Dec
20
2022
How Bid and Ask Price Work in Trading

Bid and Ask Price: Definition, Example, How It Works

By | Growing Wealth, invest, Investing | Comments Off on Bid and Ask Price: Definition, Example, How It Works

Bid and ask are commonly used investing terms, and they refer to the best potential price at which a security on the market could be bought or sold for at any given time. In other words, the best price that buyers and sellers would potentially be willing to buy (the “bid” price) or sell (the “ask” or offer price) the asset.

It’s important for traders to understand the bid vs ask price of a security, as well as the difference between the two, which is known as the bid-ask spread.

The market price is a historical price: the price of the last trade that occurred with the security. The bid and ask prices, on the other hand, show what buyers and sellers would be willing to trade the security for now.

What Are Bid and Ask?

If you’re just getting started investing in stocks, you’re probably wondering about bid vs. ask prices. Bid and ask prices show the current market supply and demand for the security. The bid price represents demand for a security; the ask price represents supply.

When an asset has high liquidity — i.e. the market has a high trading volume not dominated by selling — the bid and ask prices will be fairly close. In other words the bid-ask spread, or the difference between the bid and ask prices, will be narrow in a highly liquid market. When there’s a greater gap between demand and supply, the spread will be wider.

That’s why the bid-ask spread is often considered a gauge of liquidity.

Bid Price

The bid price is the best potential price that retail investors would be willing to pay to buy a security.

So if a trader wants to sell a security, they would want to know how much they’d be able to sell it for. They can find out the best price they could get for the security by looking at the current bid price in the market, which would show the highest potential amount they could get for it.

Ask Price

Conversely, ask price is the lowest price investors are willing to sell a security for at any given time. If a trader wants to buy a security, they want to get the lowest possible price, so they look at the ask price to find out what that is.

Bid and Ask Price Examples

Let’s imagine that an investor wants to buy Stock X at the quoted price of $75, so they plan to buy 10 shares for $750. But they end up paying $752. That’s not an error, but rather because the ask price (the selling price) is $75.20.

The current price of $75 per share is the last traded price. But prices can change quickly, and in this case the ask price was 20 cents higher. The bid or buyer’s price is almost always lower than the ask price.

Investors can use limit orders to set specific parameters around the price at which they’re willing to buy or sell a security. This can give investors some control, so they’re not simply paying the current price, which may or may not be advantageous.

Evaluating the bid-ask spread can be part of an investor’s due diligence when trying to gauge rates of return for different securities.

What the Bid-Ask Spread Signals

How far apart the ask price and bid price are can give you a sense of how the market views a particular security’s worth.

If the bid price and ask price are fairly close together, that suggests that buyers and sellers are more or less in agreement on what a security is worth. On the other hand, if there’s a wider spread between the bid and ask price, that might signal that buyers and sellers don’t necessarily agree on a security’s value.

How Are Bid and Ask Prices Determined?

Essentially it’s the supply and demand of the market that sets the bid and ask prices. And many factors can play into supply vs. demand. Because of this, investors who are interested in active investing can use the difference in price between the bid and the ask of a security to gauge what the market thinks the security is worth.

Investors and market-makers can place buy or sell orders at a price they set. These orders will be fulfilled if someone is willing to sell or buy the security at that bid or ask price. Those order placements determine the bid and ask price.

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What’s the Difference Between Bid and Ask Prices?

In any market, from stocks to real estate to lemonade stands, there is almost always a difference between what someone is willing to pay for an item versus what someone wants to sell it for.

A buyer may want to buy a house for $300,000, but the seller is selling it for $325,000. An investor may want to buy a stock for $100, but the sell or ask price is $105.

That difference in price is called the spread, and when the spread is narrow it’s a lot easier to close the sale. When the spread is wider, there is a bigger gap between what the buyer thinks an item is worth vs. what the seller thinks it’s worth.

What Does It Mean When Bid and Ask Are Close?

A narrow spread, i.e. when the bid and ask price are close, means traders will be able to buy and sell the security at roughly the same price. This generally means there is a high trading volume for the security, with a lot of people willing to buy and sell because of high demand.

If demand increases for the security, the bid and ask prices will move higher, and vice versa. If there is a surge in demand, but not enough supply, that might drive the bid price up. Conversely, if supply outpaces demand, the bid price of a security could fall In either case, the spread would likely get wider when the bid or the ask prices outweighs the other.

The Bid-Ask Spread

The bid-ask spread is the gap between the two prices: the bid or buyer’s price and the ask or offer price. There are different factors that can affect a stock’s spread, including:

•   Liquidity. A measure of how easily a stock or security can be bought and sold or converted to cash. The more liquid an investment is, the closer the bid and ask price may be, since the market is in agreement about what the security is worth.

•   Trading volume. This means how many shares of a stock or security are traded on a given day. As with liquidity, the more trading volume a security has, the closer together the bid and ask price are likely to be.

•   Volatility. A way of gauging how rapidly a stock’s price moves up or down. When there are wider swings in a stock’s price, i.e. more volatility, the bid-ask price spread can also be wider as market makers attempt to profit from the price changes.

Who Benefits From the Bid-Ask Spread?

The difference in price between the bid and the ask is where brokers and market makers make their profit.

But traders can also benefit from the bid-ask spread, if they use limit orders to get the best possible price on a desired trade, as opposed to using market orders.

How the Bid-Ask Spread Is Used

When you understand how bid-ask spread works, you can use that to invest strategically and manage the potential for risk. This means different things whether you are planning to buy, sell, or hold a stock.

If you’re selling stocks, that means getting the best bid price; when you’re buying, it means paying the best ask price. Essentially, the goal is the same as with any other investing strategy: to buy low and sell high.

Bid-Ask Spread Impact on Trading Profits

Naturally, the bid-ask spread impacts trading profits, and in fact can act almost as a hidden cost.

For example, if an investor places a market order on a stock with a bid price of $90 and an ask price of $91, they’ll get the stock at $91 per share. If the price of the stock rises 5%, so the bid price is now $94.50 and the ask price is $95.55 and the bid-ask spread is $1.05.

If the investor decides to sell the shares they bought at $91 through a market order, they will receive $94.50 per share. So their profit is $3.50 per share, even though the stock price rose by $4.55. The $1.05 gap in profit reflects the $1.05 bid-ask spread on this stock.

Wide vs Narrow Bid-Ask Spread

What is the difference between wide and narrow bid-ask spreads, and what is the significance of each?

Narrow Bid-Ask Spreads

The bid-ask spread, often just called the spread, is tighter when a security has more liquidity, i.e. there’s higher trading volume for that stock. When you think of big companies, industry leaders, constituents of different indexes like the Dow Jones or the S&P 500, those companies may have higher volume and narrower spreads.

Wider Bid-Ask Spreads

Conversely, smaller companies or those that aren’t in demand tend to have wider spreads, reflecting a lower level of market interest. These trades tend to be more expensive, as investors must contend with lower liquidity.

Impact of the Bid-Ask Spread

The narrower the bid-ask spread, the more favorable it is for traders. If an investor wants to buy 100 shares of Stock A at $60, but shares are being offered at $60.25, that 25 cent spread may not seem like much. It would add up to $25 (100 x 0.25). But if that trader wanted to buy 500 shares or more, the cost of the spread is about $125.

The Takeaway

Bid and ask prices help traders know exactly how much they may buy and sell securities for. The bid price is the highest price a buyer is willing to pay for a security. The ask price is the lowest price a seller is willing to accept. The difference between them is the bid-ask spread, or “spread.”

The spread ends up being a transaction cost, as market makers pocket the cost of the spread.

Since the bid price and the ask price are essentially a function of supply and demand in the market, investors can consider the bid-ask spread as a gauge of risk. The narrower the spread, the more aligned buyers and sellers are on the value of a certain security, and thus there’s higher volume and more liquidity — and lower risk to the investor that the stock or security might lose value (although it could, as there are no guarantees).

To understand bid and ask prices, you can start trading stocks with only a few dollars using the SoFi app. When you set up an Active Invest account, you can research, track, buy and sell stocks, right from your phone or laptop. SoFi doesn’t charge a commission, and you can see all your financial information in one simple dashboard.

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

FAQ

Do I buy a stock at the bid or ask price?

You buy a stock at the ask price, that’s the lowest price the seller is willing to offer.

Is the last price the same as the market price?

The last price is the last traded price for a security, or the last price at which it closed. The market price is the best current price.

Is it better if your bid is higher than the asking price?

The bid price is typically lower than the seller’s price or ask price, so it would be unusual if the bid was higher than the ask. If a bid price is higher than the ask, a trade would occur, but it would put the buyer at risk of a potential loss.

Photo credit: iStock/eclipse_images

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.

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20
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Female dentist with patient

8 Smart Tips To Finance Expensive Dental Work

By | Budgeting & Goals, personal_loan | No Comments

So you need expensive dental work, and you’re wondering how to pay for it. After getting a quote from your dentist and learning how little your insurance will cover, you may be thinking, This can’t be right. I must be missing something.

We’ve got good news and bad news. Bad news first: Despite insurance, dental work can cost a lot out-of-pocket. The good news: While there’s no simple and obvious solution to covering the bills, there are many tricks you can use to make your dollar stretch farther (and get a tax break while you’re at it).

We’ll explain all the ways you can save a little here and there on dental work. Altogether, they can add up to quite a discount off your dentist’s quote.

8 Ways To Pay for Dental Work

Many people cover their dental work by combining several of the strategies below. It’s tough to avoid paying out-of-pocket entirely, but you can get a hefty discount off the original quote.

1. Medical Insurance

Dental work isn’t typically covered by medical insurance, but certain procedures may be covered if they’re deemed “medically necessary.” For instance, oral surgery potentially can be billed as a medical procedure. Before you move forward with any dental work, it’s a smart idea to talk to your medical insurance company to find out what may be covered.

Recommended: Beginner’s Guide to Health Insurance

2. Dental Insurance

You should know that there’s a difference between a dental office that takes your insurance and a dental office that is in-network. A dentist may take your insurance even though they are out-of-network.

When a dentist says that they take your insurance, that likely means that they will file an insurance claim for you. But if your insurance doesn’t cover a procedure or service, the price will generally be set at your dentist’s discretion — and you’ll typically be responsible for paying the costs out-of-pocket.

Generally, using an out-of-network dentist means your insurance will cover less and you’ll pay more. Being in-network, on the other hand, usually means that your insurance company has pre-negotiated the fees with the dentist and they generally can’t charge more than that. So you’ll usually pay less with an in-network dentist.

Recommended: Budgeting as a New Dentist

3. Payment Plans

Paying a bill on a weekly or monthly basis can be much more manageable than paying it in a lump sum. That’s why many dental offices offer payment plans for procedures not covered by insurance.

Payment plans can be offered directly through your dentist’s office, or by third-party services like CareCredit. Ask about the specific terms of any payment plan offered. For example:

•   What procedures qualify for a payment plan?

•   Will they charge interest? And if so, how much?

•   Do they have to check your credit first?

Asking these questions beforehand can help keep you from getting blindsided by unexpected costs.

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4. Flexible Spending Account

A Flexible Spending Account (FSA) is a special savings account offered through some employer benefit plans. FSAs allow employees to pay for certain out-of-pocket medical and dental costs with tax-free money.

The typical taxpayer saves about 30% in federal, state, Social Security, Medicare, and Unemployment taxes. That translates to a 30% discount off all eligible medical and dental expenses.

FSA rules cap the amount of money that can be placed in the account each year ($3,050 for 2023), and also dictate which types of expenses are FSA-eligible. Most routine dental work and orthodontia qualify: cleanings, X-rays, fillings, crowns, extractions, implants, and Invisalign.

FSAs can’t be used for any procedure that is considered “cosmetic,” including teeth whitening and veneers. But in some instances, if a typically cosmetic procedure is deemed medically necessary — as with some veneers — you may be able to use your FSA. Talk to your dental insurance company for more information.

One drawback of FSAs is that any funds that are unused at the end of the plan year are forfeited — so make sure you don’t leave any money on the table. In the plus column, because FSAs are funded with pre-tax dollars, they reduce your taxable income, which is always nice.

5. Health Savings Account

A Health Savings Account (HSA) is similar to an FSA in several ways:

•   Both are funded with pre-tax dollars

•   Both are used to cover healthcare expenses

•   Both can be established through your employer, and funded with payroll deductions

But there are also key differences between an FSA and HSA:

•   HSAs must be used with a High Deductible Health Plan (HDHP)

•   The 2023 HSA funding cap is $3,850 for individuals, $7,750 for families

•   HSA funds roll over from year to year

•   You can set up an HSA through some health insurance companies and banks, making them a good option for the self-employed

If you don’t have access to an FSA — and you are currently covered by a high-deductible health plan — you can open an HSA at any time.

6. Talk With Your Dentist

The cost of dental work can actually be negotiable, depending on your dentist and your situation. First, have your dentist walk you through the treatment plan. Ask lots of questions, including:

•   Are all the procedures they’re suggesting equally urgent? Can some be postponed?

•   Can you get a discount by paying cash or the entire cost upfront? Some dentists give a percentage off for this.

•   If you don’t have insurance, ask if you can score an uninsured rate.

Some dentists will be flexible, and the worst that can happen is they say no. Another thing you can do is to have an honest conversation with your dentist about your financial situation. If your budget has no breathing room, see if they are open to giving you a discount, or if they are willing to push out your bill for a few months.

If the planned dental work is important but not super urgent, you may be able to schedule your appointments so they straddle two plan years. For example, if your plan year is January-December, you might schedule half the appointments for December, and a half for the following January. That way, you can take advantage of two annual benefit maximums for insurance and two years’ worth of FSA or HSA funds.

7. Credit Cards

In some circumstances, a credit card can be a suitable payment option for dental bills. If you have a card that offers rewards or cash back, it can also provide some benefits in return.

You might also consider looking for a medical credit card. These cards are issued by banks, credit unions, and other lenders and can only be used for healthcare and within a specific provider network.

Some medical credit cards defer interest for a period of time after your healthcare charges are incurred — much like 0%-interest cards. No interest is charged so long as those charges are paid off in full before the interest-free period expires. Late payments or balances that have not been fully paid before the deferment period ends can incur interest charges.

Speaking of 0%-interest cards, they’re another option to finance expensive dental work. By law, these interest-free promotional financing offers must last at least six months. But the most competitive offers go well beyond this to offer 0% introductory APR financing for 14 months or longer.

Before you commit to a new card, it’s a good idea to shop around for the best terms and make sure dental work meets the requirements for any rewards.

8. Personal Loan

A personal loan is an unsecured loan that you can use for almost anything. Because of this flexibility, many people use personal loans to pay for out-of-pocket medical expenses.

Using a personal loan to finance dental work might be a better option than a credit card. The lower the interest rate, the lower your monthly payment. And personal loans tend to have lower interest rates than credit cards. Credit cards currently have an average interest rate of 22.4%, but online lenders such as SoFi offer personal loans with lower interest rates to qualified borrowers.

How much you can borrow is also flexible, and getting approved for a personal loan can be done entirely online. In short, a dental loan might be a good option to cover additional dental needs, from basic fillings to more complex, high-cost procedures.

Recommended: Secured vs. Unsecured Personal Loans

The Takeaway

There is no one perfect solution for financing expensive dental work. But there are a number of resources and tricks you can call upon to stretch your dollar. Discuss your options with your dentist to find out what discounts and payment plans they may offer. Avail yourself of an FSA or HSA to pay with pre-tax dollars — an effective discount of 30%. Another option is to pay your bill with a 0% interest credit card, rewards card, or medical credit card that defers interest for six months or more. And you can maximize your insurance and FSA/HSA benefits by scheduling your appointments so they straddle two plan years.

Another option is to finance your dental work with a personal loan. SoFi offers personal loans with low fixed rates, no fees, and flexible repayment terms. From a simple whitening treatment to a complicated root canal, SoFi loans help cover the costs that insurance won’t.

Pay for medical costs — without sinking into high-interest debt.

FAQ

What can I use as financial assistance for dental work?

To finance expensive dental work, you may have to employ a few different tricks. First, if you have an FSA or HSA, paying your bills with pre-tax funds will net you an effective 30% discount. You can also schedule work to straddle two plan years so that your dental insurance and FSA/HSA cover twice the annual amount. If you’re uninsured, explain your financial situation to your dentist to see if they’ll offer a discount. And consider taking out an unsecured personal loan.

Can I use a personal loan as financial assistance for dental work?

Yes, a personal loan can be a great option for covering expensive dental work, compared to high-interest revolving credit. Shop around for the best rate and terms, and watch out for hidden fees.

Is it hard to get financial assistance for dental work?

It will take some work on your part, but financial assistance is available for low-income patients through dental schools, clinical trials, United Way, Medicare, and Medicaid. Find out what kind of assistance you may be eligible for on the U.S. Department Health & Human Services website at HHS.gov.

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Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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

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.

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

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Defensive Investment Strategy: Definition and Types

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Defensive Investment Strategy: Definition and Types

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

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

What Is a Defensive Investment Strategy?

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

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

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

What Are Defensive Investments?

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

Typical investments in a defensive portfolio include:

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

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

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

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

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

5 Examples of Defensive Investments and Strategies

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

Portfolio Diversification

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

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

Portfolio Rebalancing

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

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

Dollar Cost Averaging

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

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Value Investing

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

💡 Recommended: Value vs Growth Stocks

Stop Loss Orders

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

Pros and Cons of Defensive Investing

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

Pros

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

Pros of Defensive Investing

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

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

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

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

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

Cons of Defensive Investing

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

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

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

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

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

When Is It Smart to Use a Defensive Investment Strategy?

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

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

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

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

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

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

The Takeaway

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

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

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

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.

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Guide to Taxes and Mutual Funds

By | Growing Wealth, invest, Investing | Comments Off on Guide to Taxes and Mutual Funds

For a long time, mutual funds have been a popular investment vehicle for millions of investors, largely because they offer an easy way to purchase no-fuss, diversified assets with relative ease. This out-of-the-box diversification and risk mitigation is something that individual stocks can’t match.

However, many investors don’t know where to start regarding mutual funds taxes. Read on to learn how taxes on mutual funds work, what investors should expect or anticipate when dealing with mutual funds and the IRS, and some strategies for tax-efficient investing.

Quick Mutual Fund Overview

First, it makes sense to review the basics. A mutual fund is a pooled investment vehicle that allows individuals to invest in a professionally managed portfolio of stocks, bonds, and other securities. Mutual funds are managed by professional portfolio managers who use the pooled capital to buy and sell securities according to the fund’s stated investment objective. When investors buy into a mutual fund, they’re purchasing a spectrum of assets all at once.

Mutual funds can be actively managed, where the portfolio manager actively buys and sells securities in the fund, or passively managed, where the fund tracks an index. Mutual funds are a popular way for individuals to diversify their portfolios and access professional investment management.

💡 Recommended: How to Buy Mutual Funds Online

Do You Pay Taxes on Mutual Funds?

Mutual fund investors generally have to pay taxes on any income or capital gains the mutual fund distributes, including dividends, interest, and realized capital gains from the sale of securities within the fund.

It’s worth noting that mutual funds can be structured in different ways, and the tax treatment of mutual fund investments can vary depending on the specific type of mutual fund. For example, some mutual funds are classified as tax-exempt or tax-deferred, which means that they are not subject to certain taxes or that taxes on the income or gains from the fund are deferred until later.

When a mutual fund distributes income or capital gains to its investors, it must provide them with a Form 1099-DIV , which reports the distribution amount and any associated taxes. Investors are then responsible for reporting this income on their tax returns and paying any taxes that are due.

How Are Mutual Funds Taxed?

Mutual funds are taxed based on the income and capital gains they generate and distribute to their investors. This income and capital gains can come from various sources, such as dividends on stocks held by the fund, interest on bonds held by the fund, and profits from the sale of securities within the fund.

The tax treatment of mutual fund investments can vary depending on the type of fund and the type of income or capital gains it generates. Here are some general rules to keep in mind:

Paying Tax on “Realized Gains” from a Mutual Fund

It may come as a surprise that shareholders may owe taxes on their mutual fund holdings even if they don’t sell shares of the fund. That’s because shareholders still generate income from those holdings, often called “realized” gain.

Mutual funds are often actively managed, meaning that a portfolio manager regularly makes decisions about what the fund contains by buying and selling investments — a process that can net profits. Those profits, or gains, are then passed back to shareholders as distributions (or as dividends) or reinvested in the fund.

When shareholders are awarded distributions from funds, they see a “realized” gain from their investment. For that reason, shareholders may end up owing tax on investments that they have not sold or may have lost value over the year.

Paying Capital Gains on Mutual Funds

Most investors likely know that when they sell shares of a mutual fund, they’ll need to pay taxes on the earnings. Specifically, they’ll pay capital gains tax on the profit from selling an investment. The capital gains tax rate will vary depending on how long an investor holds the investment (short-term versus long-term).

Because funds contain investments that may be sold during the year, thereby netting capital gains, investors may be responsible for capital gains taxes on their mutual fund distributions. As each fund is different, so are the taxes associated with their distributions. So reading through the fund’s prospectus and any other available documentation can help investors figure out what, if anything, they owe.

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How Much Tax Do You Pay on Mutual Funds?

The amount of tax you pay on mutual fund investments depends on the type of fund, the type of income or capital gains the fund generates, and your individual tax situation.

Here are some general rules to keep in mind:

•   Dividends: Dividends paid by mutual funds are taxed at different rates, depending on whether the payouts are ordinary or qualified dividends. Qualified dividends are taxed at a lower rate than ordinary dividends; they’re taxed at the long-term capital gains rate, which ranges from 0% to 20%. In contrast, ordinary dividends are taxed at an investor’s ordinary income tax rate.

•   Interest: The tax on the interest income from mutual funds depends on whether the payout comes from tax-exempt bonds, federal debt, or regular fixed-income securities. Depending on the type of asset, the interest may be taxed at ordinary income tax rates or exempt from certain taxes.

•   Capital gains: When a mutual fund sells securities for a profit, it may realize a capital gain, which is subject to tax. The tax rate on capital gains depends on how long the securities were held and your tax bracket. Short-term capital gains (on securities held for one year or less) are taxed at the same rate as ordinary income. In comparison, long-term capital gains (on securities held for more than one year) are generally taxed at the lower capital gains tax rate.

How to Minimize Taxes on Mutual Funds

When it comes to mutual funds, taxes will be a part of the equation for investors — there’s no way around it. But that doesn’t mean that investors can’t make some smart moves to minimize what they owe. Here are a handful of ways to potentially lower taxable income associated with mutual funds:

Know the Details Before You Invest

Do your homework! The holdings in each fund and how they’re managed will ultimately play a significant role in the tax liabilities associated with each fund. Before investing in a specific mutual fund, it’s worth digging through the prospectus and other documents to understand what to expect.

For example, an investor can typically find out ahead of time if a mutual fund makes capital gains distributions or how often a fund pays out dividends. Those types of income-generating events will need to be declared to the IRS come tax time.

Some investors may look for tax-efficient funds specifically designed to help mutual fund investors avoid taxes.

Use a Tax-deferred Account

Some brokerage or investment accounts — including retirement accounts like IRAs and 401(k)s — are tax-deferred. That means they grow tax-free until the money they contain is withdrawn. In the short term, using these types of accounts to invest in mutual funds can help investors avoid any immediate tax liabilities that those mutual funds impose.

💡 Recommended: Are Mutual Funds Good for Retirement?

Hang Onto Your Funds to Avoid Short-term Capital Gains

If the goal is to minimize an investor’s tax liability, avoiding short-term capital gains tax is important. That’s because short-term capital gains taxes are steeper than the long-term variety. An easy way to ensure that an investor is rarely or never on the hook for those short-term rates is to subscribe to a buy-and-hold investment strategy.

This can be applied as an overall investing strategy in addition to one tailor-made for avoiding additional tax liabilities on mutual fund holdings.

Talk to a Financial Professional

Of course, not every investor has the same resources, including time, available to them. That’s why some investors may choose to consult a financial advisor specializing in these services. They usually charge a fee, but some may offer free consultations. For some investors, the cost savings associated with solid financial advice can outweigh the initial costs of securing that advice.

How Do You Report Mutual Funds on Your Taxes?

If you own mutual funds, you will generally need to report any income or capital gains you receive from the fund on your tax return.

Mutual funds are required to provide their investors with a Form 1099-DIV, which reports the amount of any dividends, interest, and capital gains distributions the fund paid out during the year. Make sure to keep this form for your records and use it to help complete your tax return.

You will then need to report any dividends, interest, and capital gains distributions you received from your mutual fund on your tax return, specifically on IRS Form 1040 or Schedule D (Form 1040) .

The Takeaway

Mutual fund taxes are generally unavoidable, but with a little planning, you can minimize the amount you get taxed. Employing some of the above strategies can help you minimize your mutual taxes. For example, those investing for long-term financial goals, like retirement, can use tax-deferred accounts as their primary investing vehicles. And by using those accounts to invest in mutual funds and other assets, they can help offset their short-term tax liabilities.

Investing in mutual funds is a popular way for investors to diversify their holdings in a single security. However, there are other ways to build a diversified portfolio. With a SoFi Invest® online investment account, you can trade your favorite stocks with no commissions and exchange-traded funds (ETFs) to create a personalized financial portfolio.

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

Do you pay taxes when you sell mutual funds?

Yes, you may be required to pay taxes when you sell mutual funds. The specific taxes you may be required to pay will depend on several factors, including the type of mutual funds you are selling, how long you have held the funds, and the type of gains you have earned from the sale.

Are mutual funds taxed twice?

Mutual funds are not taxed twice. However, some investors may mistakenly pay taxes twice on some distributions. For example, if a mutual fund reinvests dividends into the fund, an investor still needs to pay taxes on those dividends. Later, when the investor sells shares of the mutual fund for a gain, they’ll have to pay capital gains taxes on those earnings. But the capital gain includes the reinvested dividends, on which the investor already paid taxes. So, the investor may end up paying taxes twice on the same earnings. To avoid paying taxes twice, the investor needs to adjust the cost basis of their investment.

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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.

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.

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.

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Can a Personal Loan Hurt Your Credit?

By | Credit, personal_loan | No Comments

If you’re considering a personal loan, you might wonder what kind of impact it may have on your credit. It’s true that the application process can cause your credit score to dip temporarily, but a loan can potentially help it too.

We’ll run through all the ways a personal loan can affect your credit score, as well as when you might consider a personal loan for your financial life.

How Is Your Credit Score Calculated?

What makes up your credit score?

To understand how a personal loan can affect your credit, it helps to know the basics of how your credit score is calculated. According to FICO®, a company that generates credit scores, five principal components are used to calculate your FICO Score:

•   Payment History (35%): Your history of making on-time payments to lenders is a key factor, accounting for more than a third of your score.

•   Amounts Owed (30%): The amount of credit you are currently using is the second-most important factor.

•   Length of Credit History (15%): The length of time you’ve had credit accounts open, and in good standing, is also a factor. Opening new lines of credit will bring down the average age of your credit history.

•   New Credit (10%): This component considers the amount of new credit recently taken out.

•   Credit Mix (10%): This final factor takes into account the different types of credit you hold: credit cards, personal loans, mortgages, etc.

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How Do Personal Loans Work?

A personal loan is a borrowed sum of money that is paid back in installments, with interest. Loan amounts typically range from $5K to $100K.

Common uses for personal loans include consolidating high-interest credit card debt, and funding large purchases such as home improvements, weddings, unexpected medical expenses, moving expenses, and funerals.

Recommended: Types of Personal Loans

Do Personal Loans Hurt Your Credit?

Any debts you have can impact your credit, so taking out a personal loan might lead to a drop in your credit score over the short term. On the flip side, there are ways for your personal loan to positively affect your credit score.

Here’s how a personal loan can impact your credit score, negatively or positively:

A Personal Loan’s Impact on Credit Score

Pros Cons

•   Can add to your credit mix

•   Could improve your payment history if you pay on time

•   May help keep your credit utilization ratio in check

•   No collateral required

•   Requires a hard credit inquiry

•   May increase amounts owed

•   Could negatively impact your payment history if you miss payments

•   Fees can drive up the cost of the loan

Con: Requires a hard credit inquiry

Taking out a loan often requires a hard credit inquiry, which can adversely impact your credit score. Hard inquiries remain on your credit report for two years, though their negative effect on your score is minor (typically 5 points or less) and lasts only a year.

Con: May increase amounts owed

The “amounts owed” on your credit score may increase because you are taking on new debt. However, if you’re consolidating credit card debt, you will reduce that debt by paying it down with the personal loan — your amount owed doesn’t change.

Con: Can impact your payment history if you miss a payment

If you miss a payment on your personal loan, that can negatively impact the “payment history” component of your credit score. That factor specifically looks at whether you make your debt payments on time.

Con: Some lenders charge fees

Fees can drive up the cost of a loan, beyond what you’re paying in interest. For example, an origination fee, which lenders charge upfront, is typically a percentage of the principal. And prepayment penalties discourage borrowers from paying off their loan early. (SoFi never charges any fees.)

Pro: Can add to your credit mix

Having a new loan type (and paying it back on-time) can positively impact the “new credit” and “credit mix” components of your score.

Pro: Can improve your payment history if you pay on time

Making on-time payments and showing responsible management of a personal loan is a nice checkmark for the “payment history” part of your credit score.

Pro: May help you keep your credit utilization ratio in check

If you’re using a personal loan to reduce credit card debt, it replaces revolving debt (your credit card debt) with an installment loan. Revolving debt is one you can continue adding to even when paying it down. An installment loan involves borrowing one specific amount and repaying it in — wait for it — installments. Because you won’t be able to add further debt to your installment loan, it may help you keep your credit utilization ratio under control, which can be a good thing for your credit score.

Pro: No collateral required

Loans can be either secured or unsecured. A secured loan is one that requires the borrower to put up collateral, such as a car or home. An unsecured loan requires no collateral.

When To Consider Taking Out a Personal Loan

There’s not a clearcut answer to whether a personal loan can hurt your credit, because everyone’s financial situation is different. But here are some instances when a personal loan may be appropriate:

•   You’re consolidating high-interest debt

•   You have an emergency expense you can’t otherwise afford

•   You’re paying for a home improvement project that will add value to your home

•   It’s your least expensive borrowing option

•   You don’t have any collateral to offer

Before you take on any debt, it’s always important to consider whether it’s really necessary and what other ways you might cover your costs. For instance, it’s often not recommended to take out a personal loan to pay for a vacation when you can scale back on your travel plans or simply wait until you’ve saved up enough money. It’s obviously a very different story if you have to cover the cost of a medical emergency.

Consider whether you can afford to make the payments on time. And make sure you understand the total cost of the loan, with interest and any fees added in. Also think about whether your credit score is high enough to qualify for competitive rates and terms, and whether it can withstand any dips applying for a loan might cause.

Recommended: How To Get Approved for a Personal Loan

The Takeaway

Applying for a personal loan requires a hard credit inquiry, which typically dings your credit score by around 5 points. But overall, as long as you don’t borrow more than you can pay back, and you make all scheduled payments on time, a personal loan can have a positive impact on your credit score over the long term. A personal loan can add to your credit mix, and will improve your available credit if you’re using it to pay off high-interest credit cards.

Shop around for the best personal loan offers for you. SoFi’s personal loan calculator can show you what your monthly payment might be in different scenarios. SoFi can give you a rate quote in minutes.

With SoFi, you can check your rate in 60 seconds, and get your loan funded fast.

FAQ

Is a personal loan bad for your credit?

There’s no clearcut answer because personal loans can have a positive or negative impact on your credit score. The loan itself has less of an impact than how you manage your loan. If you never miss a payment, a personal loan can help your credit score over time. But if you can’t afford to make your monthly payments on time, that can hurt your score.

Will a personal loan affect my credit card application?

It can. If you applied for the loan recently, you may want to wait and see how your credit score is affected before applying for a credit card. A personal loan can have a positive or negative impact on your credit score, depending on your financial situation and how you manage the loan.

Will a personal loan affect my car loan application?

It can. A personal loan affects your “credit utilization,” which impacts your credit score. How much impact it has depends on your financial situation. If the personal loan is your only debt, for instance, your credit utilization might be able to accommodate both loans.

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

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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

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