Apr
05
2023
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Investing as a HENRY (High Earner, Not Rich Yet)

By | Growing Wealth, invest, Investing | Comments Off on Investing as a HENRY (High Earner, Not Rich Yet)

Coined in 2003, the term HENRY, or “High Earner Not Yet Rich,” refers to people who make an above-average salary but still don’t manage to accumulate much wealth. The term is said to apply to one of two groups of people: 1) millennials who make between $100,000 and $200,000 per year, or 2) families that make roughly $250,000 to $500,000 per year.

But no matter their personal situations, HENRYs share something: namely, they make high incomes but aren’t saving a sizable chunk of their earnings. Despite taking home higher-than-average salaries, HENRYs’ expenditures leave little money left each month for either savings or income-producing investments.

Because of this, HENRYs are sometimes referred to as the “working rich.” If they were to stop working, they wouldn’t continue to be high earners since they make money mainly from their jobs. This is in contrast to ultra-high net worth individuals, who frequently own significant income-producing assets (like real estate holdings, revenue-creating businesses, or dividend-yielding stocks).

There are a few ways that HENRYs could potentially pull themselves out of their situation, though. Here’s a look at how.

Relocating to a More Affordable Area

One important factor for HENRYs to consider is location. Where an investor lives can make a huge difference in their ability to accumulate wealth. The cost of living can vary dramatically from region to region — as can state taxes.

The state of California, for example, has a state income tax rate of up to 13.30%. Meanwhile, Utah has a flat income tax rate of 4.85%, while Texas residents pay zero state income tax.

Living costs can have an even bigger impact on expenses than taxes. The median price of a home in Hawaii is $829,000. In West Virginia, it’s only $289,400 .

According to data published by Equifax, HENRYs tend to live in metro areas with higher costs of living, which may make growing assets harder. Choosing to relocate to a more affordable area might be an appealing option for those who can work remotely or transfer locations at their current jobs. Savings from a reduced cost of living could add up significantly over time.

It is worth noting that the average annual salary in more affordable areas is often lower as well, so HENRYs may want to investigate whether their jobs can be done remotely or if their skills are in high demand in other towns, cities, and states.

While moving may not be easy or simple, it could be one way for a high earner not rich yet to cut income-consuming costs and begin setting aside more money for wealth-aimed investments or savings.

Examining Tax Deductions

On top of local living expenses, another expense burden that tends to weigh heavily on many individuals, especially HENRYs, is taxes. Employees who earn higher salaries tend to pay more in income taxes. This is especially true in states that have state tax brackets that tax individuals at higher rates if they earn more money, as opposed to states with flat tax rates.

One common way to reduce income tax burdens is by contributing to a traditional individual retirement account, such as a 401(k) or IRA. (Contributions to Roth IRAs aren’t deductible). Some HENRYs might already have a retirement account through their employers. In that case, they may opt to make the maximum contribution, especially if their employer will match it.

Certain amounts of donations to qualifying charitable organizations can also be tax-deductible. Of course, if a high earner not rich yet has little disposable income left at the end of each month, sizable cash or non-cash property donations might not be a viable option for some.

For HENRYs who own a home, energy-efficiency tax benefits could be something to look into as well. Installing solar panels and solar-powered water heaters are among the most common items that can qualify for this kind of tax deduction. Others that are less common include geothermal heat pumps, renewable-energy fuel cells, and wind turbines. Energy-efficiency tax deductions can apply to a primary residence. And, where applicable, they can be claimed on other properties an individual might own.

HENRYs who have children and live in a state that allows it might be able to deduct 529 savings plan (aka a college fund) contributions from their state income taxes. Opening a 529 plan can address both how to pay for a child’s college expenses and, potentially, reduce state income tax liability.

A high earner not rich yet with no children could still open a 529 plan for friends, nieces, nephews, or even for themselves if they plan on going to college in the future. While 529 contributions aren’t tax-deductible on the federal level, the funds can grow tax-free. Plus, many states allow for the deduction of funds deposited into these accounts from state income taxes.

Paying Down Debt

It’s common for HENRYs to carry heavy debt burdens. Most often, this comes from student loans, a mortgage, auto loans, and credit card debt.

One reliable way to pay down debt is to make higher-than-minimum payments on debts carrying the highest interest rates. In this way, individuals can pay less in interest than if the higher rate debts were to continue compounding. Credit cards typically have the highest interest rates of any debt that most people carry (payday loans and some other types of unconventional loans might have higher rates still, but let’s assume HENRYs aren’t relying on these services).

For many borrowers, student loan debts can quickly become a problem. Interest rates on student loans can vary — especially if borrowers have a mix of federal and private student loans. And, when large enough payments aren’t made toward the principal or on already capitalized student loan interest, borrowers might get stuck with a lot of their monthly payments going toward accruing interest. In turn, this may make it difficult to quickly pay off outstanding educational debts.

Becoming as debt-free as possible can help individuals not relinquish income to interest payments.

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Diversifying Investments for the Future

Once the above items are taken care of, HENRYs could invest the extra income saved in ways that will help their money grow. Even investors in their 20s may want to research ways to start investing. Here’s a look at the types of investments HENRYs might consider.

Income-Producing Assets

Wealth, understood as an expanding total net worth, is the kind of thing HENRYs are aiming for but never seem to achieve — despite their high-earner incomes. Breaking this cycle could involve first cutting certain expenditures (i.e., cost of living or high-interest debt).

Then, individuals may opt to take some of their newly freed-up funds and invest in income-producing assets. Income-producing assets may span securities that bear interest or dividends — bonds, real estate investment trusts (REITs), and dividend-yielding stocks.

Recommended: Income vs. Net Worth: Main Differences

Dividend Reinvestment Programs (DRIPs)

HENRYs can take advantage of the power of compounding interest by utilizing what’s known as a dividend reinvestment program (DRIP). Enrolling eligible securities into a DRIP means that any dividends paid out will automatically be used to purchase shares of the same security.

With the DRIP approach to investing, the next dividend payment will be larger than the last. This is due to the fact that more shares will be held, and payments are made to shareholders in proportion to how many shares they own.

Exchange-Traded Funds

Given that some HENRYs might not have a lot of non-work time to actively manage their investments, passive investment vehicles like exchange-traded funds (ETFs) might be an additional investment option.

Many ETFs yield dividends, although those dividends tend to be somewhat smaller than those offered to individual shareholders of company stocks.

Real Estate

HENRYs often own their own home. As such, mortgage payments combined with interest can make up a substantial portion of their regular monthly expenses.

While some people opt to buy a home as an investment, hoping that the property will grow in value over the years, buying real-estate does not always guarantee a profitable return. Someone seeking to shirk their HENRY status could decide to switch or downsize to a less expensive apartment or home — assuming the cost of rent or a new mortgage is less than their current house payments. In some areas, rentals can be quite pricey, so it’s worth doing your homework to compare the pros and cons of renting vs. buying where you live.

When individuals can cut back on monthly housing expenses, it may then be possible to invest some of their freed-up income into additional assets. If an investor still wants to have exposure to property, they could choose to invest in REITs, which are known for having some of the highest dividend yields in the market.

Since REITs are required by law to pay a certain percentage of their income to investors in the form of dividends, it’s not surprising that they’re a favorite among investors seeking potential earnings. Naturally, as with any real estate investment, fluctuations in interest rates and demand may impact an REIT’s market performance.

Investing Now for the Future

When it comes time to start investing, there’s no need to wait until retirement is nigh. After all, the longer certain securities are owned, the more time they could potentially accrue value or that dividends could be paid out.

SoFi Invest® offers individuals the tools they need to start investing online, whether they’re a new investor, HENRY or experienced market watcher. Plus, with SoFi Invest, members can access complimentary financial planners, who can discuss the investor’s financial goals and help them map out various paths to a financial future.

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

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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.

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

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Apr
05
2023
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Pros & Cons of the 60/40 Portfolio

By | Growing Wealth, invest, Investing | Comments Off on Pros & Cons of the 60/40 Portfolio

There are many different strategies when it comes to building an investment portfolio, but each involves investing in a certain percentage of various assets, and some also involve buying and selling assets at particular times. One of the most popular strategies recommended by financial advisors is called the 60/40 portfolio, which involves building a portfolio that contains 60% equities (stocks) and 40% bonds.

Like any investment strategy, this simple long-term approach has both upsides and downsides. Let’s look into the details of the 60/40 portfolio, its pros and cons, and who it’s best suited for.

What Is the 60/40 Portfolio?

An investment portfolio divided as 60% stocks and 40% bonds is commonly understood as a “60/40 portfolio.”

The 60/40 portfolio is designed to withstand volatility and grow over the long-term. The strategy is that when the economy is strong, stocks perform well, and when it’s weak, bonds perform well. By holding more stocks than bonds, investors can take advantage of growth over time. Meanwhile, the bonds mitigate the risk of losing a huge amount during downturns.

60/40 Portfolio Historical Returns

Over the past century, the 60/40 portfolio was very popular because of its reliable returns. Although it hasn’t always performed as well as an equity-only portfolio, it carries less risk and is less volatile. However, historical returns aren’t necessarily an indicator of how the 60/40 portfolio will perform in the future.

Since 1928, a 60/40 portfolio containing 10-year U.S. Treasuries and the S&P 500 has had an average annual return of 9%. With inflation factored in, that return decreases to 5.9%.

The 60/40 portfolio grew 7000% since the 1970s, with only a 30% maximum decline. Unfortunately, returns on the 60/40 portfolio are predicted to be lower in the coming decades than they’ve been in the past. This is due to a few factors:

•   Inflation: As inflation increases, purchasing power decreases. Currently, a lot of bond yields aren’t even keeping up with the rate of inflation, and this may continue for a long time.

•   Real GDP growth: Real GDP is the amount of national economic growth minus inflation. As the economy has matured in recent years, the GDP has been growing more slowly than in decades prior.

•   Dividend yields: The amount that companies pay out through dividends is typically much lower now than it used to be.

•   Valuation: Companies are valued much higher than they used to be, and large companies are growing more slowly. As such, investors can expect slower growth in stock earnings.

How to Build a 60/40 Portfolio

The simplest way to build a portfolio with 60% equities and 40% bonds would be to purchase the S&P 500 and U.S. Treasury Bonds. This portfolio would include mostly U.S. investments, though some investors might choose to diversify into international investments by purchasing foreign stocks and bonds.

Financial advisors putting together a 60/40 portfolio for investors generally include high-grade corporate bonds and U.S.government bonds, along with index funds, mutual funds, and blue-chip stocks. This combination avoids taking on too much risk — which is a possibility when purchasing an unknown stock and it fails — and typically yields steady growth over time.

Investors may also choose to invest in exchange-traded funds (ETFs), which are mutual funds that are traded on an open market exchange (like the New York Stock Exchange), just like stocks. By investing in funds, investors increase their exposure to different companies and industries, thereby diversifying their portfolio. There are many types of ETFs. Some of them are groups of stocks within a particular industry, while others are grouped by company size or other factors.

If an investor were looking to generate income from their investments, they might choose to buy dividend-paying stocks and real estate investment trusts (REITs).

In terms of bonds, there are also a number of options. Investors might choose to buy municipal bonds, which earn tax-free interest, or high-yield bonds, which earn more than other bonds but come with increased risk.

It’s recommended that investors rebalance their portfolio annually to ensure the percentages remain on track.

Pros of the 60/40 Portfolio

The 60/40 portfolio is a simple strategy that has several upsides:

•   It can be very simple to set up, especially by purchasing the S&P 500 and U.S. Treasury Bonds.

•   It’s a “set it and forget it” investment strategy, needing only yearly rebalancing.

•   Holding bonds helps balance the risk of equity investments.

•   It typically offers steady growth over time.

Cons of the 60/40 Portfolio

Of course, as with any investing strategy, the 60/40 portfolio strategy comes with some downsides. While the 60/40 portfolio used to be the standard choice for retirement, people are now living longer and need a portfolio that will continue growing steadily and quickly to keep up with inflation. Here are some other factors to consider:

•   If investors buy individual stocks, they can be volatile.

•   Mutual funds and ETFs can have high fees.

•   Bonds tend to have low yields.

•   The strategy doesn’t take into account personal investment goals and factors, such as age, income, and spending habits.

•   Diversification is limited, as investors can also add alternative investments, such as real estate, to their portfolio.

•   There is the potential for both stocks and bonds to decline at the same time.

•   Over time, a 60/40 portfolio won’t grow as much as a portfolio with 100% equities. This is especially true over the long-term because of compounding interest earned with equities.

Who Might Use the 60/40 Portfolio Strategy?

Some investors can’t sleep if they’re afraid their stock portfolio is going to crater overnight. Using the 60/40 strategy can take some of that anxiety away.

The 60/40 strategy is also a viable choice for investors who don’t want to make a lot of decisions and just want simple rules to guide their investing. Beginner investors might decide to start out with a 60/40 portfolio and then shift their allocations as they learn more.

Additionally, those who are closer to retirement age may choose to shift from a stock-heavy portfolio to a 60/40 portfolio. This could help to reduce risk and ensure they have enough savings to fund their retirement.

Investors who have a high risk tolerance and are looking for a long-term growth strategy might not gravitate toward a 60/40 plan. Instead, they may choose to allocate a higher percentage of their portfolio to stocks.

Alternatives to the 60/40 Portfolio

In recent years, some major financial institutions have declared that the 60/40 portfolio is dead. They’ve instead been recommending that investors shift more toward equities, since bonds have not been returning significant yields and don’t provide enough diversification. Some suggest holding established stocks that pay dividends rather than bonds in order to get a balance of growth and stability. However, these recommendations are partly based on the fact that the current bull market is over, and they aren’t necessarily looking at the long-term market.

There are many other investment strategies to choose from, or investors might create their own rules for portfolio building. Here are a few common strategies to consider.

Permanent Portfolio

This portfolio allocates 25% each to stocks, bonds, gold, and cash.

The Rule of 110

This strategy uses an investor’s age to calculate their asset allocation. Investors subtract their age from 110 to determine their stock allocation. For example, a 40-year-old would put 70% into stocks and 30% into bonds.

Dollar-Cost Averaging

Using this strategy, investors put the same amount of money into any particular asset at different points over time. This way, sometimes they will buy high and other times they’ll buy low. Over time, the amount they spent on the asset averages out.

Alternative Investments

Investors may consider allocating a portion of their funds to alternative investments, such as gold, real estate, or cryptocurrencies. These investments may help increase portfolio diversification and could generate significant returns (although the risk of loss can also be significant).

The Takeaway

The 60/40 portfolio investing strategy — where a portfolio consists of 60% stocks and 40% bonds — is a popular one, but it’s not right for everyone. It carries less risk and is less volatile than a portfolio that contains only stocks, making it a traditionally safe choice for retirement accounts. However, experts worry that the current and expected future rate of return isn’t enough to keep up with inflation.

Still, for investors who want a simple “set it and forget it” investment strategy, the 60/40 portfolio can be appealing. Other investors may decide to investigate alternative strategies. Regardless of which direction investors go, the first step in building a portfolio is determining personal goals and then creating a plan based on expected income, time horizon, and other personal factors.

One easy way to get started building a portfolio is by using an online investing platform like SoFi Invest®. The investing platform makes it simple to buy and sell stocks and other assets right from your phone, and you can research and track your favorite stocks and set up personal investing goals.

Plus, SoFi offers both automated and active investing, so you can either select each stock you want to buy, or choose from pre-selected groups of stocks and ETFs. If you need help getting started, SoFi has a team of professional advisors available to answer your questions and assist you in creating a personalized financial plan to reach your goals.

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

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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.
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Apr
05
2023
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401(k) Hardship Withdrawals: What Are They and When Should You Use them?

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on 401(k) Hardship Withdrawals: What Are They and When Should You Use them?

A hardship withdrawal is the removal of funds from your 401(k) in response to a pressing and significant financial need. For people who find themselves in a financial bind where they need a large sum of money but don’t expect to be able to pay it back, a 401(k) hardship withdrawal may be an appropriate option.

But before making a withdrawal from a 401(k) retirement account, it’s important to understand the rules and potential drawbacks of this financial decision.

Who Is Eligible for a Hardship Withdrawal?

According to the IRS, an individual can make a hardship withdrawal if they have an “immediate and heavy financial need.”

However, not all 401(k) plans offer hardship withdrawals, so if you’re considering this option talk to your plan administrator — usually someone in an employer’s human resources or benefits department. Another way to get clarity on a particular 401(k) account is to call the number on a recent 401(k) statement and ask for help.

If a retirement plan does allow hardship withdrawals, typically you’ll be expected to present your case to your plan administrator, who will decide if it meets the criteria for hardship. If it does, the amount you are able to withdraw will be limited to the amount necessary to cover your immediate financial need.

In general, a hardship withdrawal should be considered a last resort. To qualify, a person must not have any other way to cover their immediate need, such as by getting reimbursement through insurance, liquidating assets, taking out a commercial loan, or stopping contributions to their retirement plan and redirecting that money.

What Qualifies as a Hardship?

You may be qualified for a hardship withdrawal if you need cash to meet one of the following conditions:

•   Medical care expenses for you, your spouse, or your dependents.

•   Costs related to the purchase of a primary residence, excluding mortgage payments. (Buying a second home or an investment property is not a valid reason for withdrawal.)

•   Tuition and other related expenses, including educational fees and room and board for the next 12 months of postsecondary education. This rule applies to the individual, their spouse, and their children and other dependents.

•   Payments needed to prevent eviction from a primary residence, or foreclosure on the mortgage of a primary residence.

•   Certain expenses to repair damage to a principal residence.

•   Funeral and burial expenses.

•   In certain cases, damage to property or loss of income due to natural disasters.

How Do You Prove Hardship?

A 401(k) provider may need to see proof of hardship before they can determine eligibility for a hardship withdrawal.

Typically, they do not need to take a look at financial status and will accept a written statement representing your financial need. That said, an employer cannot rely on an employee’s representation of their need if the employer knows for a fact that the employee has other resources at their disposal that can cover the need. In this case, the employer may deny the hardship withdrawal.

It’s important to note that employees do not have to use alternative sources if doing so would increase the amount of their financial need. For example, say an employee is buying a primary residence. They do not need to take on loans if doing so would hinder their ability to acquire other financing necessary to purchase the house.

How Much Can You Withdraw?

The amount a person can withdraw from their 401(k) due to financial hardship is limited to the amount that is necessary to cover the immediate financial need. The total can include money to cover the taxes and any penalties on the withdrawal.

In the past, hardship distributions were limited by the amount of elective deferrals that employees had contributed to their 401(k). In other words, employees couldn’t withdraw money that had come from their employer, and they couldn’t withdraw earnings.

However, under recent reforms, employers may allow employees to withdraw elective deferrals, employer contributions, and earnings. Employers are not required to follow these rules though, so it’s important to ask your provider which money in your 401(k) you can draw on.

What Are the Penalties of 401(k) Hardship Withdrawals?

Taking a hardship withdrawal can be a costly endeavor. You will owe income tax on the amount you withdraw, unless you are withdrawing Roth contributions.

Since you’re in your working years, your income tax bill may be considerably more than if you were to withdraw the same money after you retire. In addition, anyone under the age of 59 ½ will also likely pay a 10% early withdrawal penalty.

The IRS provides a list of criteria that can exempt you from the 10% penalty, including if you are disabled or if you’re younger than 65 and the amount of your unreimbursed medical debt exceeds 10 % of your adjusted gross income.

It’s important to know that a hardship withdrawal cannot be repaid to the plan. That means that whatever money you remove from your retirement account online is gone forever — no longer earning returns or subject to the benefits of tax-advantaged growth. The withdrawn amount will not be available to you in your retirement years.

Should You Consider a 401(k) Loan Instead?

Borrowing from your 401(k) may be an alternative to a hardship withdrawal. The IRS limits the amount that an individual can borrow to 50% of their vested account balance or $50,000, whichever is less.

However, if your vested account balance is less than $10,000, you may borrow up to that amount. There’s a reason for this: Your vested balance is the amount of money that already belongs to you. Some employers require you to stay with them for a set period of time before making their contributions available to you.

A person typically has five years to repay a 401(k) loan and usually must make payments each quarter through a payroll deduction. If repayments are not made quarterly, the remaining balance may be treated as a distribution, subject to income tax and a 10% early-withdrawal penalty.

While you do have to pay interest on a 401(k) loan, the good news is you pay it to yourself.

There are some drawbacks to taking out a 401(k) loan. The money you take out of your account is no longer earning returns, and even though it will get repaid over time, it can set back your retirement savings. Loans that aren’t paid back on time are considered distributions and are subject to taxes and early withdrawal penalties for people younger than 59 ½.

The Takeaway

A 401(k) hardship withdrawal can be an important tool for individuals who have exhausted all other options to solve their financial problem. Before deciding to make a hardship withdrawal, it’s a good idea to carefully consider the potential drawbacks, including taxes, penalties, and the permanent hit to a retirement savings account.

It’s also important to know that money in a 401(k) account is protected from creditors and bankruptcy. For anyone considering bankruptcy, taking money out of a 401(k) plan might leave it vulnerable to creditors.

Other options may make more sense, such as working with creditors to come up with an affordable payment plan, or taking out a 401(k) loan, which allows an individual to replace the borrowed income so that their retirement savings can continue to grow when the loan is repaid.

Visit SoFi Invest® to learn more about setting and meeting your financial goals for retirement.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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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Mar
30
2023
CeFi vs DeFi: Similarities and Differences Compared

CeFi vs DeFi: Similarities and Differences Compared

By | Growing Wealth, invest, Investing | Comments Off on CeFi vs DeFi: Similarities and Differences Compared

CeFi and DeFi are two terms that have become increasingly popular in the world of finance and cryptocurrency. CeFi, or Centralized Finance, refers to crypto and blockchain companies that operate like traditional financial systems, meaning a private central authority controls them and users are customers. DeFi, or Decentralized Finance, on the other hand, is a new type of financial system that operates on a blockchain network. Unlike CeFi, DeFi products and services are not controlled by a private central authority but are managed by an open-source network of computers.

While CeFi and DeFi may sound similar and have similar functions, there are some critical differences between the two. Investors should know this before investing in cryptocurrencies or blockchain technology.

DeFi vs CeFi: Similarities

Decentralized finance (DeFi) and centralized finance (CeFi) are more known for the distinction between the two financial systems. Nonetheless, DeFi and CeFi have several things in common:

Financial Services

As their names suggest, DeFi and CeFi platforms allow users to access financial services such as lending, payments, and trading securities exchanges. They also both use digital assets as collateral for these services.

Also, a large number of people around the world can access DeFi and CeFi products, making it easy for individuals and businesses to access financial services regardless of their location.

Recommended: Centralized vs. Decentralized Exchanges: Six Differences to Consider

Use of Technology

Another similarity is that both DeFi and CeFi platforms use digital and internet-based technologies to provide financial services. DeFi platforms are built on blockchain technology, while CeFi platforms use traditional technologies such as databases and servers to provide their services, in addition to some use of blockchain technology. These technologies allow both algorithms and automated processes to facilitate financial transactions and provide financial services, making it easier and more efficient to conduct financial transactions.

DeFi vs CeFi: Differences

As noted above, DeFi and CeFi are more known for their differences than similarities. Some of these differences include the following:

Centralization

DeFi is decentralized, meaning that a single entity, such as a bank or government, does not control it. Instead, it often relies on decentralized autonomous organizations (DAOs), open source networks, and decentralized ledgers, such as a blockchain, to facilitate financial transactions and provide financial services. CeFi, on the other hand, is centralized, meaning that a single private entity, such as a bank or financial institution, controls it.

Asset Custody

Asset custody refers to the process of securely holding and managing digital assets, such as cryptocurrencies, on behalf of users. Asset custody is a critical component of DeFi, as it ensures the security and integrity of users’ assets and helps prevent theft and fraud. In DeFi, users generally manage their digital assets directly, using a crypto wallet or other secure storage solution. In contrast, CeFi platforms generally act as a user’s asset custodian, meaning they control the assets.

Smart Contracts

DeFi relies on smart contracts, self-executing contracts with the terms of the agreement between buyer and seller directly written into lines of code. Smart contracts enable DeFi transactions to be transparent, secure, and automated. CeFi does not use smart contracts and instead relies on traditional contracts and intermediaries to facilitate financial transactions.

Transparency

Some experts consider DeFi more transparent than CeFi, as it relies on public decentralized networks and blockchain technology; users and researchers can track transactions in case of issues. CeFi, on the other hand, is vulnerable to centralized points of failure, such as hacks and data breaches.

Innovation

DeFi is often considered more innovative and experimental than CeFi, as it is a newer and less established financial system constantly evolving and exploring new technologies and approaches. CeFi, on the other hand, is a more established and traditional financial system that tends to be more conservative and risk-averse.

Customer Service

CeFi companies usually have robust customer support staff to assist users when they encounter issues. This customer service gives users a sense of security. In contrast, there are fewer customer support services with DeFi platforms, which may be an issue if problems arise when using the products.

Regulations

CeFi companies are subject to laws and regulations by government agencies and financial authorities, which aim to ensure the integrity and stability of the financial system. Some regulations include Know Your Customer (KYC) and anti-money laundering rules. In contrast, DeFi platforms operate in a regulatory gray zone.

Pros and Cons of DeFi

Pros

 Cons
Users control their own assets Lack of regulatory oversight
May be resistant to sudden changes Potential for technical issues

DeFi has both pros and cons. Some of the main advantages of DeFi include greater accessibility and control for users. Because DeFi platforms are built on blockchain technology and operate without the need for a central authority, they offer users greater control over their assets. Additionally, the open source and decentralized nature of the blockchain may make DeFi platforms, like decentralized exchanges (DEX), resistant to sudden changes because users can observe and verify operations.

However, DeFi also has some disadvantages. One of the main disadvantages is the lack of regulatory oversight. Because DeFi platforms operate without the need for a central authority, they are not subject to the same level of regulatory oversight as traditional financial institutions. This can make it difficult for users to know if they are using a trustworthy DeFi platform and they can be susceptible to fraud and scams.

Another disadvantage is the potential for technical issues. Because DeFi platforms are built on complex technology such as smart contracts and blockchain, there is a risk of technical issues arising that could affect the platform’s functionality. Relatedly, DeFi usually has difficult user experience which prevents non-tech savvy users access to the platforms.

Pros and Cons of CeFi

Pros

 Cons
Stability and security Users lack control of their own assets
Many financial services Potential for censorship

Some of the main advantages of CeFi include stability and security. Because CeFi platforms are controlled by a central authority, they are subject to regulatory oversight and may be more stable and secure than decentralized platforms. This can provide users with a greater sense of trust and confidence in the platform.

Another advantage of CeFi is the ability to access a broader range of financial services. Because CeFi platforms are typically operated by institutions with ties to traditional finance, they can offer a wider range of services, such as loans, credit cards, and investment products. Additionally, CeFi companies can offer seamless conversion of digital assets to fiat currency and vice versa. This can provide users with more options and flexibility.

However, CeFi also has some disadvantages. One of the main disadvantages is the lack of control for users. Because CeFi platforms are controlled by a central authority, users are subject to the policies and regulations of that authority. This can limit users’ ability to access and control their own assets.

Another disadvantage is the potential for censorship. Because CeFi platforms are controlled by a central authority, there is a risk that the authority could censor certain transactions or activities on the platform. This could limit users’ freedom and ability to access certain services.

Can CeFi and DeFi Work Together?

Many analysts believe it is possible for CeFi and DeFi to work together. While the two types of platforms have some differences, they also have some similarities and can potentially complement each other.

One way that CeFi and DeFi could work together is by combining the strengths of both types of platforms. For example, DeFi could provide the accessibility and control that users desire, while CeFi could provide the stability and security of traditional financial institutions. This could allow for a more balanced and comprehensive approach to finance.

Another way that CeFi and DeFi could work together is through the use of interoperability. Interoperability refers to the ability of different systems or platforms to work together and exchange data. By using interoperability, CeFi and DeFi platforms could share information and services, allowing users to access a wider range of financial services.

The Takeaway

CeFi and DeFi offer unique opportunities for investors and users to access financial services and products. CeFi is typically more regulated and centralized, while DeFi is more decentralized and operates outside of traditional financial systems. Both have their advantages and disadvantages, and it is up to the individual investor or users to decide which platform best fits their needs and goals. Ultimately, the choice between CeFi and DeFi will depend on an individual’s risk tolerance, preference for regulation, and desire for decentralization.

FAQ

How does DeFi differ from centralized finance?

DeFi differs from centralized finance in several key ways. The main difference is that DeFi platforms operate without a central authority, whereas centralized finance relies on traditional financial institutions controlled by a central authority. This lack of a central authority in DeFi means that users theoretically have complete control over their assets and are not subject to the policies and regulations of a central authority. In contrast, centralized finance is subject to the policies and regulations of the institutions and governments that control and oversee it.

How are crypto and DeFi different?

Cryptocurrency and DeFi are two related but distinct concepts in finance. Cryptocurrency is a digital asset that uses cryptography for security and operates on a decentralized ledger called the blockchain. DeFi, on the other hand, refers to the use of blockchain technology to provide financial services such as lending, borrowing, and trading without the need for a central authority.

Is all crypto based on decentralized finance?

Not all cryptocurrency is based on decentralized finance. While DeFi is a growing movement in cryptocurrency, not all cryptocurrencies are designed specifically for use in DeFi, like lending or asset trading.

Photo credit: iStock/Delmaine Donson

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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

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How to Use the Fear and Greed Index To Your Advantage

Guide to the Fear and Greed Index

By | Growing Wealth, invest, Investing | Comments Off on Guide to the Fear and Greed Index

What Is the Fear and Greed Index?

The Fear and Greed Index is a tool developed by CNN (yes, the news network) to help gauge what factors are driving the stock market at a given time.

If you’ve ever taken a look at how the market is doing on a given day and wondered just what the heck is going on, the Fear and Greed Index may be helpful in deciphering the overall mood of the markets, and what’s behind it.

CNN’s Fear and Greed Index attempts to track the overriding emotions driving the stock market at any given time — a dynamic that typically toggles between fear and greed.

The Index is based on the premise that fear and greed are the two primary emotional states that influence investment behavior, with investors selling shares of stocks when they’re scared (fear), or buying them when they sense the potential for profit (greed).

CNN explains the Index as a tool to measure market movements and determine whether stocks are priced fairly or accurately, with the logic that fear drives prices down, and greed drives them up, or is used as a signal of when to sell stocks.

There are specific technical indicators used to calculate the Fear and Greed Index (FGI), and strategies that investors can use to inform their investment decisions based on the Index.

Understanding the Fear and Greed Index

The Fear and Greed Index uses a scale of 0 to 100. The higher the reading, the greedier investors are, with 50 signaling that investors are neutral. In other words, 100 signifies maximum greediness, and 0 signifies maximum fear.

To give some historical context, on Sept. 17, 2008, during the height of the financial crisis, the Fear and Greed Index logged a low of 12. On March 12, 2020, as the pandemic recession set in, the FGI hit a low of 2 that year.

Seven different types of stock indicators are used to calculate the Fear and Greed Index.

CNN tracks how much each indicator has veered from its average versus how much it normally veers. Then each indicator is given equal weighting when it comes to the final reading. Here are the seven inputs.

1.    Market Momentum: The S&P 500 versus its 125-day moving average. Looking at this equity benchmark relative to its own history can measure how the index’s 500 companies are being valued.

2.    Stock Price Strength: The number of stocks hitting 52-week highs and lows on the New York Stock Exchange, the largest of the world’s many stock exchanges. Share prices of public companies can signal whether they’re getting overvalued or undervalued.

3.    Stock Price Breadth: The volume of shares trading in stocks on the rise versus those declining. Market breadth can be used to gauge how widespread bullish or bearish sentiment is.

4.    Put and Call Options: The ratio of bullish call options trades versus bearish put options trades. Options give investors the right but not the obligation to buy or sell an asset. Therefore, more trades of calls over puts could indicate investors are feeling optimistic about snapping up shares in the future.

5.    Junk Bond Demand: The spread between yields on investment-grade bonds and junk bonds or high-yield bonds. Bond prices move in the opposite direction of yields. So when yields of higher-quality investment-grade bonds are climbing relative to yields on junkier debt, investors are seeking riskier assets.

6.    Market Volatility: The Cboe Volatility Index, also known as VIX, is designed to track investor expectations for volatility 30 days out. Rising expectations for stock market turbulence could be an indicator of fear.

7.    Safe Haven Demand: The difference in returns from stocks versus Treasuries. How much investors are favoring riskier markets like equities versus relatively safe investments or assets, like U.S. government bonds, can indicate sentiment.

The Fear and Greed Index page on the CNN website breaks down how each indicator is faring at any given time. For instance, whether each measure is showing Extreme Fear, Fear, Neutral, Greed, or Extreme Greed among investors.

“Stock Price Strength” might be showing Extreme Greed even as “Safe Haven Demand” is signaling Extreme Fear.

Tracking the Fear and Greed Index Over Time

The Fear and Greed Index is updated often — CNN says that each component, and the overall Index, are recalculated as soon as new data becomes available and can be implemented.

Looking back over the past several years, the Index has tracked market sentiment with at least some degree of accuracy. For example, prior to the COVID-19 pandemic, the market was seeing a bull run and hitting record levels — the Index, in late 2017, was nearing 100, a signifier that the market was driven by greed at that time.

Conversely, the Index dipped into “fear” territory (below 20) during the fall of 2016, when uncertainty was on the rise due to the U.S. presidential election at that time. Note, too, that midterm elections can also affect market performance.

How Does the Fear and Greed Index Fare Against History?

As mentioned, the Index does appear to capture investor sentiment with some degree of accuracy. The past few years — which have been rife with uncertainty due to the pandemic — showed pockets of fear. For example, the Index showed “extreme fear” among investors in early 2020. That was right when the pandemic hit U.S. shores, and absolutely devastated the markets.

However, over the course of 2020, and near the end of the year, the Index was scoring at around 90, as the Federal Reserve stepped in and large-scale stimulus programs were implemented to prop up the economy.

Interestingly, the Index then dipped down into the “fear” realm in late 2020, likely due to uncertainty surrounding the outcome of the U.S. presidential election. It likewise saw a fast swing toward “greed” in the subsequent aftermath.

Again, these largely mirror what was happening in the markets at large, and economic sentiment.

How Does the Fear and Greed Index Fare Against Other Indicators?

While the Fear and Greed Index does fold several indicators into its overall calculations, it is more of an emotional barometer than anything. While many financial professionals would likely urge investors to set their emotions aside when making investing decisions, it isn’t always easy — and as such, investors can be unpredictable.

That unpredictability can have an effect on the markets as investors may panic and engage in sell-offs, or conversely start buying stocks and other investments. Ultimately, it’s really hard to predict what people and institutions are going to do, barring some obvious motivating factor.

With that in mind, there are other market sentiment indicators out there, including the American Association of Individual Investors (AAII) Sentiment Survey, the Commitment of Traders report published by the CFTC (one of several agencies governing financial institutions), and even the U.S. Dollar Index (DXY), which can be used to measure safe haven demand. They’re all a bit different, but attempt to capture more or less the same thing, often with similar results.

For instance, while the Fear and Greed Index showed a state of fear in mid-March, the AAII Sentiment Survey likewise showed a majority of investors with a “bearish” sentiment as well during the same time frame.

And, of course, there are a number of other economic indicators that you can use to inform your investing decisions, such as GDP readings, unemployment figures, etc.

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Dos and Don’ts of Using the Fear and Greed Index

Why is the Fear and Greed Index useful? The same reason that any sort of measurement or gauge has value. In this case, measuring sentiment can help you determine which move you want to make next as an investor, and help you ride investing trends to potentially bigger returns.

Are you being too greedy? Too fearful? Is now the time to think about herd mentality?

Also generally, some investors often try to be contrarian, so when markets appear frothy and the rest of the herd appears to be overvaluing assets, investors try to sell, and vice versa.

💡 Recommended: Should I Pull My Money Out of the Stock Market?

Dos

Use the Index to realize that investing can be emotional, but it shouldn’t be.

You can also use it to determine when to enter the market. Let’s say, for instance, you’ve been monitoring a stock that becomes further undervalued as investor fear rises, that could be a good time to buy the stock.

Don’ts

Don’t only rely on the Fear and Greed Index or other investor sentiment measures as the sole factor in making investment decisions. Fundamentals — like how much the economy is growing, or how quickly companies in your portfolio are growing revenue and earnings (which will be apparent during earnings season) — are important.

For instance, the FGI may be signaling extreme greed at some point, with all seven metrics indicating a rising market. However, this extreme bullishness may be warranted if the economy is firing on all cylinders, allowing companies to hire and consumers to buy up goods.

💡 Recommended: Using Fundamental Analysis on Stocks

What Is the Crypto Fear and Greed Index?

While CNN publishes and maintains the traditional Fear and Greed Index, there are other websites that publish a similar index for the cryptocurrency markets.

The Crypto Fear and Greed Index operates in much the same way as CNN’s Index, but instead, focuses on sentiment within the crypto markets. The Crypto Fear and Greed Index is published and maintained by Alternative.me.

The Takeaway

The Fear and Greed Index is one of many gauges that tracks investor sentiment, and CNN’s Index focuses on seven specific indicators to measure whether the market is feeling “greedy” or “fearful.” While it’s only one indicator, in recent years, it has served as a somewhat accurate barometer of the markets, particularly regarding major events like elections and the pandemic.

But, as with anything, investors shouldn’t rely solely on the Fear and Greed Index to make decisions, though it can be used as one of many tools at their disposal. As always, it’s best to check with a financial professional if you have questions.

Ready to buy and sell stocks, ETFs, or fractional shares on your own? Online trading with SoFi Invest offers an Active Investing platform, where investors can make their own decisions on how they want to build their portfolios.

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

FAQ

Is the Fear and Greed Index a good indicator?

It can be a “good” indicator in the sense that it can be helpful when used in conjunction with other indicators to make investing decisions. That said, it shouldn’t be the only indicator investors use, and isn’t necessarily going to be accurate in helping determine what the market will do next.

Where can you find the Fear and Greed Index?

The Fear and Greed Index is published and maintained by CNN, and can be found on CNN’s website.

When does it make sense to buy, based on the Fear and Greed Index?

While you shouldn’t make investing decisions solely based on the Fear and Greed Index’s readings, generally speaking, the market is bullish when the Index produces a higher number (greed), and is bearish when numbers are lower (fear).

Photo credit: iStock/guvendemir

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
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2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
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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.

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