Unlike market capitalization, which measures a company’s total equity value based on its current share price, book value per share (BVPS) is a way to calculate a company’s total assets minus liabilities, and divide that total by the number of outstanding shares to get a more accurate gauge of its share price.
Thus, BVPS can be useful when deciding whether a stock is overvalued or undervalued. For example, the book value per share of an undervalued stock would be higher than its current market price, so knowing the BVPS can help investors better assess stock prices.
Key Points
• Book value per share (BVPS) is a financial metric that calculates a company’s total assets minus liabilities, divided by the number of outstanding shares.
• BVPS helps investors assess whether a stock is overvalued or undervalued by comparing it to the company’s current market price.
• A BVPS higher than the current market price can indicate that a stock is undervalued, while a declining BVPS may signal a potential stock price decrease.
• BVPS theoretically represents what shareholders would receive if a company were liquidated after all assets were sold and liabilities paid.
• Companies can increase their BVPS by repurchasing common stocks or by increasing assets and reducing liabilities using profits.
What Is Book Value Per Share?
Book value per share (BVPS) is the ratio of a company’s equity available to common shareholders relative to the number of outstanding company shares.
Using BVPs helps investors assess whether a stock price is undervalued or overvalued by comparing it to the firm’s market value per share (more on that below). BVPS represents what shareholders would likely receive if the firm was liquidated and its assets sold and its debts were paid.
This ratio calculates the minimum value of a company’s equity and determines a firm’s book value, or net asset value (NAV), on a per-share basis. In other words, it defines the accounting value (i.e. book value) of a share of a company’s publicly traded stock.
Book Value Per Share vs Market Value Per Share
The book value per share provides information about how the value of a company’s stock compares to the current market value per share (MVPS), or current stock price. For example, if the BVPS is greater than the MVPS, the stock market may be undervaluing a company’s stock.
The market value per share is a more complex measurement that includes metrics such as the price-to-earnings ratio. It’s forward-looking, since it’s based on what investors think a company should be worth.
Commonly used by stock investors and analysts, the book value per share (BVPS) metric helps investors determine whether it’s undervalued compared to the stock’s current market price.
An undervalued stock will have a BVPS higher than its current stock price, which can help investors make decisions when they buy stocks online.
If the company’s BVPS increases, investors may consider the stock more valuable, and the stock’s price may increase. On the other hand, a declining book value per share could indicate that the stock’s price may decline, and some investors might consider that a signal to sell the stock.
Book value per share also theoretically reflects what shareholders would receive in a company liquidation after all its assets were sold and all of its liabilities paid.
BVPS Can Indicate a Vulnerability
If a company’s share prices dip below its BVPS, the company can potentially be vulnerable to a hostile takeover by a corporate raider who could buy the company and liquidate its assets risk-free.
Conversely, a negative book value could indicate that a company’s liabilities exceed its assets, making its financial condition “balance sheet insolvent.”
Understanding Preferred Shares
Book value per share solely includes common stockholders’ equity and does not include preferred stockholders’ equity. This is because preferred stockholders are ranked differently than common stockholders in the event the company is liquidated.
If a corporate raider intends to liquidate a company’s assets, the preferred stockholders with a higher claim on assets and earnings than common shareholders are paid first and that amount gets deducted from the final shareholders’ equity distributed among common stockholders.
Whereas some price models and fundamental analyses are complex, calculating book value per share is fairly straightforward. At its core, it’s subtracting a company’s preferred stock from shareholder equity and dividing that sum by the average amount of outstanding shares.
Book Value Per Share = (Total Equity – Preferred Equity) / Total Shares Outstanding
Total Equity = Total equity of all shareholders.
Total Shares Outstanding = Company’s stock currently held by all shareholders.
Example of Book Value Per Share
Company X has $10 million of shareholder equity, of which $1 million are preferred stocks and an average of 3 million shares outstanding. With this information, the BVPS would be calculated as follows:
BVPS = ($10,000,000 – $1,000,000) / 3,000,000
BVPS = $9,000,000 / 3,000,000
BVPS = $3.00
How to Increase Book Value Per Share
A company can increase its book value per share in two ways.
Repurchase Common Stocks
A common way of increasing BVPS is for companies to buy back common stocks from shareholders. This reduces the stock’s outstanding shares and decreases the amount by which the total stockholders’ equity is divided.
For example, in the above example, Company X could repurchase 500,000 shares to reduce its outstanding shares from 3,000,000 to 2,500,000.
The above scenario would be revised as follows:
BVPS = ($10,000,000 – $1,000,000) / 2,500,000
BVPS = $9,000,000 / 2,000,000
BVPS = $4.50
By repurchasing 1,000,000 common shares from the company’s shareholders, the BVPS increased from $3.00 to $4.50.
Increase Assets and Reduce Liabilities
Rather than buying more of its own stock, a company can use profits to accumulate additional assets or reduce its current liabilities. For example, a company can use profits to either purchase more company assets, pay off debts, or both. These methods would increase the common equity available to shareholders, and hence, raise the BVPS.
The Takeaway
There are many methods that investors can use to evaluate the value of a company. By leveraging formulas such as a company’s book value per share, investors can assess a company’s value relative to its current market price.
While it has limitations, the BVPS can help identify companies that are undervalued (or overvalued) according to core fundamental principles, and it’s a relatively straightforward calculation that even beginner investors can use.
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FAQ
What does BVPS tell an investor?
Book value per share gives investors the company’s net value on a per share basis. It’s a way of evaluating a company’s share price before making a trade.
Is a higher BVPS better?
A higher book value per share than the market share price tells investors that the company seems to be well-funded and the stock may be a bargain (i.e., undervalued).
What is book value vs market value?
The book value is the net value of a company’s assets, as shown on its balance sheet. Book value per share, then, is the per-share price that reflects the book value. The market value is what the market is willing to pay per share, and is a more complex calculation that’s reflected by the market price.
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The payback period is when an investment generates enough cashflow or value to cover its initial cost. It’s the time it takes to get to the break-even point. Knowing the payback period is something that investors, corporations, and consumers use as a way to gauge whether an investment or purchase is likely to be profitable or worthwhile.
For example, if a $1 million investment in new technology is likely to increase company revenue by $200,000 a year, the payback period for that technology is five years.
A longer payback period is associated with higher risk, and a shorter payback period is associated with lower risk and a greater potential for returns. While calculating the payback period is fairly straightforward, it doesn’t take into account a number of factors, including the time value of money.
Key Points
• The payback period is the time it takes for an investment to generate enough cash flow or value to cover its initial cost, essentially reaching a break-even point.
• A shorter payback period generally indicates lower risk and a greater potential for returns, while a longer period is associated with higher risk.
• There are two primary methods for calculating the payback period: the averaging method (Initial Investment / Yearly Cash Flow) for consistent cash flows, and the subtraction method for variable cash flows.
• Benefits of using the payback period include its simplicity, ease of calculation, and its utility in risk assessment and comparing investment options.
• However, a key limitation of the payback period is that it does not consider earnings after the initial investment is recouped or the time value of money.
What Is the Payback Period?
The payback period is the amount of time it will take to recoup the initial cost of an investment, or to reach its break-even point.
Although investors who are thinking about buying stock in a certain company may want to consider the payback period for certain capital projects at that company (and whether those might support growth), the payback period is more commonly used for budgeting purposes by companies deciding how best to allocate resources for maximum return.
While the payback period is only an estimate, and it doesn’t factor in unforeseen or future outcomes, it’s a useful tool that can provide a baseline for assessing the relative value of one investment over another.
The Value of Time
The payback period can help investors decide between different investments that may be similar, when investing online or via a broker-dealer, as they’ll often want to choose the one that will pay back in the shortest amount of time.
The longer money remains locked up in an investment without earning a return, the more time an investor must wait until they can access that cash again, and the more risk there is of losing the initial investment capital.
The payback period is calculated by dividing the cost of the investment by the annual cash flow until the cumulative cash flow is positive, which is the payback year. Payback period is generally expressed in years.
Prior to calculating the payback period of a particular investment, one might consider what their maximum payback period would be in order to move forward with the investment. This will help give them some parameters to work with when making investment decisions.
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Payback Period Formula (Averaging Method)
There are two basis payback period formulas:
Payback Period = Initial Investment / Yearly Cash Flow
Using the averaging method, the initial amount of the investment is divided by annualized cash flows an investment is projected to generate. This works well if cash flows are predictable or expected to be consistent over time, but otherwise this method may not be very accurate.
Example of a Payback Period
If a company makes an investment of $1,000,000 in new equipment which is expected to generate $250,000 in revenue per year, the calculation would be:
$1,000,000 / $250,000 = 4-year payback period
If they have another option to invest $1,000,000 into equipment which they expect to generate $280,000 in revenue per year, the calculation would be:
$1,000,000 / $280,000 = 3.57-year payback period
Since the second option has a shorter payback period, this may be a more cost effective choice for the company.
Payback Formula (Subtraction Method)
Using the subtraction method, an investor can start by subtracting individual annual cash flows from the initial investment amount, and then do the division. This method is more effective if cash flows vary from year to year.
Payback Period = the last year with negative cash flow + (Amount of cash flow at the end of that year / Cash flow during the year after that year)
Example of Payback Period Using the Subtraction Method
Here’s an example of calculating the payback period using the subtraction method:
A company is considering making a $550,000 investment in new equipment. The expected cash flows are as follows:
Year 1 = $75,000
Year 2 = $140,000
Year 3 = $200,000
Year 4 = $110,000
Year 5 = $60,000
Calculation:
Year 0 : -$550,000
Year 1 : -$550,000 + $75,000 = -$475,000
Year 2 : -$475,000 + $140,000 = -$335,000
Year 3 : -$335,000 + $200,000 = -$135,000 Year 4 : -$135,000 + $110,000 = -$25,000
Year 5 : -$25,000 + $60,000 = $35,000
Year 4 is the last year with negative cash flow, so the payback period equation is:
4 + ($25,000 / $60,000) = 4.42
So, the payback period is 4.42 years.
Other factors
Investors might also choose to add depreciation and taxes into the equation, to account for any lost value of an investment over time.
Consumers may want to consider the payback period when making repairs to their home, or investing in a new amenity. For example: How long would it take to recoup the cost of installing a fuel-efficient furnace?
Benefits of Using the Payback Period
The payback period is simple to understand and calculate. It can provide individuals and companies with valuable insights into potential investments, and help them decide which option provides the best return on investment (ROI). It also helps with assessing the risk of different investments. Advantages include:
• Easy to understand
• Simple to calculate
• Tool for risk assessment
• Helps with comparing and choosing investment options
• Provides insights for financial planning
• Other calculations, such as net present value and internal rate of return, may not provide similar insights
• A look at the amount of time it takes to recoup an investment
Although the payback period can be a useful calculation for individuals and companies considering and comparing investments, it has some downsides.
A Limited Time Period
The calculation only looks at the time period up until the initial investment will be recouped. It doesn’t consider the earnings the investment will bring in after that, which may either be higher or lower, and could determine whether it makes sense as a long-term investment.
If earnings will continue to increase, a longer payback period might be acceptable. If earnings might decrease after a certain number of years, the investment may not be a good idea even if it breaks even quickly. On the other hand, an investment with a short lifespan could need replacement shortly after its payback period, making it a potentially poor investment.
Other Factors May Add or Subtract Value
The payback period also doesn’t take into consideration other ways an investment might bring value, such as partnerships or brand awareness. This can result in investors overlooking the long-term benefits of the investment since they’re too focused on short-term ROI.
The payback period equation also doesn’t take into account the effects an investment might have on the rest of the company’s operations. For instance, new equipment might require a significant amount of expensive power, or might not be able to run as often as it would need to in order to reach the payback goal.
The Time Value of an Investment
Another limitation of the payback period is that it doesn’t take the time value of money (TVM) into account. The time value of money is the idea that cash will be worth more in the future than it is worth today, due to the amount of interest that it can generate.
Not only does this apply to the initial capital put into an investment, but it’s also important because as an investment generates returns, that cash can then be reinvested into something else that earns interest or income. This is another reason that a shorter payback period could be viewed as an attractive investment.
When Would an Investor Use the Payback Period?
The payback period can apply to personal investments such as solar panels or property maintenance, or investments in equipment or other assets that a company might consider acquiring.
Often an investment that requires a large amount of capital upfront generates steady or increasing returns over time, although there is also some risk that the returns won’t turn out as hoped or predicted.
How Companies Use the Payback Period
Calculating payback periods is especially important for startup companies with limited capital that want to be sure they can recoup their money without going out of business. Companies also use the payback period to select between different investment opportunities or to help them understand the risk-reward ratio of a given investment.
Knowing the payback period is helpful if there’s a risk of a project ending in the future. For example, if a company might lose a lease or a contract, the sooner they can recoup any investments they’re making into their business the less risk they have of losing that capital.
Any particular project or investment can have a short or long payback period. A short period means the investment breaks even or gets paid back in a relatively short amount of time by the cash flow generated by the investment, whereas a long period means the investment takes longer to recoup. How investors understand that period will depend on their time horizon.
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The Takeaway
Understanding the potential payback period for a given investment can help you gauge possible risks and reward for a certain asset, because it helps you to calculate when you’re likely to recoup your initial investment. You can also use the payback period when making large purchase decisions and considering their opportunity cost.
Understanding the way that companies calculate their payback period is also helpful to determine their financial viability and whether it makes sense for you to invest in them as part of your portfolio.
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FAQ
What are the two payback period formulas?
Two of the simplest and most common payback period formulas are the averaging method and the subtraction method.
What does the payback period refer to in investing?
The payback period is the estimated amount of time it will take to recoup an investment or to break even. Generally, the longer the payback period, the higher the risk of the associated investment.
What are some downsides of using the payback period?
The payback period may not consider the earnings an investment brings in following an initial investment, or other ways that an investment could generate value. It also doesn’t take into account the time value of money.
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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
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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.
Exchange-traded notes, or ETNs, are debt securities that offer built-in diversity, and offer alternatives to other investment vehicles that may have certain downsides for investors, like potential tracking errors and short-term capital gains taxes.
ETNs are similar to ETFs (exchange-traded funds), in that they may be a popular pathway to diversification because they expose investors to a wide range of financial assets, and come with lower expense ratios compared to mutual funds. As such, it can be beneficial for investors to understand ETNs and how they work.
Key Points
• Exchange-traded notes (ETNs) are debt securities that trade on exchanges.
• ETNs track the performance of an underlying commodity or index.
• ETNs may offer access to niche markets without high minimum investments.
• ETNs may provide accurate performance tracking, avoiding tracking errors.
• ETNs have potential risks, including default, redemption, and credit risks.
What Is an Exchange-Traded Note (ETN)?
An ETN, or an exchange-traded note, is a debt security that acts much like a loan or a bond. Issuers like banks or other financial institutions sell the “note,” which tracks the performance of an underlying commodity or stock market index benchmark.
ETNs do not yield dividends or interest in the way that ETFs do. Before investors can earn a profit from an ETN, they must hold the security long enough for it to mature, typically 10 to 30 years. Upon maturity, the ETN pays out one lump sum according to their underlying commodity’s return.
Exchange-Traded Notes Meaning
The term “exchange-traded note” may sound a bit off to some investors, but its meaning is fairly straightforward. For one, ETNs are “exchange-traded” because they’re literally traded on exchanges, like many other securities. And they’re called “notes” because they are debt securities, not pools of investments like a fund (as in an ETF).
Examples of ETNs
To further illustrate how an ETN works and is constructed, suppose you purchase an ETN that tracks the price of gold. As an investor, you don’t own physical gold, but the note’s value tracks gold’s performance. When you sell the ETN, during or at the end of the holding period, your return will be the difference between gold’s sale price at that time and its original purchase price, deducting any associated fees.
Similarly, you could, hypothetically, create an ETN that tracks the price of a commodity like oil. Again, investors don’t actually own barrels of crude, but the ETN would track oil prices until it matures, and then pay out applicable returns.
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Pros of ETNs
ETNs are a relatively newer type of financial security compared to some others available on the market. Their design comes with perks that some investors may find appealing.
Access to New Markets
Some individual investors may struggle to access niche markets like currencies, international markets, and commodity futures, since they require high minimum investments and significant commission prices. ETNs don’t have these limitations, making them more available to a larger pool of investors.
Accurate Performance Tracking
Unlike ETFs, ETNs don’t require rebalancing. That’s because ETNs do not own an underlying asset, rather they duplicate the index or asset class value it tracks. This means investors won’t miss any profits due to tracking errors, which means a difference between the market’s return and the ETF’s actual return.
Tax Treatment Advantages
Investors of ETNs don’t receive interest, monthly dividends, or annual capital gains distributions — which in turn means they don’t pay taxes on them. In fact, they only face long-term capital gains taxes when they sell or wait for an ETN to mature.
Liquidity
Investors have two options when selling ETNs: They can buy or sell them during regular day trading hours or redeem them from the issuing bank once a week.
Cons of ETN
Every investor must be wary of their investments’ drawbacks. Here are some potential cons of trading ETNs.
Limited Investment Options
Currently, there are fewer ETN options available to investors than other investment products. Additionally, though issuers try to keep valuations at a constant rate, pricing can vary widely depending on when you buy.
Liquidity Shortage
ETFs and stocks can be exchanged throughout the trading day according to price fluctuations. With ETNs, however, investors can only redeem large blocks of the security for their current underlying value once a week. This has the potential to leave them vulnerable to holding-period risks while waiting.
Credit, Default, and Redemption Risk
There are a range of risks associated with ETNs.
1. Risk of default. An ETN is tied to a financial institution such as a bank. It’s possible for that bank to issue an ETN but fail to pay back the principal after the holding period. If so, they’ll go into default, leaving you with a loss. There’s no absolute protection for owners in this case since ETNs are unsecured. External and social factors can lead to a default, too, not just economic influences.
2. Redemption risk. Investors can also take a loss if the institution calls its issued ETNs before maturity. This is called call or redemption risk. In this case, the early redemption may result in a lower sale price than the purchase price, leading to a loss.
3. Credit risk. The institution that issues the ETN impacts the credit rating of the security, which has to do with credit risk. If a bank experiences a drop in its credit rating, so will the ETN. That leads to a loss of value, regardless of the market index it tracks.
ETN vs. ETF: What’s the Difference?
Comparing ETNs and ETFs may help investors to see the pros and cons of either asset more clearly. Both ETNs and ETFs are exchange-traded products (ETPs) that track the metrics of an underlying commodity they represent. Other than that, though, they operate differently from each other.
Asset Ownership
ETFs are similar to a mutual fund, in that investors have some ownership over multiple assets that the ETF bundles together. You invest in a fund that holds assets. They issue periodic dividends in returns as well.
In comparison, ETNs are debt instruments and represent one index or commodity. They are an unsecured debt note that tracks the performance of an asset but doesn’t actually hold the asset itself. As a result, they only issue one payout when you sell or redeem them.
Taxation
These differences impact taxation. An ETF’s distributions are taxable on a yearly basis. Every time a long-term holder of a conventional ETF receives a dividend, they face a short-term capital gains tax.
Comparatively, ETN’s one lump-sum incurs a single tax, making it beneficial for investors who want to minimize their annual taxes.
ETNs are unsecured debt notes that track an index or commodity, and are sold by banks and other financial institutions. Like any investment, ETNs have both benefits and drawbacks, and while they may sound like ETFs, there are differences between these two products, notably that with ETNs you do not own any underlying assets.
ETNs may have a place in an investment portfolio, but it’s important that investors fully understand what they are, how they work, and how they can be incorporated into an investment strategy. It may be helpful to speak with a financial professional for guidance.
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FAQ
Who developed ETNs?
Barclays, a large international bank, first developed exchange-traded notes (ETNs) in 2006 as a way to give retail investors an easier path to investing in asset classes like commodities and currencies.
How is an ETN related to ETPs?
ETPs, or exchange-traded products, is a term that refers to a range of financial securities that trade on exchanges. ETNs, or exchange-traded notes, fall under the ETP umbrella, since they are investments that trade on exchanges.
Where are ETNs listed?
ETNs are listed on different exchanges, and can often be found by searching for their respective ticker or symbol.
About the author
Ashley Kilroy
Ashley Kilroy is a seasoned personal finance writer with 15 years of experience simplifying complex concepts for individuals seeking financial security. Her expertise has shined through in well-known publications like Rolling Stone, Forbes, SmartAsset, and Money Talks News. Read full bio.
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SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
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Corporate bonds are similar to government bonds: When investors buy corporate bonds they are loaning a company money for a specified period of time. The company agrees to pay interest for that time. When the bond reaches maturity, the company returns the principal.
Corporations typically issue bonds, usually in $1,000 increments, in order to raise funds for capital improvements, acquisitions, and other needs. Because corporate bonds carry more risk, these bonds typically offer a higher interest rate.
It’s also possible to invest in corporate bonds via exchange-traded funds (ETFs) or mutual funds.
Key Points
• Corporations issue bonds to raise funds for various needs.
• Investors typically receive semi-annual interest payments until the bond matures.
• Corporate bonds are usually issued in $1,000 blocks and generally offer higher rates than Treasurys due to higher risk.
• Some corporate bonds offer a fixed interest rate, while others pay a floating rate.
• Bond-focused mutual funds and ETFs are alternative ways to invest and may offer additional portfolio diversification.
What Is a Corporate Bond?
A bond is a debt security that functions much like an IOU. When an investor buys a corporate bond, they are effectively lending money to that company for a specified period of time, with the agreement that the company will pay interest until the bond matures, at which time the company repays the principal.
What Is the Purpose of Bonds?
Governments and companies issue bonds in order to raise funds for different needs. For example, a state might issue bonds to build a new bridge, and the U.S. Treasury issues Treasury Bills (T-Bills) to cover its expenses.
Corporations also sell bonds to raise capital. They might use the money raised through these financial securities to reinvest in their business, pay down debts, or even buy other companies.
The Size of the Bond Market
Bonds make up more of the global markets than equities, worth about $145.1 trillion in 2024 versus $126.7 trillion for global equity market capitalization, according to the Securities Industry and Financial Markets Association (SIFMA). The U.S. fixed income market is the biggest in the world, making up 58.2% of global securities.
How Do Corporate Bonds Work?
As noted, corporate bonds follow similar rules to other types of bonds. Say an investor buys $10,000 worth of bonds from Company A, at a certain interest or coupon rate, for a specified time period until maturity.
These bonds might have shorter terms (e.g, up to five years); medium terms (between five and 12 year maturities); or longer terms (more than 12 years).
The investor can expect interest payments, usually semi-annually, until the bond matures — at which point the company repays the original $10,000 in principal.
Bond Terminology
To understand the bond market and how bonds work, it helps to know a few important terms:
• Issuer: The entity issuing bonds to raise money (e.g., a government, municipality, or a corporation).
• Par Value or face value: Also known as the nominal value of the bond, the par value is the amount the investor pays for the bond (i.e., the dollar amount of the loan) — which the bond issuer promises to repay when the bond reaches maturity. It’s the principal amount. This amount does not fluctuate over the life of the bond.
• Coupon rate: This is the interest rate paid by the bond issuer on the principal amount (e.g., a $100 bond with a 2% coupon will pay $2 per year). Some coupon rates are fixed. Some can be variable.
• Maturity: The date at which a bond’s issuer must repay the original bond value to the bondholder.
• Price: A bond’s price can change based on a bond’s rating, its interest rate, and time left to maturity. The price is the amount an investor pays for a bond in the secondary market.
• Yield to maturity (YTM): Investors who buy and sell bonds on the secondary market often focus on a bond’s yield to maturity, which is different from the coupon rate. Bond yield represents the total return at maturity, incorporating the bond’s market price and the coupon rate.
Corporate Bond Ratings
Well-known ratings agencies, such as Moody’s, Standard & Poor’s, and Fitch, rate the creditworthiness of the bond issuer. The bond rating can influence the coupon rate, as it reflects the relative risk involved in purchasing the bond. More on ratings below.
The Potential for Diversification
Investors may find bonds appealing for a couple of reasons. The first is that bonds can provide a steady source of income from interest (i.e., coupon payments), which is why they are referred to as fixed-income securities. (That said, equities have historically outperformed bonds over time.)
Another reason is that bonds are generally not correlated with the stock market, and thereby may offer investors some portfolio diversification.
Benefits and Drawbacks of Corporate Bonds
While corporate bonds may offer some benefits to investors, it’s important to consider their drawbacks, as well.
Benefits
Drawbacks
Bonds can provide some portfolio diversification.
Bonds may offer lower returns than other securities, such as stocks.
Many investors consider corporate bonds to be a riskier investment than U.S. government bonds. As a result, they tend to offer higher interest rates.
Corporate bonds carry a higher risk of default than U.S. Treasurys.
Bonds are relatively liquid, meaning it is easy to buy and sell them on the market.
Some bonds are “callable”, which means issuers can pay them back early. When that happens, bond holders don’t earn as much interest and may have to reinvest.
Types of Corporate Bonds
There are three main ways to categorize corporate bonds:
Maturity Dates
This category reflects the bond’s maturity, which may range from one to 30 years. There are three maturity lengths:
• Short-term: Maturity of within five years.
• Medium-term: Maturity of five to 12 years.
• Long-term: Maturity of more than 12 years. Longer-term bonds typically offer the highest interest rates.
Risk
Every once in a while, a corporation defaults its bonds. The likelihood of default impacts a company’s creditworthiness, and investors should consider it before purchasing a bond. Bond ratings, assigned by credit rating agencies, can help investors understand this risk.
Bonds can be rated as:
• Investment grade: Companies and bonds rated investment grade are unlikely to default. High-rated corporate bonds — from AAA to BBB, depending on the agency — typically pay a slightly higher rate than government securities.
• Non-investment grade: Non-investment grade bonds are more likely to default. Because they are riskier, non-investment grade bonds tend to offer a higher interest rate and are often known as high-yield or junk bonds.
Coupon
Investors may also categorize bonds based on the type of interest rate they offer.
• Fixed rate: With a fixed-rate bond, the coupon rate stays the same over the life of the bond.
• Floating rate: Bonds that offer floating rates readjust interest rates periodically, such as every six months. The floating rate depends on market interest rates.
• Zero-coupon bonds: These bonds have no interest rate. Instead, the bond is sold at a discount. When the bond reaches maturity, the issuer makes a single payment that’s higher than purchase price (effectively paying interest).
• Convertible bonds:Convertible bonds act like regular bonds with a coupon payment and a promise to repay the principal. However, they also give bondholders the option to convert their bonds into company stock according to a given ratio.
When investors invest in stocks, they are buying ownership shares in the company. Share prices may fluctuate depending on the markets and the health of the company. If the company does well, the stock price may rise, and the investor can sell their shares at a profit. Additionally, some companies share profits with their shareholders in the form of dividends.
When an investor purchases a corporate bond, on the other hand, they do not own a piece of the company; they’ve given a loan to the company. The bondholder is therefore entitled to interest plus their original principal. Those amounts don’t change based on company profits or the stock price. When a company goes bankrupt, bondholders have priority over stockholders when it comes to claims on the issuer’s assets.
How to Buy Corporate Bonds
Investors interested in purchasing corporate bonds have a number of options to consider.
Direct Investment
Investors can buy individual corporate bonds directly through brokerage firms or banks. Corporations typically issue them in increments of $1,000. Much like investing in an initial public offering, or IPO, it can be tricky for retail investors to get in on newly issued bonds. Investors may need a relationship with the organization that’s managing the offering.
However, investors can also purchase individual bonds on the secondary market.
Bond Funds
Another way to gain access to the bond market is by purchasing bond funds, including mutual funds and exchange-traded funds (ETFs) that invest in bonds. These funds can be a good way to diversify a bond portfolio as they typically hold a diverse basket of bonds that tracks a bond index or a certain sector.
Retirement Accounts
Investors can also purchase bonds or bond funds through an Individual Retirement Account, or IRA, as well as an employer-sponsored retirement account such as a 401(k).
The Takeaway
Before buying bonds, it’s important that individuals consider how these securities might fit in with their financial goals, risk tolerance, and time horizon. For example, if you’re working toward retirement and have decades to save, you may want a portfolio that’s tilted toward stocks, since stocks generally tend to outperform bonds in the long run. If you’re close to your goal — or have a low appetite for risk — you may want to stick with bonds.
Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.
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FAQ
Are corporate bonds a good investment?
Corporate bonds generally pay a higher rate of interest than government bonds, but they come with a higher risk of default. While some investors may find the income potential from corporate bonds appealing, others may not want the added risk exposure.
What’s the difference between a Treasury bond and a corporate bond?
All types of U.S. Treasury bonds, bills, and notes are issued by the United States government and “backed by the full faith and credit” of the same. The United States has never defaulted on its debts. Corporate bonds carry more risk, and therefore offer higher interest rates.
Are bonds safe if the market crashes?
Generally speaking, bonds are less likely to be impacted by a stock market crash, and therefore can provide some ballast in a portfolio during times of market volatility. That said, no investment is 100% guaranteed to be “safe” under any circumstances.
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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
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Mutual Funds (MFs): Investors should read and carefully consider the information contained in the prospectus, which contains the Mutual Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or SoFi's customer service at: 1.855.456.7634. Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risks. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may have tax implications.
Investment Risk: Diversification can help reduce some investment risk, but cannot guarantee profit nor fully protect in a down market.
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.
Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®
No matter what kind of investments an individual makes, they’ll likely face some kind of investing fee. Investment fees are the charges investors pay to use investment products and services, such as management fees, brokerage fees, and commissions.
Over time, fees can make a profound impact on potential returns. That’s why it’s important to understand those fees, and how they may affect your strategy. Here’s a closer look at the types of investment fees investors may come across.
Key Points
• Investment fees, such as management and trading fees, can vary widely, often around 1% for management.
• Many brokerages and investment platforms have gotten rid of commissions for several types of trades in recent years.
• Over time, fees can significantly reduce investment returns, impacting overall gains.
• Broad-index ETFs and mutual funds generally have lower fees compared to specialized funds.
• Hedge funds traditionally charge “2 and 20,: a fee structure that includes a percentage of assets managed, as well as a performance fee.
What Are Investment Fees?
Investment fees are charges investors pay when using financial products, whether they have short vs. long-term investments. Investing fees can include broker fees, trading fees, management fees, and advisory fees.
Broadly speaking, investing fees are structured in two ways: recurring or one-time transaction charges. Recurring is when the charge is a portion of the assets you’ve invested, usually expressed as an annual percentage rate. One-time transaction charges work more like a flat fee, such as a certain number of dollars per-trade.
💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you open an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.
Why Are Investment Fees Charged?
Like any purchase you make, there are fees for investment products and services. For instance, a broker will typically charge a fee for buying and selling stocks or managing your portfolio.
While some investing fees and expenses may seem small, over time they can make an impact on your investment and can affect the value of your portfolio. As an investor, it’s important to be aware of these fees and understand exactly what you’re being charged to help make sure you’re getting a good return on investment.
Who Charges Investment Fees?
Financial professionals such as brokers, financial advisors and financial planners usually charge investing fees and expenses. Brokerage firms typically charge fees and commissions. And there are investment fund fees for various financial products, such as mutual fund management fees and fees for operating and administering a 401(k).
6 Common Types of Investment Fees
Generally, there are a handful of different types of investment fees that investors should know about.
1. Management Fees
When it comes to types of investment costs for mutual funds, every mutual fund charges a management fee. And other investment vehicles, such as hedge funds, do as well. This pays the fund’s manager and support staff to select investments and trade them according to the fund’s mandate. In addition to the manager, it also covers the administrative expenses of managing the fund.
This fee is typically assessed as a portion of an investor’s assets, whether the investments do well or not. Some investments, such as hedge funds, charge a performance fee based on the success of the fund, but these are not widely used in most mutual funds.
Management fees vary widely. Some index funds charge as little as 0.10%, while other highly specialized mutual funds may charge more than 2%.
Management fees are expressed as an annual percentage. If you invest $100 in a fund with a 1% management fee, and the fund neither goes up or down, then you will pay $1 per year in management fees.
2. Hedge-fund Fees: Two and Twenty
The classic hedge-fund fee structure is known as “two and twenty” or “2 and 20.” This means that there’s a 2% management fee, so the hedge fund takes 2% of the investor’s assets that are invested. And then there’s a 20% performance fee, so with any profits that are made, the hedge fund takes an additional 20% of those returns.
So let’s say an investor puts $1 million into a hedge fund, and the firm makes a profit of $500,000 in a year. That means the hedge fund would take a management fee of $20,000 plus a performance fee of $100,000 for a total compensation of $120,000.
Bear in mind, investors who are clients at hedge funds are typically institutional investors or accredited investors, those typically with a net worth of at least $1 million, excluding their primary residence. Hedge funds also tend to have higher minimum initial investment amounts, ranging from $100,000 to $2 million, although it varies from firm to firm.
Due to lackluster performance and competition however in recent years, the classic “two and twenty” hedge-fund fee model has become challenged in many years. Many hedge funds now offer rates like “1 and 10” or “1.5 and 15”–a trend dubbed as “fee compression” in the industry.”
3. Expense Ratio
The expense ratio is the percentage of assets subtracted for costs associated with managing the investment. So if the expense ratio is 0.035%, that means investors will pay $3.50 for every $10,000 invested.
The expense ratio includes the management fee, and tells the whole story as to how much of the fund’s assets go toward the people running and selling the fund.
In addition to management fees, a mutual fund may charge other annualized fees. Those can include the fund’s advertising and promotion expense, known as the 12b-1 fee. Those 12b-1 fees are legally capped at 1% annually. But when added to the management fee, it can make a fund more costly than at first glance. That’s one reason to double check the expense ratio.
Another reason is that the expense ratio may actually be lower than the management fee. That’s because some mutual funds will waive a portion of their fees. They may implement a fee waiver to compete for the dollars of fee-wary investors. Or they may do so as a way to hold onto investors after the fund has underperformed.
In the 2010s, some money market funds waived or reimbursed some of their fees after historically low bond yields wiped out any return they offered to investors. While mutual fund companies can reimburse part or all of a fund’s 12b-1 fee, it happens very rarely.
4. Sales Charges
In addition to the annual management and possibly also 12b-1 fees, mutual fund investors may pay sales charges.
Typically, these charges only apply to mutual fund purchases that an investor makes through a financial planner, or an investment advisor. This fee, also called a sales load, is how the advisor gets paid for their service. It isn’t a transaction fee however. Rather it’s a percentage of the assets being invested.
While the maximum legal sales charge for a mutual fund is 8.5%, the common range is between 3% and 6%.
These sales charges can come in different forms. Front-end sales charges come out of an investor’s assets at the time of the sale. Back-end sales charges, on the other hand, are deducted from the investment when the investor chooses to sell. Lastly, contingent deferred sales charges may not come out at all, if the investor stays in the fund for a specified period of time.
5. Advisory Fees
When an investing professional–a financial planner, advisor, or broker–offers advice, this is how they’re paid. Some advisors have a business model where they charge a percentage of invested assets per year. Other advisors, though, charge a transaction fee, in the form of a brokerage commission. Lastly, some simply charge an hourly fee.
Asset-based money management fees are usually expressed as a percentage of the assets invested through them. Typically, a hands-on professional will charge 1% or more per year for their services. That fee is most often deducted from an account on a quarterly basis. And it comes on top of the fees charged by any professionally managed vehicles, such as mutual funds.
But that fee can be much lower for automated investing platforms, also known as “robo-advisors.” Some of these robo-advisors charge annual advisory fees as low as 0.25%. But it’s worth noting that these platforms often rely heavily on mutual funds, which charge their own fees in addition to the platform fees.
Robo-advisors are famous for having rock-bottom fees. However, when investors are comparing robo-advisor fees, they’ll see that there’s a wide range. The minimum balances can also determine what sort of fees investors pay, and there may be additional fees like a potential set-up payment.
When an investor wants to buy or sell a stock, bond or an exchange traded fund (ETF), they typically use a brokerage firm. Fees and commissions vary widely depending on the type of transaction and the type of broker. Those fees can be based on a percentage of the transaction’s value, or it can be a flat fee, or a combination of the two.
And when investing, that fee depends on whether an investor uses a full-service broker or a discount broker. While a full-service broker can offer a wide range of advice and services, their commissions per trade are far higher than a discount or online brokerage might charge.
Because discount brokers offer less in the way of advice and services, they can charge a lower flat fee per trade. In recent years, the biggest online brokerage firms have offered free trading, partly due to competition and partly because they instead get paid through a practice known as payment for order flow.
Payment for order flow, or PFOF, is the practice of retail brokerage firms sending customer orders to firms known as market makers. In exchange, the brokerage firms receive fees for that order flow.
While widespread and legal, payment for order flow has been controversial because critics say it misaligns the incentives of brokerage firms and their customers. They argue that customers may actually be “paying” for their trades by getting worse prices on their orders. Defenders argue customers get better prices than they would on public exchanges and benefit from zero commissions.
💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).
Cost of Investment Fees
The cost of investment fees can vary depending on the type of fee, who is charging it, and the type of account an investor has. For instance, a standard management fee is about 1%.
A broker or brokerage might charge an annual fee of $50 to $75 a year. Not all brokers have an annual fee, so try to find one that doesn’t.
A broker might also charge anywhere from a few dollars to $30 for research. Again, not all brokers levy this charge, so choose a broker that doesn’t charge for research.
In addition, trading platform fees may range from $50 to $200 or more a month. You might also have to pay transfer or closing fees of $50 to $75 to have the brokerage transfer your account elsewhere or close it out.
Pros and Cons of Investment Fees
There are obvious drawbacks of investment fees. The biggest: Investment fees can diminish the returns on your investments. For instance, if your return was 8%, but you paid 1% in fees, your return is actually 7%. Over the years, that difference can be significant.
When it comes to benefits, there may be some advantages to using a fee-only financial advisor over one who charges commissions. For one thing, the costs may be more predictable. A financial advisor may charge a flat fee or charge by the hour. In contrast, a financial advisor who works on commission may suggest financial products that they earn commission from. In addition, many fee-only advisors are fiduciaries, which means they are obligated to act in the client’s best interests at all times.
Each investor should find out the specific fees involved relating to their investment. And don’t be afraid to ask questions. It’s critical to know exactly what you’ll be paying and what those costs cover.
How Much Is Too High a Price To Invest?
The cost of investment fees varies widely, depending on the type of fee. Advisory fees of more than 1% may be considered too high a price for many investors. Sales charges typically range between 3% and 6%, so anything higher than that might be something to avoid.
Of funds that charge fees, broad-index ETFs and mutual funds often charge the lowest fees.
The Takeaway
No matter how an investor gets into the market, they will pay some kind of fee. It may be the quarterly deduction made by a financial advisor, or the trading costs and account fees of an online brokerage account, or the regularly deducted management fees of a mutual fund.
Those fees and commissions add up to the “cost of investment.” That cost is deducted from assets and represents a drag on any return an investor may earn over time. As such, investing fees require close attention, regardless of an investor’s strategy or long-term goals.
Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.
Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹
FAQ
What are typical investment fees?
Typical investment fees include broker fees, trading fees, sales charges, management fees, and advisory fees.
Investment fees tend to be structured either as recurring fees, in which the charges are a percentage of the assets you’ve invested, or as one-time transaction charges that are similar to a flat fee, such as a certain amount of money per-trade.
Is a 1% management fee high?
A 1% management fee is a fairly typical fee. However, even though it is standard, you can try negotiating for a smaller fee than 1%. Some financial advisors may be willing to lower the percentage.
How much should you pay for investment management fees?
Generally, you can expect to pay about 1% for an investment management fee. Overall, percentage fees like this tend to be best for investors with smaller investments, while a flat fee tends to be more advantageous to investors with a very large investment (meaning more than $1 million).
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
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.
¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.
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.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.
Mutual Funds (MFs): Investors should read and carefully consider the information contained in the prospectus, which contains the Mutual Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or SoFi's customer service at: 1.855.456.7634. Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risks. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may have tax implications.
Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®
This article is not intended to be legal advice. Please consult an attorney for advice.
