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Defensive Investment Strategy: Definition and Types

When the stock market is volatile, investors might wonder if their investment strategy makes sense for the specific conditions. After all, a volatile market may act as a drag on a portfolio, making it harder for an investor to meet their financial goals. So, some investors will employ a defensive investing strategy during times of economic stress, which is a way to manage a portfolio to minimize risk and protect capital.

With all investing strategies, it helps to know the upsides and downsides before committing to a particular path. Defensive investing, like other investing strategies, has pros, cons, and timing factors to consider for when it might make the most sense to use this strategy.

What Is a Defensive Investment Strategy?

A defensive investment strategy is a way investors try to minimize losses on their investments. The goal of a defensive investment strategy is to reduce the risk of losing principal while still generating modest returns. Investors who are risk-averse or nearing retirement and want to preserve the value of their assets may employ a defensive investment strategy.

The strategy is what the name suggests: defensive. Instead of an aggressive or offensive strategy, which targets high-growth assets and has the potential for high risk, a defensive strategy focuses on preserving a portfolio’s capital while still pursuing modest growth in the form of dividend or interest payments.

Generally speaking, an investor with a defensive strategy portfolio would likely try to diversify their holdings across industries and regions, invest in blue-chip stocks, regularly rebalance their portfolio, buy short-maturity bonds, and place stop-loss orders.

What Are Defensive Investments?

Defensive investments are designed to provide stable, long-term returns with minimum volatility. These types of investments are often considered relatively low risk and, therefore, suitable for investors looking to preserve their capital.

Typical investments in a defensive portfolio include:

•   High-quality, short-maturity bonds (such as U.S. Treasury notes)

•   Exchange-traded funds (ETFs) that mimic market indices

•   Large, high-quality established company stocks (i.e., blue-chip stocks)

•   Dividend-paying stocks. These investments may provide lower returns than assets in a growth-oriented portfolio, but they can help investors preserve their wealth and generate a steady income stream.

Additionally, investors may hold cash and cash equivalents, like money market accounts and certificates of deposit (CDs), in a defensive portfolio. The advantage to these conservative investments is that they’re liquid assets, meaning that if an investor needs cash quickly, they’re easily convertible.

5 Examples of Defensive Investments and Strategies

There are several different types of defensive investments and strategies, each with its unique set of advantages and disadvantages. Some of the most common types of defensive investment strategies include:

Portfolio Diversification

Diversifying your portfolio spreads your investment across a wide range of asset classes, such as stocks, bonds, and cash. The idea behind portfolio diversification is that by investing in various assets – like defensive stocks, blue-chip stocks, and high-quality bonds – you can reduce the overall risk of your portfolio and protect yourself against market downturns.

Some defensive stock sectors include utilities, consumer staples, and healthcare.

Portfolio Rebalancing

Another tool for defensive investing is portfolio rebalancing. A portfolio’s asset allocation will change depending on how the assets perform. For example, if the stock market is particularly strong, stocks may become a higher percentage of a portfolio than desired.

Rebalancing is when an investor or portfolio manager adjusts investments to reflect the agreed-upon asset mix. For defensive investing, it would likely be a smaller percentage of stocks and a higher percentage of bonds or other, more conservative investments.

Dollar Cost Averaging

A dollar cost averaging strategy is when you regularly invest a fixed amount of money in a particular asset, such as monthly or quarterly. This can help smooth out the market’s ups and downs and reduce your exposure to volatility.

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Value Investing

Value investing is a strategy in which you focus on investing in companies with strong balance sheets and solid performance track records. Searching for value stocks can help protect your portfolio from the risks associated with more speculative investments.

💡 Recommended: Value vs Growth Stocks

Stop Loss Orders

Defensive investing includes strategies such as using stop-loss orders to minimize losses. A stop-loss order is when an investor tells a stockbroker to sell a stock when its price falls to a predetermined level. Setting up stop-losses helps an investor shed falling stocks automatically to minimize losses.

Pros and Cons of Defensive Investing

A defensive investor may find the risk-averse nature of a conservative portfolio appealing, but it’s still critical to be aware of the pros and cons of this investing strategy.

Pros

Cons

Capital preservation Limited growth
Income generation Potential underperformance
Lower volatility Loss of purchasing power
Diversified portfolio Limited investments

Pros of Defensive Investing

Some of the advantages of using a defensive investing strategy include:

•   Capital preservation: Defensive investing focuses on preserving capital by investing in low-risk assets less likely to suffer significant losses in a volatile market. This can help investors avoid substantial losses and protect their wealth.

•   Income generation: Defensive investments often generate income through dividends or interest payments. This can provide investors with a regular stream of income they can use to meet their financial needs or to fund other investments.

•   Reduced volatility: Defensive investments are generally less sensitive to market fluctuations, making them less likely to experience significant price swings. This can make them a more stable option for investors who are risk-averse or have a low tolerance for stock volatility.

•   Diversification: A defensive investment strategy can help investors diversify their portfolios and reduce their overall risk. This can be especially beneficial for investors with concentrated holdings in a single asset or sector.

Cons of Defensive Investing

Some of the disadvantages of using a defensive investing strategy include the following:

•   Limited growth potential: Because defensive investments are generally less risky, they may offer a lower potential for high returns than investments in stocks or other growth-oriented assets. This means that investors who pursue a defensive strategy may miss out on opportunities for significant gains.

•   Underperformance in rising markets: Defensive investments may underperform in a bull market. Because these investments are designed to be less sensitive to market fluctuations, they may benefit less from increased market values. This can make them a less attractive option for investors who are looking to maximize their returns.

•   Loss of purchasing power: The income generated by defensive investments may not keep pace with inflation, which can erode the purchasing power of investors’ capital over time. This can make it difficult for investors to maintain their standard of living or meet their long-term financial goals.

•   Fewer investment options: Defensive investing typically involves investing in low-risk, income-generating assets such as government bonds and dividend-paying stocks. This limits the range of investment options available to investors and may not provide exposure to other asset classes or sectors that could offer higher returns.

When Is It Smart to Use a Defensive Investment Strategy?

When deciding how to invest, it’s important to know the options at hand, and when it’s best to employ a certain strategy.

For defensive investing, several factors come into play. If an investor is risk-averse, this type of conservative strategy may be recommended, as it typically offers less risk.

There are a number of reasons why an investor might be risk-averse. For example, a retiree on a fixed income could fall into this category, or, someone who has limited funds and not much wiggle room for losing capital.

Another possibility is someone who is nearing retirement, and who wishes to preserve the gains they made with earlier investing. An investor who wants to conserve money, yet still aim to outpace inflation, might also choose this strategy.

Outside of individual preferences and situations, defensive investing could be helpful in times of market downturn and volatility. In turbulent environments, a defensive investment strategy can help investors sleep at night by keeping assets in less risky investments.

During times of economic stress, investors might opt for a defensive strategy to help them hang on to capital. While no investment is risk free, shifting a portfolio to more conservative assets can help provide a cushion for volatility.

The Takeaway

A defensive investment strategy may be a useful way of mitigating risk and preserving the value of your investments. By understanding the different types of defensive strategies available, you can choose the approach that best suits your needs and goals.

You can start building a portfolio with a strategy that best suits your needs by opening a SoFi Invest® online brokerage account. With a SoFi Invest account, you can trade stocks, ETFs, IPOs, fractional shares, and more with no commissions for as little as $5.

Take a step toward reaching your financial goals with SoFi Invest.


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What Is a Bridge Loan?

Bridge Loan: What It Is and How It Works

A short-term bridge loan allows homeowners to use the equity in their existing home to help pay for the home they’re ready to purchase.

But there are pros and cons to using this type of financing. A bridge loan can prove expensive.

Is a bridge loan easy to get? Not necessarily. You’ll need sufficient equity in your current home and stable finances.

Read on to learn how to bridge the gap between addresses with a bridge loan or alternatives.

What Is a Bridge Loan?

A bridge loan, also known as a swing loan or gap financing, is a temporary loan that can help if you’re buying and selling a house at the same time.

Just like a mortgage, home equity loan, or home equity line of credit (HELOC), a bridge loan is secured by the borrower’s current home (meaning a lender could force the sale of the home if the borrower were to default).

Most bridge loans are set up to be repaid within a year.

How Does a Bridge Loan Work?

Typically lenders only issue bridge loans to borrowers who will be using the same financial institution to finance the mortgage on their new home.

Even if you prequalified for a new mortgage with that lender, you may not automatically get a bridge loan.

What are the criteria for a bridge loan? You can expect your financial institution to scrutinize several factors — including your credit history and debt-to-income ratio — to determine if you’re a good risk to carry that additional debt.

You’ll also have to have enough home equity (usually 20%, but some lenders might require at least 50%) in your current home to qualify for this type of interim financing.
Lenders typically issue bridge loans in one of these two ways:

•   One large loan. Borrowers get enough to pay off their current mortgage plus a down payment for the new home. When they sell their home, they can pay off the bridge loan.

•   Second mortgage. Borrowers obtain a second mortgage to make the down payment on the new home. They keep the first mortgage on their old home in place until they sell it and can pay off both loans.

It’s important to have an exit strategy. Buyers usually use the money from the sale of their current home to pay off the bridge loan. But if the old home doesn’t sell within the designated bridge loan term, they could end up having to make payments on multiple loans.

Bridge Loan Costs

A bridge loan may seem like a good option for people who need to buy and sell a house at the same time, but the convenience can be costly.

Because these are short-term loans, lenders tend to charge more upfront to make bridge lending worth their while. You can expect to pay:

•   1.5% to 3% of the loan amount in closing costs

•   An origination fee, which can be as much as 3% of the loan value

Interest rates for bridge loans are generally higher than conventional loan rates.

Repaying a Bridge Loan

Many bridge loans require interest-only monthly payments and a balloon payment at the end, when the full amount is due.

Others call for a lump-sum interest payment that is taken from the total loan amount at closing.

A fully amortized bridge loan requires monthly payments that include both principal and interest.

How Long Does It Take to Get Approved for a Bridge Loan?

Bridge loans from conventional lenders can be approved within a few days, and loans can often close within three weeks.

A bridge loan for investment property from a hard money lender can be approved and funded within a few days.

First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.


Examples of When to Use a Bridge Loan

Most homebuyers probably would prefer to quickly sell the home they’re in, pay off their current mortgage, and bank the down payment for their next purchase long before they reach their new home’s closing date.

Unfortunately, the buying and selling process doesn’t always go as planned, and it sometimes becomes necessary to obtain interim funding.

Common scenarios when homebuyers might consider a bridge loan include the following.

You’re Moving for a New Job, or Downsizing

You can’t always wait for your home to sell before you relocate for work. If the move has to go quickly, you might end up buying a new home before you tie up all the loose ends on the old home.

Or maybe you’ve fallen in love with a smaller home that just hit the market, decided that downsizing your home is the way to go, and you must act quickly.

Your Closing Dates Don’t Line Up as Hoped

Even if you’ve sold your current home, the new-home closing might be scheduled days, weeks, or even months afterward. To avoid losing the contract on the new home, you might decide to get interim funding.

You Need Money for a Down Payment

If you need the money you’ll get from selling your current home to make a down payment on your next home, a bridge loan may make that possible.

Bridge Loan Benefits and Disadvantages

As with any financial transaction, there are advantages and disadvantages to taking out a bridge loan. Here are some pros and cons borrowers might want to consider.

Benefits

The main benefit of a bridge loan is the ability to buy a new home without having to wait until you sell your current home. This added flexibility could be a game-changer if you’re in a time crunch.

Another bonus for buyers in a hurry: The application and closing process for a bridge loan is usually faster than for some other types of loans.

Disadvantages

Bridge loans aren’t always easy to get. The standards for qualifying tend to be high because the lender is taking on more risk.

Borrowers can expect to pay a higher interest rate, as well as several fees.

Borrowers who don’t have enough equity in their current home may not be eligible for a bridge loan.

If you buy a new home and then are unable to sell your old home, you could end up having to make payments on more than one loan.

Worst-case scenario, if you can’t make the payments, your lender might be able to foreclose on the home you used to secure the bridge loan.

Alternatives to Bridge Loans

If the downsides of taking out a bridge loan make you uneasy, there are options that might suit your needs.

HELOC

Rather than the lump sum of a home equity loan, a home equity line of credit lets you borrow, as needed, up to an approved limit, from the equity you have in your house.

The monthly payments are based on how much you actually withdraw. The interest rate is usually variable.

You can expect to pay a lower rate on a HELOC than a bridge loan, but there still will be closing costs. And there may be a prepayment fee, which could cut into your profits if your home sells quickly. (Because your old home will serve as collateral, you’ll be expected to pay off your HELOC when you sell that home.)

Many lenders won’t open a HELOC for a home that is on the market, so it may require advance planning to use this strategy.

Home Equity Loan

A home equity loan is another way to tap your equity to cover the down payment on your future home.

Because home equity loans are typically long term (up to 20 years), the interest rates available, usually fixed, may be lower than they are for a bridge loan. And you’ll have a little more breathing room if it takes a while to sell the old home.

You can expect to pay some closing costs on a home equity loan, though, and there could be a prepayment penalty.

Keep in mind, too, that you’ll be using your home as collateral to get a home equity loan. And until you sell your original home, unless it’s owned free and clear, you’ll be carrying more than one loan.

401(k) Loan or Withdrawal

If you’re a first-time homebuyer and your employer plan allows it, you can use your 401(k) to help purchase a house. But most financial experts advise against withdrawing or borrowing money from your 401(k).

Besides missing out on the potential investment growth, there can be other drawbacks to tapping those retirement funds.

Personal Loan

If you have a decent credit history and a solid income, typical personal loan requirements, you may be able to find a personal loan with a competitive fixed interest rate and other terms that are a good fit for your needs.

Other benefits:

•   You can sometimes find a personal loan without the origination fees and other costs of a bridge loan.

•   A personal loan might be suitable rather than a home equity loan or HELOC if you don’t have much equity built up in your home.

•   You may be able to avoid a prepayment penalty, so if your home sells quickly, you can pay off the loan without losing any of your profit.

•   Personal loans are usually unsecured, so you wouldn’t have to use your home as collateral.

The Takeaway

A bridge loan can help homebuyers when they haven’t yet sold their current home. But a bridge loan can be expensive. Is a bridge loan easy to get? Not all that easy. Only buyers with sufficient equity and strong financials are candidates.

If you find yourself looking to bridge the gap between homes, you might also consider a personal loan or a HELOC.

A personal loan is an alternative worth considering. SoFi offers fixed-rate personal loanss of $5,000 to $100,000 with no prepayment penalty.

And SoFi brokers a home equity line of credit. Access up to 95%, or $500,000, of your home’s equity.

Finally, once you’ve moved into your new home and sold the previous one, you’ll usually want a more traditional mortgage. SoFi can help there, too. Check out SoFi’s mortgage loan offerings.

And then find your rate in just a few clicks.


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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.


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Terms and conditions apply. Not all products are offered in all states. See SoFi.com/eligibility for more information.


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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Financial Charts

Understanding Stock Dilution

Stock dilution is when a company action increases the number of outstanding shares of its stock, typically reducing the ownership stake of current shareholders.

There are a number of ways share dilution can occur. Sometimes companies issue new stock as part of a secondary or follow-on offering in addition to the shares issued as part of its initial public offering (or IPO).

A company may create more shares through stock options for employees or board members as part of a compensation or retirement plan.

However the stock dilution happens, the increase in the number of shares means that each individual stockholder ends up owning a smaller, or diluted, portion of the company. This isn’t necessarily bad news for investors, however, as the issuance of these additional shares may be put toward the company’s debt or into research and development, potentially enhancing the company’s long-term value.

What Is Stock Dilution?

Stocks are shares of ownership in a company. Owning even one share of stock is like owning a tiny piece of the operations of a business.

When a company’s board of directors first makes the decision to take a company public, the IPO process allows a set number of shares of that company’s stock to trade on public stock exchanges. This initial number of shares is often called the “float.”

Any further issuance of stock (often referred to as a secondary offering) will result in the outstanding shares being diluted. (The same applies if the secondary offering occurs after a backdoor listing.) While this may or may not affect the price, it does impact current investors’ ownership stake.

Example of Stock Dilution

Let’s say a company has 10,000 shares of stock as part of its initial offering, and decides to issue 10,000 more shares as a secondary offering to raise more capital. In that case, existing investors could see a dilution factor of 50%. So if they previously owned 5% of the company, they would now own 2.5%.

Owing to a decrease in their percentage of ownership, stock dilution can also reduce the voting power of some shareholders.

How Does Stock Dilution Work?

There are any number of reasons that companies choose to issue secondary shares of stock. A company might want to give rewards to its employees or raise new capital.

Issuing new shares as a method of raising money can be a particularly desirable option because it allows a business to receive an infusion of cash without going into debt or having to sell any assets that belong to the company.

It should be noted that stock splits are separate events that do not result in dilution. And a stock buyback, which reduces the number of outstanding shares, can be a way of enhancing the value of the stock.

When a business has a standard split of its stock, investors who already hold that stock receive additional shares, so their ownership in the company stays the same. Dilution of stock only occurs when new shares are issued and sold to additional investors who hadn’t purchased shares before the secondary offering.

Reasons Why Stock Dilution Occurs

What is stock dilution, and why does it happen? When share dilution occurs, a company usually has its reasons for issuing the additional shares.

•   Additional shares may be sold to pay down debt or increase capital for R&D or other purposes.

•   Companies may offer stock options to employees as rewards or bonuses. When employees exercise these options, that increases the number of outstanding shares.

•   A company might issue stock warrants or bonds as another way of raising capital. But when or if these are converted to shares, they can be dilutive.

•   Some shareholders may push for an action that would end up diluting shares, as a way to reduce the power of smaller shareholders.

Is Stock Dilution Bad?

Stock dilution isn’t inherently bad or good, because the repercussions of diluting stock can affect all parties differently.

While all shareholders may see their ownership stake decrease, that will affect some more than others.

Even if shareholders are unhappy in the short term, the resulting cash infusion from making more shares available on the market can benefit the company long-term — which in turn might increase the value of the stock.

Stock Dilutions and Stock Price

When a company increases the number of outstanding shares, that action of course has an impact on earnings per share (EPS) as well as dividends — because there are now more shares on the market, or in investors’ hands. And when EPS and dividends effectively become diluted (or reduced) as well, that can impact the price per share.

So instead of looking only at basic EPS, investors should take into consideration convertible securities that may be outstanding as well. By understanding the whole picture, investors can arrive at the diluted earnings per share, which captures a more accurate picture of company fundamentals.

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How Does Stock Dilution Affect Investors?

When a company creates new shares of stock, the value of existing shares becomes diluted, meaning they decrease in value. If you’re thinking of cashing out stocks, this is something to consider.

Think of it like a birthday cake. At first, you and seven of your friends agree to each have one slice of cake. But then two of your other friends unexpectedly show up, also wanting cake. Now you have to slice the cake into 10 pieces rather than eight, so each piece will be smaller.

This scenario is similar to what happens when a company issues more shares of stock and stockholders see the value of their shares reduced.

The difference is that each share not only becomes like a smaller piece of the cake, but usually (but not always) becomes less valuable and entitles its holder to less company ownership and voting rights.

Stock Dilution and Dividends

For dividend-yielding stocks, dilution can also lead to smaller dividend payouts unless earnings per share rise enough to make up the difference.

Because more shareholders now have to be paid, paying the same dividend yield takes a heavier toll on profits.

If a company is only issuing new shares out of an attempt at raising new capital because their business is hurting, then they may have to cut dividends even deeper down the line or halt them altogether.

This has consequences for investors who hold equities for income. Dividend investors will do well to keep an eye on the number of shares outstanding for any stock, as well as how previous dilutions (if any) have affected dividends.

To be clear, dilution doesn’t have to affect dividends. Dilution cuts down on earnings per share (EPS) but not necessarily on dividends per share (DPS), but it’s likely it would.

While EPS measures a company’s profitability per each share of stock outstanding, DPS measures the value of dividends paid out to investors per each share of stock outstanding. A company can choose to keep DPS the same after dilution, although doing so will cut into the profits of their business to a larger extent than before.

The more dividends per share a company pays out, and the more shares there are, the more unsustainable the dividend is likely to become, since a company can only afford to pay so much of its profits out to investors.

The only way for big dividend payments to be sustainable is when a company is either growing rapidly or taking on lots of debt to finance its operations.

Other Stock Dilution Effects

Stock dilution has an impact on more than just the price of a stock or potential dividend payouts.

When additional shares are created, this reduces the stock’s earnings per share (there will be fewer earnings per share with more shares on the market) as well as the voting rights of the shareholder (holders of stocks sometimes get to cast a vote for important company decisions, like the addition or removal of board members).

In fact, income statements issued by companies often show both “basic” and “diluted” earnings per share (EPS) numbers. This allows for shareholders and investors thinking about purchasing the stock to see the effect that dilution would have if the maximum number of potential shares were to come into existence (through the use of unexercised stock options, for example).

Dilution of a stock can also have a positive impact on the stock’s valuation, however. That’s because the issuing of new shares being bought increases the stock’s market cap, as people buy those shares. If this momentum outpaces any selling caused by negative market views of the secondary offering, then share prices could rise.

Beyond the short-term, news-based influence of dilution, the long-term effects of new stock shares coming into existence depends largely on how a company’s management decides to spend the funds they just received.

Pros and Cons of Stock Dilution

While it’s easy to interpret stock dilution as a negative thing from the perspective of those who hold shares before the dilution occurs, the concept isn’t so one-sided.

When done in the right way for purposes that contribute to company growth, dilution can benefit both a company and its shareholders over the long-term.

When done recklessly or in an attempt at covering up bad business performance, dilution can provide a temporary cash flow boost that doesn’t solve any real problems and puts shareholders in a precarious position.

It comes down to whether or not a management team has a good reason for diluting their stock and what they choose to do with the funds raised afterward.

Pros of Stock Dilution

In some ways, dilution of stock can be a good thing. When new shares are used to reward managers and employees, this can indicate a company is growing and performing well, and that it wants to share some of its good fortune.

When new shares are issued at a price higher than what the stock is currently selling for, this can also be a win-win scenario. It indicates demand for shares while minimizing the share dilution that existing shareholders must endure.

Ideally, companies should have a good reason to issue new shares and use the resulting cash infusion in a productive manner. Raising money for a new product, research and development, or bringing on new and valuable employees might be some good reasons for dilution of a stock.

When a company dilutes its stock without good reason, or doesn’t use the proceeds in a productive way, then the cons of stock dilution are all that’s left.

Cons of Stock Dilution

In general, investors don’t take kindly to the concept of new stock shares being issued to internal shareholders, as it usually decreases the value of the stock and the ownership stake of those who already hold shares. To the investing public that has some kind of awareness of this, stock dilution can be seen as negative news.

Some of the things mentioned previously can also be considered cons of stock dilution: a decrease in earnings per share, less voting power for shareholders, or declining share prices.

Recurring, new stock issuances can be perceived as a warning sign by investors. If a company needs to keep diluting its stock to raise money, perhaps their business operations haven’t been performing well.

This perception might lead people to sell shares, resulting in a decline in the stock price. Sometimes this happens when a company merely announces that they might be issuing new shares in the future. The perception can become reality before anything even happens.

Stock Dilution vs Stock Splits

While share dilution and stock splits both increase the number of outstanding shares, a stock split has a different motive and different results.

A company often conducts a stock split to bring down the price per share. For example, a company trading at $200 per share could do a 4 to 1 stock split, bringing down the PPS to $50. Shareholders still hold the same dollar amount, but the number of shares they own has increased, so their ownership percentage doesn’t change.

Stock Dilution

Stock Split

Increases # of outstanding shares Increases # of outstanding shares
Used for capital infusion or for employee incentives/bonuses Used to reduce the stock price
Investors’ ownership stake is reduced Investors’ stake remains constant

Understanding Corporate Buyback

The opposite of a company creating more shares is when a company buys its own shares back. This is sometimes called a corporate buyback and reduces the number of shares outstanding, usually leading to a rise in the price of a stock (due to the law of supply and demand).

While this might be good for shareholders in the short-term, it can be a bad thing for a company overall, since the money used could have been spent to improve business operations instead.

Sometimes stock can become highly overvalued due to the practice of corporate share buybacks, leading to precipitous drops in prices later on.

Sometimes companies issue public statements detailing their exact plans for dilution as well as their reasons for doing so.

This way, both current and future investors can prepare accordingly. The news alone can sometimes lead to a stock selloff due to the fact that the concept of stock dilution is usually interpreted in a negative way by most investors.

Investors would do well to monitor the amount of shares a company has outstanding. If the number keeps increasing, earnings per share are likely to decline or stay flat while investor’s voting rights diminish in their influence.

And while a drop in share counts can be a good thing, they can cover up a lack of growth by boosting earnings per share without any real underlying growth happening.

The Takeaway

Stock dilution — when a company issues additional shares — is neither good nor bad, but it does have specific consequences for shareholders, who typically see their ownership stake decrease.

In some cases, the additional capital raised by the shares in a secondary offering (one that occurs after the IPO) can benefit a company long term by paying down debt or adding to its assets or intellectual capital. But stock dilution can impact earnings per share, as well as dividend payouts, which in turn can impact the price.

But if the company sees a gain, growth, or expansion from the additional revenue, that could boost the stock price. It’s just important for investors to understand what a stock dilution might mean.

If you’re ready to start investing in online, consider opening an Active Invest account with SoFi Invest. You can trade stocks, IPO shares, fractional shares, and more. SoFi doesn’t charge a commission. And SoFi members can access perks like complimentary financial planning.

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


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The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
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 . 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.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.

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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Green Bonds, Explained

Green Bonds, Explained

Green bonds are debt instruments used to raise money for new and existing environmental and sustainability projects while providing investors with steady returns, similar to ordinary bonds. Green bonds may help fund climate change mitigation and adaptation, renewable energy, conservation, waste management, transportation, and more.

To qualify as actual green bonds, these investments have to be certified by a third party, like the Climate Bonds Standard and Certification Scheme. Green bonds may offer investors certain tax benefits versus other kinds of bonds.

What Is a Green Bond?

A green bond is a type of fixed-income security that pension funds or institutional investors can buy. Individual investors can add green bonds to their portfolio by purchasing ETFs or mutual funds that include green bonds. They are issued by corporations, governments, and financial institutions to raise money for specific sustainability and environmental projects. The World Bank is one of the largest green bond issuers.

A green bond is similar to other types of bonds, but the money borrowed through their sale goes towards vetted projects that fit into pre-determined frameworks to meet sustainability standards.

Most green bonds are asset-linked bonds or “use of proceeds” bonds, where the money raised from the sale of the bonds is earmarked for green projects and backed by the issuer’s balance sheet. For example, “use of proceeds” revenue bonds use the issuer’s revenue as collateral; green project bonds rely on the assets and balance sheet of the particular project as collateral; and green securitized bonds where a group of projects are collateral.

Green Bonds vs Climate Bonds vs Blue Bonds

Green bonds can be structured in different ways and generally fall into the category of impact investing.

•   For example, the term green bond can cover a broad spectrum of projects, from renewable energy to waste management to climate change.

•   There are also climate bonds that put money specifically towards climate change projects such as reducing emissions or adapting infrastructure to changing climate conditions.

•   Blue bonds specifically fund water-related projects, such as cleaning up plastic from the oceans, marine ecosystem restoration and conservation, sustainable fisheries, and wastewater treatment projects.

How Do Green Bonds Work?

Green bonds work much the same as other types of bonds. They’re issued by an entity and pay a certain interest rate, with the main difference being that institutional investors are usually buying the bonds, not retail investors.

Who Issues Green Bonds?

When a company, government, or financial institution wants to raise money for a sustainability project, they might choose to issue green bonds, which can be purchased by individual or institutional investors. Generally green bond issuers are large municipalities or public corporations, because a strong credit rating provides the issuer with a better borrowing rate.

The difference between investing in a green bond and buying a traditional bond is the issuer publicly discloses their plans for how the money will be spent. Uses of the money must be considered ‘green’ for it to be marketed as a green bond. The issuer generally releases a pre-issuance report describing the projects the funds will be used for and their expected impact.

Certifying Green Bonds

Issuers don’t have to follow specific requirements to call their bond green, but many follow voluntary frameworks such as the Climate Bonds Standard (CBS) or the Green Bond Principals (BGPs). By following those frameworks the bond will have a higher rating and investors will be more likely to buy it.

The guidelines outline the types of projects funds are recommended to be used for, how to select green projects, and how to report on the use of funds and results of the bond issuance.

Third-party firms work with the issuer as underwriters, certifiers, and auditors to ensure the money is going towards quality projects and used in the ways the borrower claimed it would be.

The Importance of Pre-Issuance Reports

Many issuers also work with third parties to prepare pre-issuance reports. Those parties help validate the quality of the bond to the extent the issuer chooses. There are four levels of validation a third-party can provide:

1.    An external opinion about the quality of the bond

2.    Verification that the bond aligns with certain environmental and business goals and criteria

3.    Certification with a particular standard such as CBS or BGPs

4.    A bond rating or score

If an issuer plans to issue multiple bonds, they might develop their own green bond framework to outline their particular criteria, goals, and impact. Issuers can either sell directly to investors or go through an exchange that works with green bonds, like the Luxembourg Stock Exchange (LuxSE).

Since the process of creating and tracking a green bond is costly and time consuming, they tend to be issued for large-scale projects.

Once the bond is issued and money raised, the issuer puts the money towards the projects stated in the pre-issuance report. The project could either be directly funded and internally run, or the money could go towards a service company like an energy provider.

The green bond issuer then puts out regular public post-issuance reports to investors, usually on an annual basis. The reports describe the way money has been used, progress, and results of the projects.

Green Bond Principles

In 2014, a group of investment banks established four “Green Bond Principles” to help investors understand green bonds. The principles are:

1.    Use of Proceeds: How money is spent and what types of projects are included

2.    Process for Project Evaluation and Selection: How projects are chosen and vetted

3.    Management of Proceeds: How the money raised by the bond is managed

4.    Reporting: How project progress and impact is shared

Issuers

Issuers of green bonds can include federal, state or city governments, financial institutions, or corporations.

Some reasons a company, government, or financial institution might issue a green bond include:

•   The desire to promote one’s sustainability efforts and image

•   Attracting new investors looking specifically for ESG investment products

•   There can be tax benefits and incentives for issuing green bonds

•   Issuing green bonds can be a good way to raise low-cost capital

•   The issuer is looking to raise millions of dollars or more for particular sustainability projects

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Examples of Green Bonds

One example of a green bond is the World Bank Green Bond, which was developed in collaboration with Skandinaviska Enskilda Banken (SEB) and launched in 2008. SEB and the World Bank saw that there was a demand for a triple-A-rated fixed income product that supports climate change projects, so they developed the World Bank Green Bond in response.

Sale of the bonds raises money from investors looking for a fixed-income asset, and the money goes towards projects vetted by the World Bank that focus on mitigating and adapting to climate change.

Around $18 billion in World Bank Green Bonds have been issued since 2008. There have been 200 different bonds available in 25 currencies. Investors who buy the bonds can both earn a fixed amount and know that their money is going towards climate change mitigation and adaptation projects.

Other green bonds that have been issued by corporations include:

•   Goldman Sachs Renewable Power issued a 24-year, $500 million bond, certified by Sustainalytics, to use for solar energy projects

•   PNC Financial Services Group issued a 5-year, $650 million bond, using an internal green bond framework, to use for energy projects

•   Verizon Communications Inc. issued a 10-year, $1 billion bond to use for energy generation and storage, buildings, and land use projects

When Did Green Bonds Start?

In 2008, the first green bond was issued by the World Bank and European Investment Bank (EIB). The bond was rated AAA. After that it took a few years for green bonds to take off, but since 2014 the market has grown significantly each year.

In 2013, the first USD 1 billion green bond issued by IFC sold out within just one hour after issuance. The first green bond issued by a corporation was issued in 2013 by Vasakronan.

Also in 2013, the first green muni bond was issued by Massachusetts, the first Green City bond was issued by Gothenburg, and the first solar asset-backed securities (ABS) were issued by SolarCity (now Tesla).

The Growth of the Green Bond Market

Over $1 trillion in green bond issuance has been put on the market since the first green bonds were issued in 2007.

Over the past 15 years, the green bond market has grown exponentially. In 2019, $51.3 billion in green bonds was issued in the U.S., and $257.7 billion in bonds was issued worldwide.

The largest green bond issuer is government-backed mortgage firm Fannie Mae in the United States. They issue 9% of the world’s green bonds. Green bonds have been issued by city governments and large corporations including Verizon, Pepsi, and Apple.

Although the U.S. currently has the biggest green bond market, it is projected to be overtaken by the EU in coming years. Between European companies and governments, about $300 billion has been allocated to green bond issuances over the next five years.

Investing In Green Bonds

Interest in sustainability, ESG, renewable energy, and climate change has increased significantly in recent years and is projected to keep growing. As investor interest grows, more and more green bonds are being made available with better disclosure and transparency to give investors peace of mind about the quality of the asset.

Investing in green bonds can be a good way for investors to put their money where their values are. Like other kinds of sustainable investing, ESG investing, or impact investing, green bonds are a way to both make money and make a positive difference in the world

While individuals can’t usually purchase green bonds directly, they can add them to their portfolio by purchasing certain ETFs and mutual funds.

Are Green Bonds a Good Investment?

Like other types of bonds, green bonds can be a relatively safe investment that provides fixed income without a high risk of loss. Bonds don’t tend to pay out high interest rates, but are less risky than other types of investments.

One risk of investing in green bonds is the phenomenon of greenwashing, where an issuer markets a bond as green but it doesn’t actually result in as much positive impact as advertised. A few questions an investor can explore to choose the best green bonds are:

•   Why is the bond being marketed as green?

•   What is the definition of green being used?

•   Is the issuer using a standard such as CBS and working with a third-party certifier?

•   Does the bond have an independent rating?

•   How will the use of funds and impacts be disclosed to investors?

•   Has the issuer issued green bonds in the past and what were the results and reporting standards?

Benefits Of Green Bonds

The main benefit of green bonds is they are designed help support sustainability projects (companies, new technologies) that support people and ecosystems around the world. Market demand is growing for green bonds, and they can be a good way to earn stable, low-risk interest.

Another benefit of green bonds is they can come with tax exemptions and tax credits, so investors might not have to pay income tax on the interest earned from the bond.

The Takeaway

Green bonds are an increasingly popular type of investment product that aim to help make the world a more sustainable place. When a company, government, or financial institution wants to raise money for a sustainability project, they might choose to issue green bonds.

Though green bonds work similar to other types of bonds, in that they’re a form of debt issued by an entity and pay a certain interest rate, the main difference is that institutional investors typically purchase the bonds, not retail investors.

Generally green bond issuers are large municipalities or public corporations, because a strong credit rating provides the issuer with a better borrowing rate.

Investors interested in adding green bonds to their portfolio can purchase ETFs and mutual funds that include green bonds. If you are interested in investing in green bonds through the purchase of fund shares, consider using SoFi Invest®. You can set up an Active Invest account seamlessly and security. The online investing platform lets you research and buy ETFs, stocks, and other assets right from your phone. All you need is a few dollars to get started with sustainable investing.

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


Photo credit: iStock/PeopleImages

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
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 . 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.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.

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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Guide to New Money vs. Old Money

Maybe you’ve heard people mention new money vs. old money in conversation, perhaps in a whisper. Old money and new money both refer to wealthy groups of people. The key difference between old money and new money is how a person obtained their wealth.

In short, old money represents generational wealth — money that has been passed on from generation to generation in the form of cash, investments, and property. New money refers to self-made millionaires and billionaires, those who earned their money (or lucked into it, like in the lottery).

Pop culture and literary references to new vs. old money abound. For instance, James Cameron’s Titanic (1997) includes a depiction of the “Unsinkable Molly Brown” as new money, shunned by some snooty old money types. F. Scott Fitzgerald’s The Great Gatsby puts new money (Jay Gatsby in West Egg) and old money (Tom and Daisy Buchanan in East Egg) at odds throughout the course of the novel.

Why should it matter when and how someone built their wealth? Let’s take a closer look at this topic, including:

•   What is considered new money vs. old money

•   The difference between old money and new money

•   Tips for building wealth.

What Is Old Money?

Old money refers to people who have inherited significant generational wealth; their families have been wealthy for several generations.

In the past, old money would have referred to an elite class: the aristocracy or landed gentry. In the U.S., families like the Vanderbilts and Rockefellers represented early examples of old money. Today, old money families include the Waltons (Walmart), the Disneys (The Walt Disney Company), and the Kochs (Koch Industries). Should families like the Kardashians continue to generate and pass down wealth, they could one day be considered old money as well.

Recommended: How to Build Wealth at Any Age

What Is New Money?

New money then refers to people who have recently come into wealth, typically by their own labor or ingenuity.
Common examples of new money include tech moguls and self-made billionaires like Jeff Bezos, Mark Zuckerberg, and Bill Gates. Someone who wins millions of dollars in the lottery or becomes famous from a reality TV series (like the cast of Jersey Shore) would also qualify as new money.

You may sometimes hear the French term “nouveau riche,” which means “newly rich.” This tends to describe people who recently became wealthy and spend their money in a flashy, ostentatious manner.

Recommended: Building Wealth in Your 30s

Differences Between Old and New Money

So what is the difference between old money and new money? There are quite a few distinctions, but remember that these are all generalizations. Each person who obtains wealth is unique.

Source of Wealth

The most obvious difference between new money and old money is the source of wealth. Old money has been passed down from generation to generation. Each member of old money typically feels a fierce responsibility to protect — and increase — that wealth.

Members of new money have earned that money in their lifetime, whether for building a tech empire, becoming a famous actor, making it to the big leagues as a sports player, or even making money on social media as an influencer. Some new money members might come into money through a financial windfall like winning the lottery or a major lawsuit.

Long-Standing Traditions

Inheriting generational wealth comes with a responsibility: Old money recipients usually must protect the family’s wealth to pass on to future generations. For that reason, those who come from old money may stick to their traditional investments and ways of life. Many inherit their parents’ business and then pass it on to their own children.

Those who are self-made or come into money quickly do not have long-standing traditions to fall back on. They are often the first in their community to make multimillion dollar spending decisions. This can mean a steep learning curve and the need for guidance, which could make them vulnerable to poor advice and unscrupulous hangers-on.

Spending and Investing

How old and new money generally approach wealth management is one of their starkest contrasts.

Though they do live lavishly, members of old money can be more frugal (or calculated) with purchases than you might expect. For members of old money, spending is often more about investing than shopping for pleasure.

People who are a part of new money may feel more entitled to and excited by their funds. They may spend it more lavishly (and publicly). Some might feel that they worked hard to earn their money — and they’d like to enjoy it.
They might want to show off their newly achieved status with designer watches or mega mansions.

That’s not to say that members of new money don’t invest. Famous celebrities, athletes, and businesspeople often invest in real estate or buy companies to increase their wealth. Generally speaking, new money might make riskier investment decisions for faster yields. They’re not thinking about generational wealth to protect with tried and true investment methods.

Taken to its extreme, this can have disastrous results. It’s not uncommon to hear stories of people who make a lot of money for the first time and spend it all, leading to bankruptcy and even mental health issues.

Recommended: What Is Asset Management?

Leisure

The stereotypes might be a little tired, but in general, people associate old money with traditional activities like golf, skiing, horseback riding, and polo. On the flip side, members of new money might buy courtside seats to a basketball game, a garage full of shiny new luxury cars, or even a rocketship for a joyride into outer space.

Recommended: Knowing the Difference Between ‘Rich’ and ‘Wealthy’

Social Perception

Interestingly, some of the richest people in the world come from new money. They’re today’s self-made tech giants. Yet some members of old money may consider themselves to be a higher class than the likes of Gates and Bezos.

We’re speaking in generalizations here, but old money often perceive themselves — and are perceived by outsiders — to be more educated and refined.

On the other hand, the public may view members of new money as harder workers and more innovative — clear examples of the American dream.

Old and New Money Lessons

What lessons can we learn from old and new money? Even if you are not wealthy, you can learn some valuable life and financial lessons from considering the difference.

•   It’s hard to protect generational wealth. Old money is very privileged; there’s no denying it. But most families lose their wealth in just a few generations. Old money families do work hard to maintain and grow their wealth for their future generations. They are able to avoid seeing their fortune dwindle.

•   It’s important to analyze your spending. Many people who come into wealth quickly don’t take adequate steps to protect their funds and invest it wisely. Horror stories of lottery winners losing everything should be enough to remind us that — if we come into a large amount of money suddenly — we should take the time with a finance professional to build out our money management goals. Doing so may ensure your wealth grows, rather than runs out.

•   Stereotypes aren’t everything. Reflecting on the differences between old and new money, it’s important to note that these are merely stereotypes, and not everyone fits the bill. Just as one hopes that others don’t judge us before they know us, the discussion of old vs. new money is a reminder not to form assumptions about someone until you get to know them.

Recommended: How to Achieve Financial Discipline

The Takeaway

Old money refers to families who have maintained wealth across several generations. New money, on the other hand, refers to someone who earned their wealth in their lifetime. Key traits typically differentiate old vs. new money, but at the end of the day, both refer to members of a wealthy class that most people will not ever be a part of.

No matter how much wealth you have — and whether you inherited or earned it — it’s a good idea to protect it in an FDIC-insured bank account that actively earns interest. Check out SoFi’s online bank account, which earns a competitive APY and has no monthly fees, which can help your money grow faster.

Better banking is here with up to 4.50% APY on SoFi Checking and Savings.

FAQ

Is it preferable to be from new or old money?

It depends on whom you ask. Old money members often regard themselves as a higher class, but they also have less agency to spend their money on “fun” things, as they have to guard their wealth for future generations. While members of new money might feel freer to spend on things they want, they can be more likely to run out of money if they don’t follow good financial planning.

Does new vs. old money matter?

If you are a member of the wealthy class, the distinction might matter to you. Those with old money might feel it’s superior to new, but those with newly minted wealth may well be proud of their success in building their fortune. However, most people are not considered to be new or old money, and so this shouldn’t affect their daily lives.

How has old vs. new money changed since the terms were first coined?

Old money once referred to the landed gentry in Europe, but in today’s world, it might refer to a few families who struck it big a century or more ago in the U.S. New money is more common nowadays, with the advent of television, sports, and social media as the source of riches.


Photo credit: iStock/South_agency

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.


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Interest rates are variable and subject to change at any time. These rates are current as of 8/9/2023. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
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