Terminology Archives

Q: What Is Gamma?

Gamma is an important metric for pricing contracts inoptions trading. Gamma can show traders how much the delta — another metric — will change concurrent with price changes in an option’s underlying security.

Q: How Does Volatility Affect Gamma?

When a security has lowvolatility, options that are at-the-money have a high gamma and in- or out-of-the-money options have a very low gamma. This is because the options with low volatility have a low time value; their time value increases significantly when the underlying stock price gets closer to the strike price.

Oct

2025

What Is Gamma in Options Trading?

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

Gamma measures how much an option’s delta changes for every $1 price movement in the underlying security. You might think of delta as an option’s speed, and gamma as its acceleration rate.

Gamma expresses the rate of change of an option’s delta, based on a $1 price movement — or, one-point movement — of the option’s underlying security. Traders, analysts, portfolio managers, and other investment professionals use gamma — along with delta, theta, and vega — to quantify various factors in options markets.

Key Points

• Gamma measures the rate of change in an option’s delta for every $1 movement in the underlying security’s price.

• Delta provides insight into how much an option’s price might move relative to its underlying security.

• Understanding gamma is essential for risk management, as it allows traders to gauge the risk in their options holdings.

• Traders may balance positive and negative gamma in their portfolio to manage the risk of rapid price movements.

• High gamma may make long options more responsive to price movements, potentially amplifying gains, but increases risks for short options near expiration.

What Is Gamma?

Gamma is an important metric for pricing contracts in options trading. Gamma can show traders how much the delta — another metric — will change concurrent with price changes in an option’s underlying security.

An option’s delta measures its price sensitivity, and gamma provides insight into how that sensitivity may change as the underlying asset’s price shifts.

Expressed as a ratio: Gamma quantifies the rate of change in an option’s delta relative to changes in the underlying asset’s price. As an options contract approaches its expiration date, the gamma of an at-the-money option increases; but the gamma of an in-the-money or out-of-the-money option decreases.

Gamma is one of the Greeks of options trading, and can help traders gauge the rate of an option’s price movement relative to how close the underlying security’s price is to the option’s strike price. Put another way, when the price of the underlying asset is closest to the option’s strike price, then gamma is at its highest rate. The further out-of-the-money a security goes, the lower the gamma rate is — sometimes nearly to zero.

Calculating Gamma

Calculating gamma precisely is complex, and it requires sophisticated spreadsheets or financial modeling tools. Analysts usually calculate gamma and the other Greeks in real-time, and publish the results to traders at brokerage firms. However, traders may approximate gamma using a simplified formula.

Gamma Formula

Here is an example of how to calculate the approximate value of gamma. This formula approximates gamma as the difference between two in delta values divided by the change in the underlying security’s price.

Gamma = (Change in Delta) / (Change in Underlying Security’s Price)

Gamma = (D1 – D2) / (P1 – P2)

Where:

• D1 represents the initial delta value.

• D2 represents the final delta value after a price change.

• P1 represents the initial price of the underlying security.

• P2 represents the final price of the underlying security.

Example of Gamma

For example, suppose there is an options contract with a delta of 0.5 and a gamma of 0.1, or 10%. The underlying stock associated with the option is currently trading at $10 per share. If the stock increases to $11, the delta would increase to 0.6; and if the stock price decreases to $9, then the delta would decrease to 0.4.

In other words, for every $1 that the stock moves up or down, the delta changes by .1 (10%). If the delta is 0.5 and the stock price increases by $1, the option’s value would rise by $0.50. As the value of delta changes, analysts use the difference between two delta values to calculate the value of gamma.

How to Interpret Gamma

Gamma is a key risk-management tool. By figuring out the stability of delta, traders can use gamma to gauge the risk in trading options. Gamma can help investors discern what will happen to the value of delta as the underlying security’s price changes.

Based on gamma’s calculated value, investors can see the potential risk involved in their current options holdings; then decide how they want to invest in options contracts. If gamma is positive when the underlying security increases in value in a long call, then delta will become more positive. When the security decreases in value, then delta will become less positive.

In a long put, delta will decrease if the security decreases in value; and delta will increase if the security increases in value.
Traders use a delta hedge strategy to maintain a hedge over a wider security price range with a lower gamma.

💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.

How Traders Use Gamma

Hedging strategies can help professional investors reduce the risk of an asset’s adverse price movements. Gamma can help traders discern which securities to purchase by revealing the options with the most potential to offset losses in their existing portfolio.

Gamma hedging helps traders manage the risk of rapid delta changes by offsetting gamma exposure in their portfolio. This is typically done by holding a combination of options with positive and negative gamma.

If any of the trader’s assets are at risk of making strong negative moves, investors could purchase other options to hedge against that risk, especially when close to options’ expiration dates.

In gamma hedging, investors generally purchase options that oppose the ones they already own in order to create a balanced portfolio. For example, if an investor already holds many call options, they might purchase some put options to hedge against the risk of price drops. Or, an investor might sell some call options at a strike price that’s different from that of their existing options.

Benefits and Risks of Using Gamma

Gamma plays a crucial role in managing options positions, influencing how delta changes in response to price movements. While it can enhance trading strategies, it may also introduce certain risks.

Benefits of Gamma

Gamma in options Greeks is popular among investors in long options. All long options, both calls and puts, have a positive gamma that is usually between 0 and 1, and all short options have a negative gamma between 0 and -1.

Higher gamma means the option is sensitive to movements in the underlying security’s price. For every $1 increase in the underlying asset’s price, a higher gamma suggests that delta will change more significantly, potentially amplifying gains or losses depending on the trade’s direction.

When delta is 0 at the contract’s expiration, gamma is also 0 because the option is worthless if the current market price is better than the option’s strike price. If delta is 1 or -1 then the strike price is better than the market price, so the option is valuable.

Risks of Gamma

While gamma can potentially benefit long options buyers, for short options sellers it can potentially pose risks. For short options, a high gamma near expiration increases the risk of substantial losses if the underlying asset’s price moves sharply, since delta changes rapidly and can result in significant margin requirements or losses.

Another risk of gamma for option sellers is expiration risk. The closer an option gets to its expiration date, the less probable it is that the underlying asset will reach a strike price that is very much in-the-money — or out-of-the-money for option sellers. This probability curve becomes narrower, as does the delta distribution. The more gamma increases, the more theta — the cost of owning an options contract over time — decreases. Theta is a Greek that shows an option’s predicted rate of decline in value over time, until its expiration date.

For options buyers, this can mean greater returns, but for options sellers it can mean greater losses. The closer the expiration date, the more gamma increases for at-the-money options; and the more gamma decreases for options that are in- or out-of-the-money.

How Does Volatility Affect Gamma?

When a security has low volatility, options that are at-the-money have a high gamma and in- or out-of-the-money options have a very low gamma. This is because the options with low volatility have a low time value; their time value increases significantly when the underlying stock price gets closer to the strike price.

If a security has high volatility, gamma is generally similar and stable for all options, because the time value of the options is high. If the options get closer to the strike price, their time value doesn’t change very much, so gamma is low and stable.

Using Gamma Along With Other Options Greeks

Gamma is a key metric in options trading, providing insight into how delta changes as the underlying asset’s price fluctuates. It is one of the five primary Greeks that traders use to manage risk and develop options strategies. Each Greek helps measure different aspects of an option’s behavior, offering a more comprehensive view of market exposure. The Greeks are:

• Gamma (Γ): Measures the rate of change in delta as the underlying security’s price moves. Higher gamma means delta shifts more quickly, increasing both potential gains and risks.

• Delta (Δ): Measures an option’s sensitivity to changes in the underlying asset’s price. Delta helps traders understand how much an option’s price might move relative to its underlying security.

• Theta (θ): Represents time decay, indicating how an option loses value as it nears expiration. A higher theta means the option’s value declines more rapidly over time.

• Vega (ν): Reflects the impact of implied volatility on an option’s price. Higher vega suggests that increased volatility leads to larger option price swings.

• Rho (ρ): Gauges an option’s sensitivity to interest rate changes. Rho is more relevant for long-dated options, as interest rate fluctuations can significantly impact their value.

Understanding gamma alongside the other Greeks allows traders to refine their strategies and manage risk more effectively in the options market.

The Takeaway

Gamma and the Greeks indicators are useful tools in options trading for understanding derivatives and creating options trading strategies. However, trading in derivatives, like options, is primarily for advanced or professional investors.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.

Explore SoFi’s user-friendly options trading platform.

FAQ

What is a good gamma for options?

A “good” gamma depends on the trading strategy. High gamma is beneficial for short-term traders who want quick delta changes, as it makes options more responsive to price movements. Lower gamma is preferred for longer-term strategies or hedging, as it provides more stability and reduces the need for frequent adjustments.

Should gamma be high or low when trading options?

Whether gamma should be high or low depends on your strategy and risk tolerance. High gamma is ideal for short-term trades or when expecting significant price moves, as it amplifies delta changes and potential gains but also increases risk. Low gamma, common in deep in-the-money or far out-of-the-money options, provides more stability and slower delta changes, making it better suited for longer-term strategies or conservative approaches.

How do you trade options using gamma?

Trading options using gamma helps traders assess delta changes, identify opportunities, and manage risk. High gamma options, often at-the-money and near expiration, allow for rapid delta shifts, benefiting short-term trades. Gamma hedging helps balance exposure by offsetting positive and negative gamma, reducing volatility in a portfolio.

What is the best gamma ratio?

What happens to gamma when volatility increases?

When volatility increases, gamma decreases for at-the-money options and stays relatively stable for in- and out-of-the-money options. Higher volatility smooths delta changes, making gamma less sensitive, while lower volatility increases gamma, leading to sharper delta shifts.

Photo credit: iStock/Prostock-Studio

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q125-105

Oct

2025

A woman is seated in a kitchen, reviewing financial documents.

A Beginner’s Guide to Understanding Market Sentiment

By Rebecca Lake | Growing Wealth, invest, Investing, Terminology | Comments Off

Table of Contents

What Is Market Sentiment, and Why Does It Matter?
How Is Market Sentiment Measured? 5 Common Indicators
What Is Sentiment Analysis?
How to Use Market Sentiment in Your Investment Strategy
FAQ

Market sentiment describes the way investors feel about stocks, a particular company or industry, or the overall market. What is market sentiment useful for? Market sentiment indicators are a gauge of crowd psychology; they tell you how optimistic or pessimistic investors are feeling at any given point.

While market sentiment is not predictive of market outcomes, it can be used to assess whether the prevailing mood about a certain sector or an asset is bearish or bullish.

In that way, traders may use sentiment analysis in combination with other tools, such as technical or fundamental analysis, to help guide investment decisions.

Key Points

• Market sentiment is an expression of how investors feel about stocks, individual companies, or the market as a whole.

• Understanding market sentiment and how it influences asset price movements can be useful when making trading decisions.

• There are several indicators investors can use to gauge market sentiment; each of which measures a different aspect of investor outlook.

• Sentiment analysis does not guarantee specific outcomes, and price changes can occur swiftly if the mood of the market shifts.

What Is Market Sentiment, and Why Does It Matter?

Market sentiment is a measurement of the current market temperature viewed through investors’ eyes. Paying attention to stock market insights can help you be a more informed investor.

Sentiment is typically discussed in terms of whether the market mood around trading stocks or other assets is “bullish” or “bearish.”

• Bearish sentiment indicates pessimism among investors and is marked by a period of declining stock prices. A bear market occurs when the price of an index drops by 20% or more over at least a two-month period.

• Bullish sentiment suggests that investors are optimistic, with prices rising. A bull market happens when the price of an index rises by 20% or more over at least a two-month period.

Is a bull vs. bear market better? Market sentiment doesn’t indicate whether a particular investment is a good buy or a bad one, nor can it accurately predict which way stock prices will move. Instead, it’s a tool for understanding how investor psychology can impact market movements.

How Is Market Sentiment Measured? 5 Common Indicators

Market sentiment is measured using different indicators. An indicator is a mathematical model that uses market data to identify patterns or trends in price movements, which can be used when trading online or through a brokerage.

1. The CBOE Volatility Index (VIX) or “Fear Index”

The CBOE Volatility Index, or VIX, measures the 30-day expected volatility of the U.S. stock market, based on real-time prices for S&P 500 Index options. The VIX is a forward-looking indicator that measures future implied volatility.

Implied volatility means how much the market expects a stock or security’s price to swing over a set period. Whether the VIX, or Fear Index, is high or low offers insight into how investors are thinking in the short-term.

• When the VIX is high, implied volatility is high. Projected price swings typically move across a broader range.

• When the VIX is low, implied volatility is low. Projected price swings typically move across a narrower range.

Why it’s useful: The VIX helps investors gauge market moods and identify short-term trading opportunities. It’s also useful for developing defensive strategies when sentiment indicates that increased stock market volatility may be on the horizon.

2. The Fear & Greed Index

The Fear & Greed Index measures market sentiment on a scale from 0 to 100, with extreme fear at one end and extreme greed at the other. Where the Index falls on any given day is determined by seven indicators:

• Market momentum

• Stock price strength

• Stock price breadth

• Put and call options

• Market volatility

• Safe haven demand

• Junk bond demand

The Fear and Greed Index is updated regularly as underlying indicator data is refreshed.

Why it’s useful: The Fear & Greed Index gauges the mood of the market and how it motivates buying or selling behavior. It helps investors identify opportunities to buy stocks at a discount when fear is high, and sell investments at a profit when the market appears to be overvalued.

The Put/Call Ratio

The put/call ratio measures the number of puts versus the number of calls over a specified time frame. If you’re not sure what those terms mean, here’s a quick definition of each one:

• A “put” is an options contract that gives a buyer the right to sell shares of an underlying stock at a set price (called a strike price) by a certain date.

• A “call” is an options contract that gives a buyer the right to buy shares of an underlying stock at a set price by a certain date.

When you’re talking about puts and calls, you’re talking about options trading, a speculative investment strategy. So what does this have to do with market sentiment?

A high put/call ratio (above 1) indicates the market is bearish and prices may be on the decline. A low put/call ratio (below 1) suggests a bullish market, with prices set to rise.

Why it’s useful: If the PCR is high and prices are down, that could be a buying opportunity. If the PCR is low and prices are up, it could hint at inflated optimism and an overvalued market, in which case it could make sense to sell.

4. Bull/Bear Sentiment Surveys

Bull/bear sentiment surveys aim to gauge market feeling by asking a simple question: Where do you think the market is headed?

The American Association of Individual Investors (AAII) Sentiment Survey, for example, asks investors to rate whether they feel bullish, bearish, or neutral about the market looking ahead to the next six months. This investor sentiment survey is conducted weekly, and AAII maintains historical records that illustrate how bullish and bearish feelings have shifted over time.

For example, here’s how investors responded for the week ending August 13, 2025:

• Bullish (29.9%)

• Neutral (24%)

• Bearish (46.2%)

The historical averages for each category are 37.5% bullish, 31.5% neutral, and 31% bearish.

Why it’s useful: Bull/bear sentiment surveys put a finger on the pulse of how investors are thinking, and what they expect to see in the markets in the near term. Analyzing trends in sentiment from week to week can be useful in identifying potential market tops and bottoms, in conjunction with other indicators and analysis tools.

5. High/Low Indicators

High/low indicators look at stock prices measured in highs and lows over a set period. The NASDAQ 52-week high/low, for example, looks at stock prices over the previous 52 weeks. It’s a type of lagging indicator, meaning it looks backward at historical data, rather than forward, to make assumptions about market sentiment.

This indicator can tell you whether the market is trending bullish or bearish:

• A higher index suggests that more stocks are reaching new highs, and the mood of the market is bullish overall.

• A lower index indicates that more stocks are reaching new lows, and that the market is moving in a bearish direction.

Some high/low indicators use moving averages while others do not. A moving average reflects the average closing price of a stock over a specific period.

Why it’s useful: High/low indicators can be used with other types of technical indicators to either reinforce or contradict assumptions you might have made about the market, based on sentiment. Extreme highs or extreme lows on a high/low indicator may hint at favorable windows for buying or selling.

What Is Sentiment Analysis?

Sentiment analysis means reviewing data from one or more market indicators to understand what’s driving stock price movements, and/or where they may be going next. Essentially, you’re asking yourself two questions:

• How do investors feel about a stock/company/the market?

• What kind of trading activity are those feelings likely to translate to?

Sentiment analysis tools can make it easier to digest market sentiment data and get a feel for what’s happening and why it’s happening. There are pros and cons to this approach.

Advantages of Analyzing Market Sentiment

On the pro side, sentiment analysis can help you make connections between investor attitudes and their behavior. That could, in turn, make it easier to avoid missteps in periods of higher or lower volatility.

For example, you may be more inclined to buy into the market when others are panicking if you understand what’s behind the panic.

Downside of Using Market Sentiment

In terms of the cons, sentiment analysis is not a perfect science. If the underlying data that a sentiment indicator uses is flawed, for instance, that can skew results and potentially lead to mistimed investment decisions.

Likewise, following a single indicator without comparing it to other sentiment measures could create an incomplete picture of the market.

If you’re interested in how to do sentiment analysis, you may start with your online brokerage. Many brokerages offer access to proprietary sentiment analysis tools as an account benefit. There may be a slight learning curve you’ll have to master, but these tools can help you get a clearer idea of what’s driving the market.

How to Use Market Sentiment in Your Investment Strategy

Understanding market sentiment and insights can give you some powerful leverage when making investment decisions. So, how do you put it to work to grow your portfolio? Here are three possibilities for utilizing market sentiment as an investor.

Using Sentiment as a Contrarian Indicator

One of the biggest mistakes investors make is following the pack and allowing the overall mood of the market to pull them along. The 2008 financial crisis stands as a cautionary example of how fear can lead to panic selling and trigger a market crash.

Market sentiment, when viewed through a contrarian lens, embodies Warren Buffett’s advice to “be fearful when others are greedy and to be greedy only when others are fearful.” In other words, be worried about the markets when everyone else is buying in, and look for the buying opportunities when others are cashing out.

Sentiment analysis helps you determine when and if a particular market mood, such as panic, is justified and how to act accordingly. Taking this type of approach could potentially help you avoid unnecessary losses and/or purchase stocks at bargain prices.

The Risks of Relying Solely on Sentiment

Looking at market sentiment while excluding other types of indicators can put you at a disadvantage for a few reasons.

• Sentiment can change on the turn of a dime, which may not suit a long-term investing strategy.

• Rumors or misreported market news can trigger shifts in sentiment that don’t reflect the true condition of stock prices and valuations.

• Market sentiment doesn’t factor in fundamentals, which measure a company’s financial health and strength, leaving you with a limited picture of what a stock may truly be worth.

• Sentiment is tied to crowd behavior, and when the mood turns negative, that may spur panic-selling.

Combining technical indicators that measure market sentiment, along with fundamental indicators that are grounded in real-world data, can give you a more well-rounded view of market trends.

Using AI to Measure Market Sentiment

Artificial intelligence (AI) is reshaping the investment landscape, and a new crop of AI-driven sentiment analysis tools is changing the way investors study the markets. Whether you should use them or not depends on your stance on AI and the perceived benefits.

The advantage of using AI for market sentiment analysis is that it can digest large amounts of data quickly. If you’re day trading, speed matters. Mistiming a decision to buy or sell, even if you miss the mark by a few minutes, could have a significant impact on the amount of profit (or loss) you notch for the day. AI isn’t influenced by emotion either, so you can trust its analysis to be objective.

The disadvantage, of course, is that AI is still an imperfect tool. If the data being fed to an AI sentiment analysis tool is inaccurate, then its findings will be inaccurate too. You can also end up with skewed results when tools rely too heavily on historical data or analyze sentiment without any real understanding of the context behind it.

The Takeaway

Market sentiment affects what happens in the market, with negative sentiment potentially pushing prices down and positive sentiment driving them up. Sentiment analysis can help you understand how investors feel and what that, in turn, may mean for your portfolio.

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FAQ

Where can I find current market sentiment data?

You can find current market sentiment data using analysis tools or indicators that update in real-time. The Fear & Greed Index is one example; the AAII Sentiment Survey is another. When assessing market sentiment data, consider both the most recent numbers available as well as the historical data so you have some context for how they compare.

Is market sentiment the same as technical analysis?

No, they’re different tools. Market sentiment is a measure of how investors feel about the market at a particular moment. Technical analysis involves using various indicators to draw conclusions about stock trends and price movements. Many technical analysis tools take market sentiment into account, either directly or indirectly.

Can market sentiment predict a stock market crash?

No indicator can predict a stock market crash with 100% accuracy. While investor sentiment is often seen as an important factor that can contribute to market crashes, sentiment alone cannot tell you exactly when stocks will bottom out.

How do news and social media affect stock market sentiment?

News reports and social media posts can affect the way investors feel about the market. If news outlets report that a particular stock sector is reporting lower-than-expected earnings, for example, or an industry insider tweets a rumor about a major merger that may be upcoming, that can influence investors’ attitudes toward the market.

What is the difference between bullish and bearish sentiment?

Bullish sentiment means that investors feel optimistic about the market in general and that prices are trending upward. Bearish sentiment means that investors are more pessimistic and that stock prices are trending down.

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q325-050

Sep

2025

Payback Period: Formula and Calculation Examples

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

Table of Contents

What Is the Payback Period?
How to Calculate the Payback Period
Payback Period Formula (Averaging Method)
Payback Formula (Subtraction Method)
Benefits of Using the Payback Period
Downsides of Using the Payback Period
When Would an Investor Use the Payback Period?
FAQ

The payback period is when an investment generates enough cashflow or value to cover its initial cost. It’s the time it takes to get to the break-even point. Knowing the payback period is something that investors, corporations, and consumers use as a way to gauge whether an investment or purchase is likely to be profitable or worthwhile.

For example, if a $1 million investment in new technology is likely to increase company revenue by $200,000 a year, the payback period for that technology is five years.

A longer payback period is associated with higher risk, and a shorter payback period is associated with lower risk and a greater potential for returns. While calculating the payback period is fairly straightforward, it doesn’t take into account a number of factors, including the time value of money.

Key Points

• The payback period is the time it takes for an investment to generate enough cash flow or value to cover its initial cost, essentially reaching a break-even point.

• A shorter payback period generally indicates lower risk and a greater potential for returns, while a longer period is associated with higher risk.

• There are two primary methods for calculating the payback period: the averaging method (Initial Investment / Yearly Cash Flow) for consistent cash flows, and the subtraction method for variable cash flows.

• Benefits of using the payback period include its simplicity, ease of calculation, and its utility in risk assessment and comparing investment options.

• However, a key limitation of the payback period is that it does not consider earnings after the initial investment is recouped or the time value of money.

What Is the Payback Period?

The payback period is the amount of time it will take to recoup the initial cost of an investment, or to reach its break-even point.

Although investors who are thinking about buying stock in a certain company may want to consider the payback period for certain capital projects at that company (and whether those might support growth), the payback period is more commonly used for budgeting purposes by companies deciding how best to allocate resources for maximum return.

While the payback period is only an estimate, and it doesn’t factor in unforeseen or future outcomes, it’s a useful tool that can provide a baseline for assessing the relative value of one investment over another.

The Value of Time

The payback period can help investors decide between different investments that may be similar, when investing online or via a broker-dealer, as they’ll often want to choose the one that will pay back in the shortest amount of time.

The longer money remains locked up in an investment without earning a return, the more time an investor must wait until they can access that cash again, and the more risk there is of losing the initial investment capital.

How to Calculate the Payback Period

The payback period is calculated by dividing the cost of the investment by the annual cash flow until the cumulative cash flow is positive, which is the payback year. Payback period is generally expressed in years.

Prior to calculating the payback period of a particular investment, one might consider what their maximum payback period would be in order to move forward with the investment. This will help give them some parameters to work with when making investment decisions.

Payback Period Formula (Averaging Method)

There are two basis payback period formulas:

Payback Period = Initial Investment / Yearly Cash Flow

Using the averaging method, the initial amount of the investment is divided by annualized cash flows an investment is projected to generate. This works well if cash flows are predictable or expected to be consistent over time, but otherwise this method may not be very accurate.

Example of a Payback Period

If a company makes an investment of $1,000,000 in new equipment which is expected to generate $250,000 in revenue per year, the calculation would be:

$1,000,000 / $250,000 = 4-year payback period

If they have another option to invest $1,000,000 into equipment which they expect to generate $280,000 in revenue per year, the calculation would be:

$1,000,000 / $280,000 = 3.57-year payback period

Since the second option has a shorter payback period, this may be a more cost effective choice for the company.

Payback Formula (Subtraction Method)

Using the subtraction method, an investor can start by subtracting individual annual cash flows from the initial investment amount, and then do the division. This method is more effective if cash flows vary from year to year.

Payback Period = the last year with negative cash flow + (Amount of cash flow at the end of that year / Cash flow during the year after that year)

Example of Payback Period Using the Subtraction Method

Here’s an example of calculating the payback period using the subtraction method:

A company is considering making a $550,000 investment in new equipment. The expected cash flows are as follows:

Year 1 = $75,000
Year 2 = $140,000
Year 3 = $200,000
Year 4 = $110,000
Year 5 = $60,000

Calculation:

Year 0 : -$550,000
Year 1 : -$550,000 + $75,000 = -$475,000
Year 2 : -$475,000 + $140,000 = -$335,000
Year 3 : -$335,000 + $200,000 = -$135,000
Year 4 : -$135,000 + $110,000 = -$25,000
Year 5 : -$25,000 + $60,000 = $35,000

Year 4 is the last year with negative cash flow, so the payback period equation is:

4 + ($25,000 / $60,000) = 4.42

So, the payback period is 4.42 years.

Other factors

Investors might also choose to add depreciation and taxes into the equation, to account for any lost value of an investment over time.

Consumers may want to consider the payback period when making repairs to their home, or investing in a new amenity. For example: How long would it take to recoup the cost of installing a fuel-efficient furnace?

Benefits of Using the Payback Period

The payback period is simple to understand and calculate. It can provide individuals and companies with valuable insights into potential investments, and help them decide which option provides the best return on investment (ROI). It also helps with assessing the risk of different investments. Advantages include:

• Easy to understand

• Simple to calculate

• Tool for risk assessment

• Helps with comparing and choosing investment options

• Provides insights for financial planning

• Other calculations, such as net present value and internal rate of return, may not provide similar insights

• A look at the amount of time it takes to recoup an investment

Recommended: Stock Market Basics

Downsides of Using the Payback Period

Although the payback period can be a useful calculation for individuals and companies considering and comparing investments, it has some downsides.

A Limited Time Period

The calculation only looks at the time period up until the initial investment will be recouped. It doesn’t consider the earnings the investment will bring in after that, which may either be higher or lower, and could determine whether it makes sense as a long-term investment.

If earnings will continue to increase, a longer payback period might be acceptable. If earnings might decrease after a certain number of years, the investment may not be a good idea even if it breaks even quickly. On the other hand, an investment with a short lifespan could need replacement shortly after its payback period, making it a potentially poor investment.

Other Factors May Add or Subtract Value

The payback period also doesn’t take into consideration other ways an investment might bring value, such as partnerships or brand awareness. This can result in investors overlooking the long-term benefits of the investment since they’re too focused on short-term ROI.

The payback period equation also doesn’t take into account the effects an investment might have on the rest of the company’s operations. For instance, new equipment might require a significant amount of expensive power, or might not be able to run as often as it would need to in order to reach the payback goal.

The Time Value of an Investment

Another limitation of the payback period is that it doesn’t take the time value of money (TVM) into account. The time value of money is the idea that cash will be worth more in the future than it is worth today, due to the amount of interest that it can generate.

Not only does this apply to the initial capital put into an investment, but it’s also important because as an investment generates returns, that cash can then be reinvested into something else that earns interest or income. This is another reason that a shorter payback period could be viewed as an attractive investment.

When Would an Investor Use the Payback Period?

The payback period can apply to personal investments such as solar panels or property maintenance, or investments in equipment or other assets that a company might consider acquiring.

Often an investment that requires a large amount of capital upfront generates steady or increasing returns over time, although there is also some risk that the returns won’t turn out as hoped or predicted.

How Companies Use the Payback Period

Calculating payback periods is especially important for startup companies with limited capital that want to be sure they can recoup their money without going out of business. Companies also use the payback period to select between different investment opportunities or to help them understand the risk-reward ratio of a given investment.

Knowing the payback period is helpful if there’s a risk of a project ending in the future. For example, if a company might lose a lease or a contract, the sooner they can recoup any investments they’re making into their business the less risk they have of losing that capital.

Any particular project or investment can have a short or long payback period. A short period means the investment breaks even or gets paid back in a relatively short amount of time by the cash flow generated by the investment, whereas a long period means the investment takes longer to recoup. How investors understand that period will depend on their time horizon.

Test your understanding of what you just read.

The Takeaway

Understanding the potential payback period for a given investment can help you gauge possible risks and reward for a certain asset, because it helps you to calculate when you’re likely to recoup your initial investment. You can also use the payback period when making large purchase decisions and considering their opportunity cost.

Understanding the way that companies calculate their payback period is also helpful to determine their financial viability and whether it makes sense for you to invest in them as part of your portfolio.

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FAQ

What are the two payback period formulas?

Two of the simplest and most common payback period formulas are the averaging method and the subtraction method.

What does the payback period refer to in investing?

The payback period is the estimated amount of time it will take to recoup an investment or to break even. Generally, the longer the payback period, the higher the risk of the associated investment.

What are some downsides of using the payback period?

The payback period may not consider the earnings an investment brings in following an initial investment, or other ways that an investment could generate value. It also doesn’t take into account the time value of money.

Photo credit: iStock/MicroStockHub

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q325-070

Sep

2025

Institutional vs Retail Investors: What’s the Difference?

By Nina Semczuk | Growing Wealth, invest, Investing, Terminology | Comments Off

Table of Contents

Who Is Considered a Retail Investor?
Who Is Classified as an Institutional Investor?
What Are the Differences Between Institutional Investors vs Retail Investors?
Do Institutional or Retail Investors Get the Highest Returns?
How Many Retail Investors Are There?
Types of Institutional Investors
FAQ

Retail investors are individuals, typically not professional, who invest their own money through a personal brokerage or retirement account. Institutional investors are financial organizations that trade investments in large quantities, on behalf of others (e.g., pension funds, mutual funds, hedge funds, and so on).

While size and scale are two of the main differences between institutional vs. retail investors, there are other distinctions. Retail investors are afforded certain legal protections; institutional investors may have the upside in terms of research and access to capital.

In addition, retail investors typically pay higher fees for investment products, compared to institutions, which generally benefit from taking larger positions.

Key Points

• Retail investors are individual investors who typically invest their own money for their personal goals.

• Institutional investors include large organizations such as banks, mutual funds, and pension funds, which invest large amounts of capital on behalf of others.

• Institutional investors place trades on a much larger scale, which can impact market movements.

• Retail investors may be impacted by institutional trades, but the reverse rarely occurs, although there can be exceptions.

• Institutional investors typically have access to more capital and proprietary data and analysis that retail investors do not.

Who Is Considered a Retail Investor?

Any non-professional individual buying and selling securities such as stocks or mutual funds and exchange traded funds (ETFs) — whether investing online or in a traditional brokerage or other type of account — is typically a retail investor.

The parent who invests in their child’s 529 college savings plan, or the employee who contributes to their 401(k) are both considered retail investors.

So, in this case the term “retail” generally refers to an individual trading on their own behalf, not on behalf of a larger pool of investors. Retail here references the purchase and selling of investments in relatively small quantities.

Who Is Classified as an Institutional Investor?

By comparison, institutional investors make investment decisions on behalf of large pools of individual investors or shareholders. In general, institutional investors trade in large quantities, such as trading stocks by 10,000 shares or more at a time.

The professionals who do this large-scale type of investing typically have access to investments not available to retail investors (such as special classes of shares that come with different cost structures). By virtue of their being part of a larger institution, this type of investor usually has a larger pool of capital to buy, trade, and sell with.

Institutional investors are responsible for most of the trading that happens on the market. Examples of institutional investors include commercial banks, pension funds, mutual funds, hedge funds, endowments, insurance companies, and real estate investment trusts (REIT).

Recommended: Stock Market Basics

What Are the Differences Between Institutional Investors vs Retail Investors?

The main differences between institutional and retail investors include:

• Institutional investors invest on behalf of a large number of constituents (e.g., a mutual fund or municipal pension fund); retail investors are individuals who invest for themselves (e.g., in an IRA or a self-directed brokerage account).

• Size (large institutions vs. individuals) and scale of investments.

• Institutional investors typically have access to professional research and industry resources.

• Retail investors are protected by certain regulations that don’t apply to institutional investors.

Institutional Investors	Retail Investors
Professionals and large companies	Non-professional individuals
Invest in large quantities	Invest in small quantities
Trades less frequently; may manage retirement or invest as a hobby	Invest for themselves
Access to industry-level sources, research	DIY
Access to preferred share classes and pricing	Access to retail shares and pricing

There are very few similarities between institutional vs. retail investors, except that both parties tend to seek returns while minimizing risk factors where possible.

Retail vs. Institutional Investor

Do Institutional or Retail Investors Get the Highest Returns?

There are no crystal balls on Wall Street, as they say, so there’s no guaranteed way to predict whether institutional investors always get higher returns vs. retail investors.

That said, some institutional investors may have the edge in that they have access to industry-level research, as well as powerful technology and computer algorithms that typically enable them to make faster trades and more profitable calculations.

Does that mean institutional investors always come out ahead? In fact, retail investors who have a longer horizon also have a chance at substantial returns over time, although there are no guarantees on either side.

How Many Retail Investors Are There?

In the U.S., it’s fairly common to be a retail investor. About 62% of Americans say they own stock, according to a 2025 Gallup poll, meaning they own individual stocks, stock mutual funds, or they hold stock in a self-directed 401(k) or IRA.

Examples of retail investors include people who manage their retirement accounts online (e.g., an IRA) and those who trade stocks as a hobby.

Because individual investors are generally thought to be more prone to emotional behavior than their professional counterparts (and typically don’t have access to the resources and research of larger institutions), they may be exposed to higher levels of risk. Thus the Security Exchange Commission (SEC) provides certain protections to retail investors.

For example, the 2019 Regulation Best Interest rule states that broker-dealers are required to act in the best interest of a retail customer when making a recommendation of a securities transaction or investment strategy. This federal rule is intended to ensure that broker-dealers aren’t allowed to prioritize their own financial interests at the expense of the customer.

Another protection provided to retail investors is that investment advisors and broker-dealers must provide a relationship summary that covers services, investment fees and costs, conflicts of interest, legal standards of conduct, and more to new clients.

Types of Institutional Investors

The most common institutional investors are listed below.

1. Commercial Banks

Commercial banks are the “main street” banks many people are familiar with, such as Wells Fargo, Citibank, JP Morgan Chase, Bank of America, TD Bank, and countless others. Along with providing retail banking services, such as savings accounts and checking accounts, large banks are also institutional investors.

These large corporations have entire teams dedicated to investing in different markets: e.g., global markets, bond markets, socially responsible investing, and so on.

2. Endowment Funds

Typically connected with universities and higher education, endowment funds are often created to help sustain these nonprofit organizations. Churches, hospitals, nonprofits, and universities generally have endowment funds, whose funds often derive from donations.

Endowment funds generally come with certain restrictions, and have an investment policy that dictates an investment strategy for the manager to follow. This might include stipulations about how aggressive to be when trying to meet return goals, and what types of investments are allowed (some endowment funds avoid controversial holdings like alcohol, firearms, tobacco, and so on).

Another component is how withdrawals work; often, the principal amount invested stays intact while investment income is used for operations or new constructions.

3. Pension Funds

Pension funds generally come in two flavors:

• Defined contribution plans, such as 401(k)s or 403(b)s, where employees contribute what they can to these tax-deferred accounts.

• Defined benefit plans, or pensions, where retirees get a fixed income amount, regardless of how the fund does.

Employers that offer defined-benefit pension plans are becoming less common in the U.S. Where they do exist, they’re often linked to labor unions or the public sector: e.g., a teachers union or auto workers union may offer a pension.

Public pension funds follow the laws defined by state constitutions. Private pension plans are subject to the Employee Retirement Income Security Act of 1974 (ERISA); this act defines the legal rights of plan participants.

As for how a pension invests, it depends. ERISA does not define how private plans must invest, other than requiring that the plan sponsors must be fiduciaries, meaning they put the financial interest of the account holders first.

4. Mutual Funds

As defined by the Securities and Exchange Committee (SEC), mutual funds are companies that pool money from many investors and invest in securities such as bonds, stocks, and short-term debt. Mutual funds are thus considered institutional investors, and are known for offering diversification, professional management, affordability, and liquidity.

Typical mutual fund offerings include money market funds, bond funds, stock funds, index funds, actively managed funds, and target date funds.

The last category here is often designed for retail investors who are planning for retirement. The asset mix of these target date funds, sometimes known as target funds or lifecycle funds, shifts over time to become more conservative as the investor’s target retirement date approaches.

5. Hedge Funds

Like mutual funds, hedge funds pool money from investors and place it into securities and other investments. The difference between these two types of funds is that hedge funds are considered private equity funds, are considered high-risk vehicles, and are only available to accredited investors.

Because hedge funds use strategies and investments that chase higher returns, they also carry a greater risk of losses — similar to high-risk stocks. In general, hedge funds also have higher fees and higher minimum investment requirements. So, they tend to be more popular with wealthier investors and other institutional investors.

6. Insurance Companies

Perhaps surprisingly, insurance companies can also be institutional investors. They might offer products such as various types of annuities (fixed, variable, indexed), as well as other life insurance products which are invested on behalf of the investor, e.g. whole life or universal life insurance policies.

The Takeaway

Institutional investors may be larger, more powerful, and run by professionals — whereas retail investors are individuals who aren’t trained investment experts — but it’s important to remember that these two camps can and do overlap. Institutional investors that run pension funds, mutual funds, and insurance companies, for example, serve retail investors by investing their money for retirement and other long-term goals. While retail investors still have the ability to invest their own money for their own goals.

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FAQ

What are the different types of investors?

Institutional investors are big companies with teams of professional investment managers who invest other people’s money. Retail investors are individuals who typically manage their own investment (e.g. for retirement or college savings).

What percentage of the stock market is made up of institutional investors?

The vast majority of stock market investors are institutional investors. Because they trade on a bigger scale than retail investors, institutional trades can impact the markets.

Are institutional or retail investment strategies better?

Institutional investors have access to more sophisticated research and technology compared with retail investors. Thus their strategies may be considered more complex. But it’s hard to compare outcomes, as both groups are exposed to different levels of risk.

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

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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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Mutual Funds (MFs): 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 clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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.

This article is not intended to be legal advice. Please consult an attorney for advice.

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SOIN-Q325-131

Sep

2025

NBBO: What It Is and How It’s Calculated

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

Table of Contents

How Does “Bid vs Ask” Work in the Stock Market
What Is NBBO?
How NBBO and “Bid vs Ask” Prices Are Calculated
FAQ

NBBO — the National Best Bid and Offer — is a quote available marketwide that represents the tightest composite spread for a security, e.g., the highest bid price and the lowest ask price for that security trading on various exchanges.

The NBBO is a regulation put in place by the Securities and Exchange Commission (SEC) that requires brokers who are working on behalf of clients to execute a trade at the best available ask price, and the best available bid price.

Brokers must guarantee at least the NBBO to their clients at the time of a trade, per SEC rules.

Key Points

• The National Best Bid and Offer (NBBO) is a marketwide quote for the highest bid price and the lowest ask price for a security across exchanges.

• The SEC enacted the NBBO regulation to ensure brokers execute trades for clients at the best available bid and ask prices (the bid-ask spread).

• The bid-ask spread is the difference between the price an investor is willing to buy (bid) and the price a seller is willing to sell (ask).

• Securities Information Processors (SIPs) continuously process bid and ask prices to calculate and update the NBBO.

• There can be a slight lag in real-time data due to the high volume of transactions, which the SEC addresses with intermarket sweep orders (ISO).

How Does “Bid vs Ask” Work in the Stock Market

In order to understand NBBO, investors need to understand the bid-ask price of a security, such as a stock. This is also known as the spread (two of many terms investors and traders should know). If an investor is “bidding,” they’re looking to buy. If they’re “asking,” they’re looking to sell. It may be helpful to think of it in terms of an “asking price,” as seen in real estate.

The average investor or trader will typically see the bid or ask price when looking at prices for different securities. Most of the bid-ask action takes place behind the scenes, and it’s happening fast, landing on an average price. These are the prices represented by stock quotes.

That price is the value at which brokers or traders are required to guarantee to their customers when executing orders. NBBO requires brokers to act in the best interest of their clients.

What Is NBBO?

The National Best Bid and Offer (NBBO) is effectively a consolidated quote of the highest available bid and the lowest available ask price of a security across all exchanges. NBBO was created by the SEC to help ensure that brokers offer customers the best publicly available bid and ask prices when investors buy stocks online or through a traditional brokerage.

NBBO Example

Let’s run through a quick example of how the NBBO might work in the real world.

Let’s suppose that a broker has a few clients that want to buy stock:

• Buyer 1 puts in an order to the broker to buy shares of Company X at $10

• Buyer 2 puts in an order to the broker to buy shares of Company X at $10.50

• Buyer 3 puts in an order to the broker to buy shares of Company X at $11

Remember, these are “bids” — the price at which each client is willing to purchase a share of Company X.

On the other side of the equation, we have another broker with two clients that want to sell their shares of Company X, but only if the price reaches a certain level:

• Client 1 wants to sell their shares of Company X if the price hits $12

• Client 2 wants to sell their shares of Company X if the price hits $14

In this example, the NBBO for Company X is $11/$12. Why? Because these are the best bid vs. ask prices that were available to the brokers at the time. This is, on a very basic level, how calculating the NBBO for a given security might work.

Recommended: Stock Trading Basics

How NBBO and “Bid vs Ask” Prices Are Calculated

Because the NBBO is updated constantly through the day with offers for stocks from a number of exchanges and market players, things need to move fast.

Most of the heavy lifting in NBBO calculations is done by Securities Information Processors (SIPs). SIPs connect the markets, processing bid and ask prices and trades into a single data feed. They were created by the SEC as a part of the Regulation National Market System (NMS).

There are two SIPS in the U.S.: The Consolidated Tape Association (CTA) , which works with the New York Stock Exchange, and the Unlisted Trading Privileges (UTP) , which works with stocks listed on the Nasdaq exchange.

The SIPS crunch all of the numbers and data to keep prices (NBBO) updated throughout the day. They’re incredibly important for traders, investors, brokers, and anyone else working in or adjacent to the markets.

Is NBBO Pricing Up to Date?

The NBBO system may not reflect the most up-to-date pricing data. Bid, ask, and transaction data is changing every millisecond. For high-frequency traders that are making fast and furious moves on the market, these small price fluctuations can cost them.

To make up for this lag time, the SEC allows trading via intermarket sweep orders (ISO), letting an investor send orders to multiple exchanges in order to execute a trade, regardless of whether a price is the best nationwide.

The Takeaway

NBBO represents the crunching of the numbers between the bid-ask spread of a security, and it’s the price you’ll see listed on a financial news network or stock quote.

The NBBO adds some legal protection for investors, effectively forcing brokers to execute trades at the best possible price for their clients.

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FAQ

What does NBBO mean in trading?

The National Best Bid and Offer (NBBO) is a marketwide quote for the highest bid price and the lowest ask price available for a security, across exchanges. That means it’s a composite or consolidated quote that ensures investors are getting the best available price for a security.

What is Level 2?

Level 2 is a subscription-based service offered by Nasdaq that gives traders access to live trading data from the exchange, including bid-ask spreads and order sizes from market makers. Level 2 offers more in-depth information about pricing than NBBO, which is part of a Level 1 trading screen.

What is the advantage of NBBO?

First and foremost, NBBO helps protect investors, by ensuring the tightest spreads for securities prices. As such, NBBO also promotes market transparency and competition.

Photo credit: iStock/g-stockstudio

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q325-091

What Is Gamma in Options Trading?

What Is Gamma?

Calculating Gamma

Gamma Formula

Example of Gamma

How to Interpret Gamma

How Traders Use Gamma

Benefits and Risks of Using Gamma

Benefits of Gamma

Risks of Gamma

How Does Volatility Affect Gamma?

Using Gamma Along With Other Options Greeks

The Takeaway

FAQ

What is a good gamma for options?

Should gamma be high or low when trading options?

How do you trade options using gamma?

What is the best gamma ratio?

What happens to gamma when volatility increases?

A Beginner’s Guide to Understanding Market Sentiment

What Is Market Sentiment, and Why Does It Matter?

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How Is Market Sentiment Measured? 5 Common Indicators

1. The CBOE Volatility Index (VIX) or “Fear Index”

2. The Fear & Greed Index

The Put/Call Ratio

4. Bull/Bear Sentiment Surveys

5. High/Low Indicators

What Is Sentiment Analysis?

Advantages of Analyzing Market Sentiment

Downside of Using Market Sentiment

How to Use Market Sentiment in Your Investment Strategy

Using Sentiment as a Contrarian Indicator

The Risks of Relying Solely on Sentiment

Using AI to Measure Market Sentiment

The Takeaway

FAQ

Where can I find current market sentiment data?

Is market sentiment the same as technical analysis?

Can market sentiment predict a stock market crash?

How do news and social media affect stock market sentiment?

What is the difference between bullish and bearish sentiment?

Payback Period: Formula and Calculation Examples

What Is the Payback Period?

The Value of Time

How to Calculate the Payback Period

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Payback Period Formula (Averaging Method)

Example of a Payback Period

Payback Formula (Subtraction Method)

Example of Payback Period Using the Subtraction Method

Other factors

Benefits of Using the Payback Period

Downsides of Using the Payback Period

A Limited Time Period

Other Factors May Add or Subtract Value

The Time Value of an Investment

When Would an Investor Use the Payback Period?

How Companies Use the Payback Period

The Takeaway

FAQ

What are the two payback period formulas?

What does the payback period refer to in investing?

What are some downsides of using the payback period?

Institutional vs Retail Investors: What’s the Difference?

Who Is Considered a Retail Investor?

Who Is Classified as an Institutional Investor?

What Are the Differences Between Institutional Investors vs Retail Investors?

Do Institutional or Retail Investors Get the Highest Returns?

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How Many Retail Investors Are There?

Types of Institutional Investors

1. Commercial Banks

2. Endowment Funds

3. Pension Funds

4. Mutual Funds

5. Hedge Funds

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