note that most ETFs pay dividends. Investors can choose to have their dividends deposited directly into their accounts as cash or automatically reinvested through a dividend reinvestment program (DRIP).

Investors with a long-term plan in mind might do well to take advantage of a DRIP, as it allows for gains to grow exponentially. For those only looking for income, DRIP might defeat the purpose of holding securities that yield dividends, however.

Learning About ETFs First-Hand

One way to get started with an actively managed ETF, should an investor decide to do so, would be to buy shares of a chosen fund. With SoFi Invest®, investors of all experience levels can gain experience by picking investments suited to their interests and financial ability. SoFi makes it easy for investors to diversify their portfolios and invest in what makes sense for their financial situation.

Learn more about investing with SoFi.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns.. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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Curious investors have a lot to consider before taking the plunge and buying a stock. One such consideration is a company’s financial standing. Luckily, there are several key documents that are made publicly available for anyone who wants a glimpse into a company’s financial operations.

Investors may be particularly interested in a company’s profit and loss statement. A profit and loss statement reveals how much a company earned over a designated period, like a quarter or year. As the name suggests, the statement details both the revenue and expenses that led to either a profit or a loss.

At first, looking at financial statements can feel like reading another language. Investors who want to learn how to read a profit and loss statement will find it only gets easier with practice. Here’s how to get started.

What is a Profit and Loss Statement?

Ever heard someone ask, “what’s the bottom line, here?” Though this adage is now used euphemistically to inquire about only the most important details of any matter—financial or not—the phrase is borrowed from the literal “bottom line” of a profit and loss statement.

When running a business, profitability is the ultimate goal. A profit and loss statement shows how much revenue a company earned over a specific period, and then subtracts how much it spent, which results in a net profit figure. It’s the final line in the grand calculation.

A profit and loss statement is also called an “income statement.” Understandably so, as it presents both the income and expenses that ultimately created profitability—or loss—for the period.

The profit and loss statement is one of a business’s most important accounting tools. It’s also one of a handful of financial statements officially filed by public companies. Companies will also file a balance sheet, cash flow statement, and statement of shareholders’ equity. Filings are made quarterly (called 10-Q filings) and annually (10-K filings) with the Securities and Exchange Commission (SEC). Investors can find this information by searching for the company within the SEC’s EDGAR database .

It can be useful to think of each of the accounting statements as individual pieces in an overall puzzle. For example, compare the profit and loss statement to a balance sheet, which details information about a company’s assets and liabilities. The balance sheet alone may not indicate whether the company is operating at a profit, and a profit and loss statement may not provide an accurate picture into a company’s indebtedness. But together, both statements provide important context for further analysis.

How to Read a Profit and Loss Statement

Profit and loss statements are a particularly useful tool for looking into the operations of a company. They are perhaps most useful when used to compare two or more different periods, or when comparing companies within the same industry. As with almost any accounting report, context can help to anchor the information. What changed from last year (or last quarter)? What has improved? What has not?

In particular, has the company been able to decrease expenses or increase revenue in order to secure more profit? Or, are there any additional clues as to the financial inner workings of the company?

For example, perhaps a company is profitable in one period and not the next, because of an increase in research and development (R&D) costs. This is valuable information to a potential investor. In fact, such a discovery may shift their line of questioning altogether. Instead of asking about the profitability of the company right now, they might focus on the value of this one-time R&D expenditure into the future.

When learning how to read a profit and loss statement, investors should know that they generally follow a similar format. Each begins, at the top of the page, with revenue. This is how much money a company earned through sales. Next, costs are subtracted. And at the end, at the bottom of the page, is the company’s bottom line: profit or loss. Although a company’s “top line” revenue is a compelling figure, a company’s bottom line may actually be a better indicator of whether it will be an enduring, successful business.

To illustrate the point, consider a simple example of two companies. The first company posted revenue of $10,000,000 last year, but incurred the same amount in expenses. They had high revenue, but earned no profit. The second business earned $1,000,000, but incurred just $100,000 in expenses—resulting in a $900,000 profit. The second company brought in less revenue, but was more profitable than the first.

Profit and Loss Statement Overview

There are other relevant line items an investor might encounter on a profit and loss statement. To recap, one would find the total revenue at the top. This number is also called gross sales. (A gross figure is one calculated before expenses are taken out.)

On certain sales, a company may ultimately receive a modified amount. For example, items that are returned or are discounted must be accounted for. Therefore, the next line in the statement may include a figure that represents what a company does not expect to collect on overall sales.

The result is net revenues, which is likely the next line in the statement. (Net refers to a figure after the necessary deductions are made.) This is a more accurate picture of what incoming cash flow looks like.

Moving down the statement, expenses come next. Although there is no required order, it is common to list the cost of sales as the first expense. This is the amount of money that the company spent to produce the goods or services that were sold during that period. For example, if a company produces shoes, it would include money spent on supplies, labor, packaging, and shipping.

Next, there may be a line titled gross profit or gross margin. This indicates the profit made on the goods sold before operating expenses. (“Gross” indicates that there are still expenses to consider.)

Operating expenses come next. They are the general costs of running a business, such as maintaining payroll, office buildings, and marketing and research fees. Here, depreciation may also make an appearance as a line item. Depreciation is defined as the reduction in the value of an asset with the passage of time, due in particular to wear and tear. Businesses are able to treat this depreciation as an expense.

Once all operating expenses are subtracted, the result is operating profit, or “income from operations.” This figure represents the income before interest and tax expenses are accounted for. That comes next.

Interest income is money earned in interest-bearing bank accounts or other investment vehicles. Interest expense is the cost of borrowing money and paying a rate of interest on that debt. These numbers may or may not be combined into one figure.

Finally, income tax is deducted. Typically, this is the last deduction before the final line in the statement: the bottom line. The bottom line represents the net profit or the net loss, and answers the question: During this accounting period, was this company able to turn a profit, or did they operate at a loss?

Earnings Per Share

A profit and loss statement may also include an earnings per share (EPS) calculation. This is a representation of how much money each shareholder would receive if all net profit was paid out. EPS is calculated by dividing the total net profit by the number of shares a company has outstanding.

The EPS is a hypothetical calculation used by investors to assess the amount of profit created by a company. Do companies actually distribute total earnings? Not generally. Companies will typically keep some or all profits, and may make some payments to shareholders in the form of dividend payments. (The profit and loss statement may also include information on dividend payments.)

A large or a growing EPS is generally preferable but yet again, this metric alone is not sufficient in deciding whether a stock is a good investment. EPS should also be compared to the price of that stock. A company could boast a robust EPS, for example, but if the cost of the stock is relatively expensive, it might not be a good value. For a deeper look into the correlation between earnings and price, investors can consider the price-to-earnings (P/E) ratio, which divides the price of a stock by the EPS.

The Takeaway

A profit and loss statement can give an investor a look at a company’s bottom line in terms of earnings—and also allows them to compare statements from companies in the same industry, as well as statements from the same company over different time periods. Learning how to read a profit and loss statement can be an important part of researching a company in which one might want to invest.

While a profit and loss statement provides contextual insight into a company’s financials, these figures only tell us what has happened in the past, and not what will happen in the future. Given that, this information alone is not able to determine which is the “better” investment, but it is one of the many pieces of information needed to value a stock.

Once an investor has done their research, a typical next step is finding the right place to buy, sell, and trade. SoFi Invest® has made investing accessible and affordable with the SoFi app. It costs nothing to open an account, and there is no commission to buy and sell stocks. Also, SoFi Invest offers fractional shares, so investors can get started with whatever dollar amount they have available.

Find out how to open an account and buy stocks fee-free with SoFi Invest.

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The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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Saving money is an important part of just about everyone’s road to financial wellness. Stowed-away cash comes in especially handy when it’s time to make a down payment on a home or clock in for the very last time.

Of course, there are plenty of ways to stash said cash, ranging from stuffing it under a mattress (which, spoiler alert, is probably not the best move) to investing it in the stock market.

Each savings option has its own risks and benefits, and it’s important to understand them in-depth before making big decisions.

In this article, we’re going to highlight one of the unsung heroes of the money-saving game: certificates of deposit, or CDs. These unique savings vehicles offer customers a balance between growth opportunity and risk management.

Is a Certificate of Deposit Just a Savings Account?

A certificate of deposit has some similarities to a savings account. It’s a financial product built to help consumers save their money and help it grow over time.

However, unlike a savings account, CD holders aren’t able to access the funds in their certificate of deposit whenever they feel like it—at least not without paying an early withdrawal penalty, in most cases.

In exchange for giving up the ability to freely withdraw the money in a CD, the institution rewards CD holders with higher interest rates than they’d see in a typical savings account.

However, the funds are still FDIC-insured to the maximum legal limit of $250,000, making a certificate of deposit a relatively risk-free way to invest and grow your money.

Let’s take a closer look at exactly how this all works.

How Does a Certificate of Deposit Work?

When a customer goes to open a CD they’ll be asked to put down a lump sum, usually with a fairly high minimum deposit amount—perhaps $1,000 or $5,000.

The amount of money placed in a CD is also called its principal, because it is essentially a loan the consumer is offering to the bank. The interest the customer collects is what the bank pays for the privilege of borrowing the money.

Certificates of deposit also carry a “term,” much like a loan does; the term is the amount of time the funds must be left in the CD in order to glean the advertised interest rate.

The term might be as short as a few months or as long as a decade, and generally, longer terms carry higher interest rates. The day the term is over is also known as the CD’s maturity date. A longer-term CD may not necessarily require a higher minimum deposit or principal.

Long story short: When opening a CD, a customer deposits a set amount of money for a set amount of time and agrees to leave it untouched in return for a relatively high fixed interest rate they’ll earn on the principal once the term comes to an end.

But how high, exactly, are the interest rates we’re talking about?

Certificate of Deposit Rates

Certificates of deposit are attractive savings options because they usually offer higher rates than the savings accounts, but are also a lower-risk option than, for example, investing in the stock market.

Since funds in CDs are FDIC-insured, account holders can rest with some assurance that their cash won’t simply disappear (as it may do when invested in shares of a company).

At the time of this writing, the national average rate for a normal savings account is 0.08% APY, whereas the national average rate for a 12-month CD is 0.37% APY. The national average rate for a 60-month CD jumps to 0.7% APY.

But it’s possible to find CDs with even higher rates than that by shopping around.

Certificate of Deposits: Fine Print

There are a few more things it’s important to know about CDs before deciding to open one.

Generally, CDs automatically renew once the term is up if the account holder doesn’t take the money out. Generally, the bank will roll the CD over into a new CD with the same term. (For example, a one-year CD whose funds aren’t collected on the maturity date would be rolled over into a new one-year CD.)

Most financial institutions offer CD holders a grace period, or a fixed amount of days after the maturity date, during which the account holder can decide whether to withdraw the funds, transfer them to a new account or CD, or allow them to roll over.

Finally, but importantly, most CDs are generally subject to an early withdrawal penalty, which is incurred if the money is accessed prior to the maturity date.

Early withdrawal penalties are determined by each financial institution. Depending on the policy, account holders could lose out on interest, or even lose some of their principal deposit.

Certificates of Deposit: Pros and Cons

As our discussion thus far shows, CDs can play an important role in an overall savings strategy because they balance growth and risk management.

But as does any financial product, CDs have both drawbacks and benefits, which should be considered carefully before opening one.

Pros of CDs

•  Because CDs are FDIC-insured, they’re a relatively low risk account. The FDIC insures up to $250,000, which means if an FDIC-insured institution goes out of business, account holders with a CD would receive their principal and interest, up to $250,000. With riskier options, like investing in stocks, returns and contributions aren’t insured.
•  Higher interest rates are available for CDs than for similar savings vehicles, like savings accounts, making it easier to see a higher return on investment.

Cons of CDs

•  Although CDs carry higher interest rates than some other types of savings vehicles—a few of which we’ll cover in more depth in just a minute—they don’t have the same kind of exponential earning potential that stock market investments do.
•  CD holders generally don’t have the ability to withdraw their money at any time, at least without being subject to a penalty. That makes a certificate of deposit a poor choice for certain savings goals, like an emergency fund, which should be readily available.

Where to Open a Certificate of Deposit

Certificates of deposit are available from a wide variety of financial institutions, including both national banks, credit unions, and online-only financial institutions.

Shopping around can help ensure consumers find the best rates and most favorable terms for their needs.

That said, there are also some alternatives to opening a certificate of deposit that are worth considering carefully.

Alternatives to the Certificate of Deposit

Although CDs are a great way to earn interest, they’re far from the only high-interest account option out there. Here are a few options to mull over.

High-Yield Checking and Savings Accounts

Although typical savings accounts offer a relatively low interest rate, high-yield checking and savings accounts are available from some banks.

This option helps consumers combine growth potential with the ability to access their money as they need it, and can be a good alternative to CDs for those who aren’t ready to lock away their money for a year or more.

Certain high-yield accounts may offer up to high APY. However, there may be fine print involved requiring certain behaviors or actions in order to maintain that rate, such as making a minimum number of transactions per month or maintaining a minimum account balance.

Always be sure to review paperwork carefully before opening any kind of financial account.

Money Market Deposit Accounts

Money market deposit accounts are another option which, similarly to CDs, tend to offer higher interest rates than your typical savings account does.

And unlike CDs, money market deposit account holders are generally allowed to write checks or process debit transactions against their funds, which are still covered by FDIC insurance.

While money market deposit accounts can earn higher interest rates than traditional savings accounts, there are monthly restrictions on the number of deposits and withdrawals.

Money market deposit accounts might require a high minimum balance in order to avoid monthly fees.

Stock Market Investments

Finally, for consumers focused on growing their money in the long-term, investing in the stock market can provide a lot of potential for growth.

The power of compound interest means that stock market investors can see appreciable growth, especially over long periods of time.

Historically, the S&P 500—an index tracking 500 of the largest corporations exchanged on the NYSE or NASDAQ—has seen an average annual return of 8% .

Of course, an investment account is very different from a savings account or CD in that there is no FDIC insurance on the funds.

Investments in the stock market are vulnerable to market fluctuation, and there’s no guarantee that investments will be safe and make money.

It is important to remember that investments have no guarantee and are subject to potential losses.

That said, many financial professionals and advisors still recommend long-term investing as one of the best ways to grow wealth over time and as a part of an overall plan for long-term financial goals like retirement.

Alternative Account Options

CDs, money market deposit accounts, and even plain-old checking and savings accounts can all be important parts of a sound financial strategy. CDs in particular can be good vehicles to help augment savings for shorter-term financial goals.

For those looking for an alternative option, SoFi Money may be a good option to look into. SoFi Money® is a cash management account where you can spend and save with no account fees (subject to change).

Plus, you’ll earn cash back rewards on spending with recurring $500 monthly deposits.

Learn more about how SoFi Money might help you reach your financial goals.

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SoFi Money®
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC . Neither SoFi nor its affiliates is a bank.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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