May
26
2023
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5 Smart Ways to Handle Supplemental Income

By | Budgeting & Goals, Growing Wealth, invest, Investing | Comments Off on 5 Smart Ways to Handle Supplemental Income

Supplemental income is money that is earned above and beyond a person’s “regular” income, which, for most people, is earned through working a job.

Supplemental income could include income earned through a side hustle, or it could include money from a regular job that is extra: bonuses, overtime pay, tips, commissions, and so forth.

For many people, supplemental income can amount to “extra” money beyond what’s needed to cover their regular expenses. And there are some smart ways to handle that extra income, which may help people reach their financial goals sooner.

What Is Supplemental Income

As noted, supplemental income is money that is earned or otherwise accumulated beyond a typical income stream, like a paycheck. That can include bonuses or tips earned while working a job, too.

Supplemental income can also be earned in the form of a commission, by accumulating dividends on investments, or even by working a second job or side hustle.

There are numerous ways to tap into supplemental income streams, though that doesn’t mean that it’s necessarily easy. You should also know that there are generally two types of supplemental income: Active, and passive.

•   Active income: This is often defined as trading time for money. The person puts in time, whether that’s through taking photographs for websites or walking dogs, and is paid for their services in exchange. It’s a typical job, in other words.

•   Passive income: This kind of work involves little to no active investment in time once the gig is established. It could involve selling an uploaded ebook or affiliate marketing, as two examples.

For many people, a side hustle or second job is likely the quickest route to earning supplemental income. But there are government programs out there, too, that can help those in need, like the Supplemental Security Income program (SSI).

A Note About Supplemental Security Income

Supplemental Security Income (SSI) is a program administered by the Social Security Administration. SSI provides payments to people over the age of 65 who have a disability, including being blind or deaf. To qualify for Supplemental Security Income, people must also have limited financial resources, in addition to meeting the age and disability requirements. The purpose of the program is to help people meet their basic needs.

As the program is designed to help people meet their basic needs, some of the suggestions for handling supplemental income may not be applicable to those earning SSI benefits.That’s because those who do receive those benefits likely won’t have much room in their budget for additional spending, or the need to find ways to deploy that additional income — they’ll need it to cover their basic expenses.

Launching a Side Hustle

When choosing a side hustle or second job, it makes sense to pick one of interest to you; or, even better, one that inspires passion. This can help to prevent boredom and make it more likely that time and energy will continue to be invested in this income-generating activity. What hobbies, for example, can be monetized? Blogging? Making crafts or designing websites?

Ask yourself further questions: How much time can be invested in this side hustle? Can the required time ebb and flow as demands at the main job fluctuate? What resources are available to get started? And, perhaps most importantly, what’s the estimated earning potential?

Having a second job or side hustle isn’t terribly uncommon these days, as many people either need the extra money to make ends meet, or are looking for ways to pad their earnings to add to their savings or investment accounts.

One benefit of side hustles that are based on passive income is that, although work typically needs done up front to establish the side hustle, it shouldn’t need ongoing active involvement. And whether you’re renting out a room in your house, monetizing a blog, or writing ebooks to earn supplemental income, it’s important to keep some things in mind as you start to see that income roll in.

Tips for Using Your Extra Income

1. First, Manage Your Income Taxes

When working for an employer, relevant income taxes are typically withdrawn from each paycheck but, with a side hustle (one that doesn’t involve working for an employer and receiving a paycheck, that is), the worker is responsible for paying federal taxes, FICA, Medicare tax, and any state and local taxes on net income.

That’s because a “hustle” or “gig” is typically a form of self-employment. To help, the IRS has created a Gig Economy Tax Center with plenty of resources and pieces of important information, including that income taxes must be paid on side gig income of $400 or more annually.

Those earning money from a side gig may also need to pay estimated quarterly taxes. The deadline for these payments are:

•   April 15 for payment period January 1–March 31

•   June 15 for payment period April 1–May 31

•   September 15 for payment period June 1–August 31

•   January 15 for payment period September 1–December 31

At the tax-filing deadline, (typically mid-April), a Schedule C usually needs to be filed for people earning money in a self-employed side gig — and, when earning supplemental income, it’s important to deposit enough in a bank account so that funds don’t fall short when tax returns need to be filed. What’s left over after taxes are planned for can be spent in a variety of ways, some ideas might include:

•   Paying off “bad” debt.

•   Establishing an emergency savings account.

•   Saving and investing.

•   Enjoying some discretionary spending.

2. Paying Off “Bad” Debt

Bad debt can be defined, in general, as debt you acquire that results in a net loss. For example, going into debt for a vacation, a big party, clothes and/or gadgets doesn’t add to your net worth. Going into debt for your education or home may gradually add to your net worth in the future.

Bad debt can also refer to loan or lines of credit with higher interest rates, and which are harder to pay off as a result. Supplemental income can be used to pay this debt down or off.

Debt management plans to pay off debt include the snowball or avalanche methods — and a combo of the two, the fireball method. Different strategies work better for different people, so it can be worth experimenting with them to make the best choice.

With the snowball method, list bad debts by the amount owed, from the smallest to the highest. Include credit card debts, personal loans, and so forth. Then, make the minimum payment on each but put extra funds on the one with the smallest balance to get it paid off. Once that balance is zero, home in on the debt with the second smallest balance and keep using this strategy until all bad debt is paid off. Avoid using credit cards during this time.

With the avalanche method, list bad debt in order of its interest rate, from highest to lowest. Make minimum payments on all of them and put extra funds on the one with the highest rate. Pay it off and then move to the next highest rate, and so forth.

With the fireball method, take “bad” debt with interest rates of 7% or more and then list them from smallest to largest. Make the minimum payment on all and then put excess on the smallest of the “bad” debts. Rinse and repeat.

3. Establishing an Emergency Savings Account

Another smart idea is to put supplemental income into an emergency savings account. This can be accomplished in conjunction with a debt payment plan (put half of the excess funds into an emergency account and use the other half to pay down bad debt, for example) or as a single focused goal.

Funds in this account are intended for use if a financial emergency occurs. This can be a leaky roof that requires immediate attention, a significant car repair, or unexpected medical bills. Having a robust emergency fund can help to prevent the need to rely on credit cards to address unanticipated expenses.

It is commonly suggested that emergency savings accounts should contain 3-6 months’ worth of expenses. So, add those monthly bills up and multiply by three — and also by four, five, and six. This gives a range of the rainy-day fund’s goal.

4. Saving and Investing

You could save or invest your extra money! This can include saving for personal goals, from a down payment on a house to a vacation fund, and or for retirement. What’s important is to prioritize how it makes sense to use extra money being earned and then save and invest to help meet those goals. How you save or invest that money would be up to you, but you could look at some common investment choices including stocks, bonds, mutual funds, and alternative investments, and more.

5. Enjoy Some Discretionary Spending

Once the financial “need-to” items are checked off the list, it can be okay to use some supplemental income to have fun. You could update your wardrobe, buy a new video game, take in a movie, or even go out to a nice dinner. If it’s within your budget parameters, treating yourself every now and then can be a nice thing to do.

Plus, getting a taste of the finer things may help keep you motivated to make sure your spending stays in check and that you stick to your budget going forward.

The Takeaway

Supplemental income is extra income earned beyond your primary income stream, and finding ways to drive supplemental or secondary income can help you reach your financial goals sooner. It can also help you free up some room in your budget to potentially treat yourself every now and then.

You can also put that extra money to work, by saving it and earning interest, or investing it for the future.

Ready to use extra funds to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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

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.
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.
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May
26
2023
overhead view of businessman working, looking at business charts and graphs

What Is the Wash-Sale Rule?

By | Financial Independence, Growing Wealth, invest, Investing | Comments Off on What Is the Wash-Sale Rule?

A wash sale occurs when an investor sells a security at a loss, and buys a very similar security within a 30-day window of the sale (30 days before or after). The wash-sale rule is an Internal Revenue Service (IRS) regulation that states an investor can’t receive tax deduction benefits if they sell an investment for a loss, then purchase the same or a “substantially identical” asset within 30 days before or after the sale.

While investors may find themselves in a position in which it may be beneficial to sell securities to harvest losses, it’s important to know the wash-sale rule in and out to avoid triggering penalties.

Which Investments are Subject to the Wash-Sale Rule?

The wash-sale rule applies to most common investments, including:

•   Stocks

•   Bonds

•   Mutual funds

•   Options

•   Exchange-traded funds (ETFs)

•   Stock futures contracts

Transactions in an individual retirement account (IRA) can also fall under the wash-sale rule. The wash-sale rule does not apply to commodity futures or foreign currency trades. The rule also applies if an investor sells a security that has increased in value and within 30 days buys an identical security. They will need to pay capital gains taxes on the proceeds.

What Happens When You Trigger a Wash Sale?

Investors commonly choose to sell assets at a loss as part of their tax or day trading strategy, or they may regret selling an asset while the market was down, and decide to buy back in.

The intent of the wash-sale rule is to prevent investors from abusing the tax benefits of selling at a loss, and claiming artificial losses.

In the event that an investor does trigger a wash sale, they will not be allowed to write off the loss when they do their tax reporting to the IRS. This means the investor won’t receive any tax benefit for selling at a loss. The rule still applies if an investor sells an investment in a taxable account and buys it back in a tax-advantaged account, or if one spouse sells an asset and then the other spouse purchases it that also counts as a wash sale.

It’s important for investors to understand the wash-sale rule so that they account for it in their investment and tax strategy. If investors have specific questions, they might want to ask their tax advisor for help.

Recommended: Investing 101 for Beginners

Avoiding a Wash Sale

Unfortunately, the guidelines regarding what a “substantially identical” security is are not very specific. The easiest way to avoid wash sales is to create a long-term investing strategy involving few asset sales and not trying to time the market. Creating a diversified portfolio is generally a good strategy for investors.

Another important thing to keep in mind is the wash-sale rule applies across an investor’s accounts. As such, investors need to keep track of their sales and purchases across their entire portfolio to try and make sure that the wash-sale rule doesn’t affect any investment choices.

What to Do After Selling an Asset at a Loss

The safest option is to wait more than 30 days to purchase an asset after selling a similar one at a loss. An investor can also invest funds into a different asset–a different enough asset, that is–for 30 days or more and then move the funds back into the original security after the wash sale window has passed.

There are benefits to selling an asset at either a profit or a loss. If an investor sells at a profit, they make money. If they sell at a loss, they can declare it on their taxes to help offset their capital gains or income. If an investor has significant capital gains to report, they may decide to sell an asset that has decreased in value to help lower their tax bill. However, if they hoped to reinvest in an asset later, a wash sale can ruin those plans.

In some cases, simply selling a stock from one corporation and purchasing one from another, different corporation is fine. Even selling a stock and buying a bond from the same company may not trigger a wash sale.

Investing in ETFs or Mutual Funds Instead

If an investor wants to reinvest funds in a similar industry while avoiding a wash sale, one option would be to switch to an ETF or mutual fund. There are ETFs and mutual funds made up of investments in particular industries, but they are often diversified enough that they wouldn’t be considered to be too similar to an individual stock or bond. It’s possible that an investor could sell an individual stock and reinvest the money into a mutual fund or ETF within a similar market segment without violating the wash-sale rule.

However, if an investor wants to sell an ETF and buy another ETF, or switch to a mutual fund, this can be more challenging. It may be difficult to figure out which ETF or mutual fund swaps will count as wash sales, and which won’t.

Wash-Sale Penalties and Benefits

If the IRS decides that a transaction counts as a wash sale, the investor can’t use the loss to reduce their taxable income or offset capital gains on their taxes for that year.

However, there can be an upside to wash sales. Investors can end up with a higher cost basis for their new investment, because the loss from the sale is added to the cost basis of the new purchase. In addition, the holding period of the sold investment is added to the holding period of the new investment.

The benefit of having a higher cost basis is that an investor can choose to sell the new investment at a loss and have a greater loss for tax reporting than they would have. Conversely, if the investment increases in value and the investor sells, they will have a smaller capital gain to report. Having a longer holding period means an investor may be able to pay long-term capital gains taxes on a sale rather than short-term gains, which have a higher rate.

The Takeaway

The wash-sale rule is triggered when an investor sells a security at a loss, but then turns around and buys a similar security within 30 days–either before, or after. It’s a bit of an opaque rule, but there can be consequences for triggering wash sales. That’s why understanding regulations like the wash-sale rule is an important part of being an informed investor.

Part of making solid investing decisions is planning for taxes and understanding what the benefits and downsides may be for any particular transaction. This is just one aspect of tax-efficient investing that investors might want to consider.

Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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

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.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
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May
25
2023
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Tips on Evaluating Stock Performance

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Tips on Evaluating Stock Performance

Evaluating stock performance is not an exact science, and there are many factors, indicators, and tools that investors have at their disposal. However, it can be easy to get overwhelmed by the amount of information, charts, and choices available. After all, no amount of analysis can truly make accurate predictions about stock performance.

With this all in mind, for most investors, using a few simple strategies to evaluate stocks can provide a good understanding in order to help make an investment decision. Every investor has their own goals, investing and diversification strategies, and risk tolerance, so it’s beneficial for each person to come up with their own stock evaluation strategy.

Evaluating Stock Performance

Stock evaluation can involve both quantitative and qualitative analysis. Quantitative analysis involves looking at charts and numbers, whereas qualitative analysis looks into industry trends, competing firms, and other factors that can affect a stock’s performance. Both forms of analysis provide valuable information for investors, and they can be used in tandem to come up with a comprehensive picture of performance.

Here are a few key steps investors can take to evaluate stock performance or analyze a stock.

Total Returns

One of the most important metrics to look at when evaluating a stock’s performance is the total market return over different periods of time. A stock may have increased significantly in value within the past few days or months, but it could still have lost value over the past year or five years.

Investors may want to consider how long they plan to hold a stock and look into each stock’s historical performance. Some common periods to look at are the past year (52 weeks), the year to date (YTD), the five-year average return, and the 10-year average return. Investors can also look at the average annual return of a stock.

Every investor has different goals and expectations for returns. One investor might be happy with a 3% return over five years, while another might not be.

Using Indexes

Another step investors may want to take to evaluate a stock’s performance is comparing it with the rest of the stock market. A stock might seem like an attractive investment if it has had a 7% return over the past 52 weeks, but if the rest of the stock market has increased by more than that, there might be a better choice.

A single stock can be compared to the overall stock market using stock indexes. Indexes show averages of the market performance of a handful or even hundreds of stocks. Index performance metrics show how any particular stock compares to the broader market. If a stock has been performing similarly or better than the market, it may be a good investment.

Looking at Competitors

An additional way investors might consider evaluating a stock’s performance is by comparing it to other companies within the same industry. One might discover that an entire industry is doing well in the current market, or that another stock within the industry would actually be a better investment. There are numerous industries and market sectors.

Not every company within an industry will be a good comparison, so it’s best to look at companies of a similar size, those that have been around for a similar amount of time, or that have other similarities. Even if a giant, established corporation offers a similar product or service to a small startup, they may not be the best two stocks to compare within an industry.

Two questions investors might consider asking are:

•   Does the company have a competitive advantage? If the company has a unique asset or ability, such as a patent, a new research or manufacturing method, or great distribution, it may be more likely to succeed within the industry.

•   What could go wrong? This could be anything from poor management to a new form of technology making a company irrelevant. Nobody can predict the future, but if there are any red flags it’s important to pay attention to them.

Reviewing Company Revenue

Looking at stock returns is useful, but it’s also a good idea to look into the actual revenue of a company through its profit and loss statement, or earnings reports. Stock prices don’t necessarily follow a company’s revenue, but looking at revenue gives investors an idea about how a company is actually performing.

Like stock returns, investors can look at revenue over different periods of time. Revenue is categorized as operating revenue and nonoperating revenue. Operating revenue is more useful for investors to look at because non-operating revenue can include one time events such as selling off a major asset.

Using Stock Ratios in Evaluations

There are several financial ratios that can be used to evaluate a stock and find out whether it is currently under or overpriced in the market. These ratios can help investors gain an understanding about a company’s liquidity, profitability, and valuation. Some of the most commonly used ratios are:

Price to Earnings (P/E) Ratio

The most popular ratio for evaluating stock performance is the price to earnings ratio, or P/E ratio, which compares earnings per share to the share price. P/E is calculated by dividing stock share price by the company’s earnings per share. It’s important because a stock’s price can shoot up based on good news, but the P/E ratio shows whether the company actually has the revenues to back up that price. One can compare the P/E ratios of companies in the same industry to see which is the best investment.

There are two different ways to calculate P/E. A trailing P/E ratio can be calculated by dividing current stock price by earnings per share. A forward P/E ratio is a prediction that can be calculated by dividing stock price by projected earnings.

Price to Earnings Growth (PEG) Ratio

P/E is a useful ratio, but it doesn’t take growth into account. PEG looks at earnings, growth, and share price all at once. To calculate PEG, divide P/E by the growth rate of the company’s earnings. If the PEG is higher than 2, the stock may be overpriced, but if it’s under 1, the stock may be underpriced.

Price to Sales (P/S)

The price to sales ratio is calculated by dividing the company’s market capitalization by its 12-month revenue. If the P/S is low in comparison to competitors, it may be a good stock to buy.

Price to Book (P/B)

The P/B ratio looks at stock price compared to the book value of the company. The book value includes assets such as property, bonds, and equipment that could be sold. Essentially, the P/B looks at what the value of the company would be if it were to shut down and be sold immediately. This is useful to know because it shows the value of a company in terms of assets, rather than valuing it based on growth.

If the P/S is low, the stock may be a good investment because the stock might be underpriced.

Dividend Yield

Dividend yield is calculated by dividing a stock’s annual dividend amount by the current price of the stock. This gives investors the percentage return of a stock’s price. If the dividend yield is high, this means an investor may earn more cash from the stock. However, this can change at any time so isn’t a good long-term indicator.

Dividend Payout

The dividend payout ratio tells investors what percentage of company profits get paid out to shareholders. Companies that don’t pay out dividends or pay low dividends are likely reinvesting their profits back into the business, which could help the business continue to grow. Paying out dividends isn’t a negative thing, but if a company pays out high dividends they will have less money to reinvest and may not be able to continue to grow.

Return on Assets (ROA)

The ROA ratio compares a company’s income to its assets, which gives investors an indicator of how they handle their business.

Return on Equity (ROE)

ROE provides a calculation of how much profit a company makes with every dollar that shareholders invest. To calculate ROE, divide a company’s net income by shareholder equity. This gives an indication of how a company handles its resources and assets. However, as with every calculation, ROE doesn’t always provide a full and accurate picture of a stock’s performance. Companies can temporarily boost their ROE by buying back shares, which lowers the amount of equity held by shareholders.

Profit Margin

Profit margin compares a company’s total revenues to its profits. If a company has a high profit margin, this shows that a company is good at managing expenses, because they are able to keep revenue rather than spending it.

Current Ratio

The current ratio is calculated by dividing a company’s current assets by its current liabilities. This shows if a company will have enough money to pay off its debts. Current assets include cash and other highly liquid property. Current liabilities are any debts that a company must pay within one year.

Earnings Per Share (EPS)

This ratio is just what it sounds like, how much profit is a company generating per share of stock. A high EPS is a positive indicator. It’s a good idea for investors to look at EPS over time to see how it changes, because EPS could be boosted in the short term if a company has cut costs.

EPS is also useful for comparing different companies, since it gives a quick indication of how well each stock is doing. However, EPS doesn’t give a full picture of how a company is doing or how they manage their money, because some companies pay out earnings in the form of dividends, or they reinvest them back into the business.

Debt to Equity Ratio

Even if a company is growing and earning more profit, they could be doing so by getting into more and more debt. This could be a bad sign if they become unable to pay back their debts or if borrowing becomes more difficult. An ideal debt equity ratio is under 0.1, and over 0.5 is considered to be a bad sign.

Additional Factors

Aside from all the tools above, there are other factors to consider when evaluating a stock.

•   Dividends: If a stock pays dividends, investors may want to consider how those payments affect the overall returns of the stock.

•   Inflation: Factoring in how much inflation will affect stock returns is another helpful factor. This can be done by subtracting inflation amounts from a stock’s annual returns.

•   Analyst Reports: Another resource available to investors is Wall Street analyst reports put together by professional analysts. These can give in-depth insights into the broader market as well as individual companies.

•   Historical Patterns: Looking at past trends to get a sense of what the market might do in the coming months and years can help investors make informed decisions. Past trends aren’t predictions for the future, but they can still be useful.

The Takeaway

There are many tools available to help investors who are just getting started researching stocks and building a portfolio, and there’s no right or wrong way to evaluate stock performance. It can take a lot of time to gather information and research stocks, but investors can use tools to see everything at once and make quicker, more informed investment decisions.

If you’re ready to put your evaluation skills to the test, you can start investing in stocks and other securities to see if you’re on-point. But be aware that investing always involves risk.

Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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

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.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
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May
25
2023
What Is a Bear Put Spread?

What Is a Bear Put Spread?

By | Growing Wealth, invest, Investing | Comments Off on What Is a Bear Put Spread?

A bear put spread — also referred to as a debit put spread and as a long put spread — is an options trading strategy where a bearish trader purchases a put option at the same time as they sell another put option with a lower strike price and the same expiration date.

Essentially the bear put spread is a long put with the addition of a hedge of a short put to reduce risk. The level of risk is well defined; but it has limited profit potential.

Bear put spreads can be effective when you believe a stock price will fall to a specific level by the option’s expiration date. It is a net debit trade, so the most you can lose is the premium paid. While not as risky as shorting a stock, there is the risk that you will be assigned shares.

Bear Put Spread Definition

A bear put spread is an options strategy in which you purchase a high strike put and sell a low strike put. Like other options strategies, bear put spreads may be traded out-of-the-money (OTM), at-the-money (ATM), or in-the-money (ITM). You pursue this trade when you are bearish on a stock, have a downside price target, and have a time horizon.

The goal is for the underlying asset to be at or below the lower strike by expiration.

The trader will incur a debit (cost) equal to the price of the purchased put option less the price of the sold put option when they enter the trade. An investor loses the entirety of their debit if the underlying stock closes above the strike price of the long put (the higher strike price).

The closer the strike prices are to the price of the underlying asset, the higher the debit payment is. But a higher debit also means a higher potential profit.

How Does a Bear Put Spread Work?

First, a refresher on the two basic types of options: puts and calls. Options are a type of derivative that may allow investors to gain — not by owning the underlying asset and waiting for it to go up, but by strategically using options contracts to profit from the asset’s price movements.

For example, a bear put spread is one of many strategies for options trading. With a bear put spread the investor profits from a decline in the underlying stock price. It is not as bearish as buying puts outright since you are also selling a put. It also comes with lower risk than selling a put.

In options terminology, gains are maximized when the underlying asset trades at or below the lower strike price. A bear put spread is cheaper to put on since the sale of the lower strike put helps finance the trade.

Losses are limited to the debit (cost) incurred when the trade is entered. Those losses will be incurred if the underlying asset price closes above the strike price of the long put (higher strike price) at expiration.

Recommended: Bull vs Bear Markets

Maximum Profit

A bear put spread’s maximum profit is:

Width of strike prices – Premium (debit) paid

Maximum Loss

A bear put spread’s maximum loss is:

Premium paid

Break even

The break even point for a bear put spread is:

Strike price of the long put (higher strike) – Premium paid

Bear Put Spread Graph: Payoff Diagram

The profit and loss diagram below illustrates a bear put spread’s payoff. Assume a $100 strike put is bought at $4 and a $95 strike put is sold at $2. The break even in this example is $98 – the $100 strike minus the $2 net debit. Here’s where knowledge of the Greeks in options trading is key.

Bear Put Spread Payoff

Recommended: How Are Options Priced?

Impact of Price Changes

As the price of the underlying asset falls the bear put spread rises, and as the asset price rises the bear put spread value falls. The position is said to have a negative Delta since it profits when the underlying stock price falls.

Due to the dual-option structure of this trade, the rate of change in delta, known as Gamma, is minimal as the underlying asset price changes.

Impact of Volatility

The impact of volatility is minimized due to the dual option structure of the trade. Vega measures an option’s sensitivity to change in volatility. Between the short put and long put, the trade has a near-zero vega.

However, asset price changes can result in volatility affecting the price of one put more than the other.

Impact of Time

The impact of time decay, also known as theta, varies based on the asset price relative to the strike prices of the two options.

When the asset price is above the long put strike price, the value of the bear put spread decreases as time passes due to the long put decreasing in value faster than the short put.

When the asset price is below the short put strike price, the value of the bear put spread increases as time passes due to the short put decreasing in value faster than the long put.

When the asset price is between the strike prices the effect of theta is minimal as both options decay at the same rate.

Closing Bear Put Spreads

It’s generally a good strategy to close out a bear put spread before it expires, if it is profitable. If it has reached its maximum possible profit, the position should be closed out to capture the maximum gain.

Another reason to close a bear put spread position as soon as the maximum profit is reached is due to the risk of your short put being assigned and exercised. To avoid this situation you may close the entire bear put spread position, or keep the long put open and buy to close the short put.

If the short put is exercised a long stock position is created. You can close out the position by selling the stock in the market to close out your long position, or exercise the long put. Each of these options will incur additional transaction fees that may affect the profitability of your trade, hence the need to close out a maximum profit position as soon as possible.

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

Pros and Cons of Bear Put Spreads

Pros

 Cons
Not as risky as a short sale of stock You might be assigned shares
Works well with a moderate-to-large stock price drop Losses are seen when the stock price rises
Maximum loss is limited to the net debit Profits are capped at the low strike

Bear Put Spread Example

Shares of XYZ stock are currently trading at $100. You believe that the shares will decrease to $95 by the following month’s option expiration date. To enter into a bear put spread, you could purchase a $100 put for $4.00 at the same time as you sell a $95 put for $2.00. The sale of the low strike option helps to make your bearish wager less expensive since you collect that premium while paying for the high strike put option.

The maximum loss and net debit for this bear put spread is:

Premium paid = Cost of Long Put – Cost for Short Put

Premium paid = $4.00 – $2.00 = $2.00 net debit

Note: The $2.00 net debit is per share. Since an option contract is for 100 shares, the debit will be $200 per option contract.

The maximum profit for this bear put spread is:

Maximum profit = Width of strike prices – Premium paid

Maximum profit = $100 – $95 – $2.00 = $3.00 per share or $300 per option contract

The break even point for this trade is when the stock price reaches:

Break even = Strike price of long put – Premium paid

Break even = $100 – $2.00 = $98.00

Bear Put Spread vs Bear Call Spread

A bear put spread differs from a bear call spread — also known as a short call spread – in that the latter uses call options instead of put options. A bear call spread features a short call at a low strike and a long call at a higher strike. This strategy has a slightly different payoff profile compared to a bear put spread.

A bear call spread opens at a net credit, meaning proceeds from the sale of the low strike call are larger than the payment for the purchase of the long call at a higher strike. The maximum profit is limited to the net credit received when opening the trade.

The maximum loss on a bear call spread is limited to the difference between the low strike option and the high strike option, minus the credit received. The stock price is usually below the low strike when the trade is established.

The primary difference is that a bear call spread doesn’t require the underlying stock to decline to turn a profit. A flat stock price by expiration allows you to simply keep your net credit. In contrast, a bear put spread is done at a net debit, so the stock must fall to make money with a bear put spread.

Bear Put Spread

 Bear Call Spread
Buying a high strike put and selling a low strike put Buying a high strike call and selling a low strike call
Done at a net debit Done at a net credit
Underlying stock price must drop to make a profit Underlying stock can be neutral and still make a profit
Max loss is the premium paid Max gain is the premium received

When to Consider a Bear Put Spread Strategy

You should consider constructing a put bear spread when you are bearish on a stock and have a specific price target.

For example, if you believe XYZ stock will dip from $100 to $90, a bear put spread makes sense. You could buy the $105 put and sell the $90 put at a net debit.

If the stock indeed falls to $90 by the expiration date, then you keep the premium from the low strike short put and profit from a higher value on the high strike long put.

It also helps to have a timeframe in mind since you must choose your option’s expiration date.

Finally, a bear put spread should be considered when you have a bearish near-term outlook on a stock and seek to keep your capital outlay small.

A collar is another protective options strategy. You can learn about how collars work in options.

The Takeaway

Bear put spreads are used to place bearish bets on a stock. Executing a bearish outlook on a stock, while keeping costs in check, along with a defined maximum loss, are some of the benefits to a bear put spread.

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

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

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

FAQ

What is a bearish options strategy?

A bearish options strategy is an option trade betting that the underlying asset price will decline. If you are bullish, you believe an asset price will rise.

What is the maximum profit for a bear put spread?

The maximum profit for a bear put spread is the difference between the strike prices minus the premium paid.

Maximum profit = long put strike price – short put strike price – premium paid

What does it take for a bear put spread to break even?

A bear put spread strategy breaks even at expiration when the stock price is below the high strike by the amount of the net premium paid at the trade’s initiation.

Break even = long put strike price – premium paid

Photo credit: iStock/MicroStockHub

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.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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2023

How Do Employee Stock Options Work?

By | Building Your Career, Growing Wealth, invest, Investing, Life & Career | Comments Off on How Do Employee Stock Options Work?

Employee stock options (ESOs) are often included in an employee’s compensation package, and give those employees the opportunity to buy stock in their company at a certain price. Employee stock options have the potential to earn an employee some extra money, depending on the market.

Stock options can also give employees a sense of ownership (and, to a degree, actual ownership) in the company they work for. That can have benefits and drawbacks. But if you’re working in an industry in which employee stock options are common, it’s important to know how they work, the different types, and more.

What Are Employee Stock Options?

As mentioned, employee stock options give an employee the chance to purchase a set number of shares in the company at a set price — often called the exercise price — over a set amount of time. Typically, the exercise price is a way to lock in a lower price for the shares.

This gives an employee the chance to exercise their ESOs at a point when the exercise price is lower than the market price — with the potential to make a profit on the shares.

Sometimes, an employer may offer both ESOs and restricted stock units (RSUs). RSUs are different from ESOs in that they are basically a promise of stock at a later date.

Employee Stock Option Basics

When discussing stock options, there are some essential terms to know in order to understand how options — general options — work. (For investors who may dabble in options trading, some of these terms may be familiar but options trading doesn’t have any bearing on employee stock options.)

•   Exercise price/grant price/strike price: This is the given set price at which employees can purchase the stock options.

•   Market price: This is the current price of the stock on the market (which may be lower or higher than the exercise price). Typically an employee would only choose to exercise and purchase the options if the market price is higher than the grant price.

•   Issue date: This is the date on which you’re given the options.

•   Vesting date: This is the date after which you can exercise your options per the original terms or vesting schedule.

•   Exercise date: This is the date you actually choose to exercise your options.

•   Expiration date: This is the date on which your ability to exercise your options expires.

How Do Employee Stock Option Plans Work?

Again, when you’re given employee stock options, that means you have the option, or right, to buy stock in the company at the established grant price. You don’t have the obligation to exercise your options, but you have the ability to do so if it makes sense to you.

Exercising your stock options means choosing to actually purchase the stock at the given grant price, after a predetermined waiting period. If you don’t purchase the stock, then the option will eventually expire.

ESO Vesting Periods

Typically, employee stock options come with a vesting period, which is basically a waiting period after which you can exercise them. This means you must stay at the company a certain amount of time before you can cash out.

The stock options you’re offered may be fully vested on a certain date or just partially vested over multiple years, meaning some of the options can be exercised at one date and some more at a later date.

ESO Example

For example, imagine you were issued employee stock options on Jan. 1 of this year with the option of buying 100 shares of the company at $10/share. You can exercise this option starting on Jan. 1, 2023 (the vesting date) for 10 years, until Jan. 1, 2033 (the expiration date).

If you choose not to exercise these options by Jan. 1, 2033, they would expire and you would no longer have the option to buy stock at $10/share.

Now, let’s say the market price of shares in the company goes up to $20 at some point after they’ve vested on Jan. 1, 2023, and you decide to exercise your options.

This means you decide to buy 100 shares at $10/share for $1,000 total — while the market value of those shares is actually $2,000.

Exercising Employee Stock Options

It bears repeating: You don’t need to exercise your options unless it makes sense for you. You’re under no obligation to do so. Whether you choose to do so or not will likely depend on your financial situation and financial goals, the forecasted value of the company, and what you expect to do with the shares after you purchase them.

If you plan to exercise your ESOs, there are a few different ways to do so. It’s worth noting that some companies have specifications about when the shares can be sold, because they don’t want you to just exercise your options and then sell off all your stock in the company immediately.

Buy and Hold

Once you own shares in the company, you can choose to hold onto them — effectively, a buy-and-hold strategy. To continue the example above, you could just buy the 100 shares with $1,000 cash and you would then own that amount of stock in the company — until you decide to sell your shares (if you do).

Cashless Exercise

Another way to exercise your ESOs is with a cashless exercise, which means you sell off enough of the shares at the market price to pay for the total purchase.

For example, you would sell off 50 of your purchased shares at $20/share to cover the $1,000 that exercising the options cost you. You would be left with 50 shares.) Most companies offering brokerage accounts will likely do this buying and selling simultaneously.

Stock Swap

A third way to exercise options works if you already own shares. A stock swap allows you to swap in existing shares of the company at the market price of those shares and trade for shares at the exercise price.

For example, you might trade in 50 shares that you already own, worth $1,000 at the market price, and then purchase 100 shares at $10/share.

When the market price is higher than the exercise price — often referred to as options being “in the money” — you may be able to gain value for those shares because they’re worth more than you pay for them.

Why Do Companies Offer Stock Options?

The idea is simple: If employees are financially invested in the success of the company, then they’re more likely to be emotionally invested in its success as well, and it can increase employee productivity.

From an employee’s point of view, stock options offer a way to share in the financial benefit of their own hard work. In theory, if the company is successful, then the market stock price will rise and your stock options will be worth more.

A stock is simply a fractional share of ownership in a company, which can be bought or sold or traded on a market.

The financial prospects of the company influence whether people want to buy or sell shares in that company, but there are a number of factors that can determine stock price, including investor behavior, company news, world events, and primary and secondary markets.

Tax Implications of Employee Stock Options

There are two main kinds of employee stock options: qualified and non-qualified, each of which has different tax implications. These are also known as incentive stock options (ISOs) and non-qualified stock options (NSOs or NQSOs).

Incentive Stock Options (ISO)

When you buy shares in a company below the market price, you could be taxed on the difference between what you pay and what the market price is. ISOs are “qualified” for preferential tax treatment, meaning no taxes are due at the time you exercise your options — unless you’re subject to an alternative minimum tax.

Instead, taxes are due at the time you sell the stock and make a profit. If you sell the stock more than one year after you exercise the option and two years after they were granted, then you will likely only be subject to capital gains tax.

If you sell the shares prior to meeting that holding period, you will likely pay additional taxes on the difference between the price you paid and the market price as if your company had just given you that amount outright. For this reason, it is often financially beneficial to hold onto ESO shares for at least one year after exercising, and two years after your exercise date.

Non-qualified Stock Options (NSOs or NQSOs)

NSOs do not qualify for preferential tax treatment. That means that exercising stock options subjects them to ordinary income tax on the difference between the exercise price and the market price at the time you purchase the stock. Unlike ISOs, NSOs will always be taxed as ordinary income.

Taxes may be specific to your individual circumstances and vary based on how the company has set up its employee stock option program, so it’s always a good idea to consult a financial advisor or tax professional for specifics.

Should You Exercise Employee Stock Options?

While it’s impossible to know if the market price of the shares will go up or down in the future, there are a number of things to consider when deciding if you should exercise options:

•   the type of option — ISO or NSO — and related tax implications

•   the financial prospects of the company

•   your own investment portfolio, and how these company shares would fit into your overall investment strategy

You also might want to consider how many shares are being made available, to whom, and on what timeline — especially when weighing what stock options are worth to you as part of a job offer. For example, if you’re offered shares worth 1% of the company, but then the next year more shares are made available, you could find your ownership diluted and the stock would then be worth less.

The Takeaway

Employee stock options may be an enticing incentive that companies can offer their employees: they present the opportunity to invest in the company directly, and possibly profit from doing so. There are certain rules around ESOs, including timing of exercising the options, as well as different tax implications depending on the type of ESO a company offers its employees.

There can be a lot of things to consider, but it’s yet another opportunity to get your money in the market, where it’ll have the chance to grow.

Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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

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.
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.
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