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Q: What Is a Balanced Portfolio?

While it’s possible to invest all your money inone mutual fund or ETF(or stock or bond), decades of investing research shows that putting all your money into a single investment can be risky. If that single asset drops in value, it would impact your entire nest egg.

Mar

2025

How to Build an Investment Portfolio for Beginners

By Inyoung Hwang | Growing Wealth, invest, Investing | No Comments

These days it’s fairly straightforward to set up an investment portfolio, even if you’re a beginner. By understanding a few fundamentals, it’s possible to learn how to create an investment portfolio that can help build your savings over time, and support your progress toward certain goals, like retirement.

Identifying your goals is the first step in the investing process. Then, it’s important to determine a time frame you’ll need to reach your goal — e.g., one year, five years, 30 years — and understand your personal tolerance for risk.

These three fundamentals will help you make subsequent decisions about your investment portfolio, like which investments to choose.

Key Points

• It’s relatively easy to build a basic investment portfolio, using only a few key fundamentals.

• An investment portfolio is usually tied to a goal like retirement or wealth building, or sometimes a savings goal (e.g., a down payment).

• Most investment portfolios consist of securities like stocks, bonds, mutual funds, or other types of assets.

• By identifying your goal, time horizon, and risk tolerance, it’s possible to create a well-balanced portfolio that’s also diversified.

• A beginning investor can select their own investments, work with a financial professional, or choose a robo advisor (which offers pre-set portfolios).

The Basics: What Is an Investment Portfolio?

An investment portfolio is a collection of investments, such as different types of stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate, and other assets.

Types of Investment Portfolios

An investment portfolio aims to achieve specific investment goals, such as generating income, building wealth, or preserving capital, while managing market risk and volatility.

You might have an investment portfolio in your retirement account, and another portfolio in a taxable account.

While it’s possible to select your own investments, a financial advisor can also help select investment for a portfolio. It’s also possible to invest in a pre-set portfolio known as a robo advisor, or automated portfolio.

These days, investing online is a common route, whether you use an online brokerage or a brick-and-mortar one.

Why Building a Balanced Portfolio Matters

Building a balanced investment portfolio matters for several reasons. As noted above, a balanced, diversified portfolio can help manage the risk and volatility of the financial markets.

What Is a Balanced Portfolio?

While it’s possible to invest all your money in one mutual fund or ETF (or stock or bond), decades of investing research shows that putting all your money into a single investment can be risky. If that single asset drops in value, it would impact your entire nest egg.

Building a balanced portfolio, where you invest in a range of different types of assets — a strategy known as diversification — may help mitigate some risk factors, and over the long term may even improve performance (although there are no guarantees).

The Value of Diversification

Many people avoid building an investment portfolio because they fear the swings of the market and the potential to lose money. But by diversifying investments across different asset classes and sectors, the impact of any one investment on the overall portfolio is reduced.

This beginner investment strategy can help protect the portfolio from significant losses due to the poor performance of any single investment.

Additionally, by including a mix of different types of investments, investors can benefit from the potential returns of different asset classes while minimizing risk. For example, building a portfolio made up of relatively risky, high-growth stocks balanced with stable, low-risk government bonds may allow you to benefit from long-term price growth from the stocks while also generating stable returns from the bonds.

Creating a balanced portfolio and using diversification are strategies to mitigate risk, not a guarantee of returns.

Assessing Risk Tolerance and Setting Investment Goals

In the financial world, risk refers specifically to the risk of losing money. Each investor’s tolerance for risk is an essential component of their personal investing strategy, because it guides their investment choices. Below are two general strategies many investors follow, depending on their risk tolerance.

Conservative vs. Aggressive Investing

• An aggressive investment strategy is for investors who are willing to take risks to grow their money. Aggressive refers to the willingness to take on risk.

Stocks, which are shares in a company, tend to be more risky than bonds, which are debt instruments and generally offer a fixed yield or return over time. When you buy stocks, the value can fluctuate. While the price of bonds also goes up and down, owning a bond can provide a stream of income payments that, in some cases (i.e., government bonds rather than corporate), are guaranteed.

One rule you often hear in finance: High risk, high reward. Which means: Stocks tend to be higher risk investments, with the potential for higher rewards. Bonds tend to be lower risk, with the likelihood of lower returns.

• Conservative investing is for investors who are leery of losing any of their money. Conservative strategies may be better suited for older investors because the closer you get to your ultimate goal, the less room you will have for big dips in your portfolio should the market sell off. But a conservative mindset can apply to any age group.

You can prioritize lower-risk investments as you get closer to retirement. Lower-risk investments can include fixed-income (bonds) and money-market accounts, as well as dividend-paying stocks.

These investments may not have the same return-generating potential as high-risk stocks, but for conservative investors typically the most important goal is to not lose money.

Choosing a Goal for Your Portfolio

Long- and short-term goals depend on where you are in life. Your relationship with money and investing may change as you get older and your circumstances evolve. As this happens, it’s best to understand your goals and figure out how to meet them ahead of time.

If you’re still a beginner investing in your 20s, you’re in luck because time is on your side. That means, when building an investment portfolio you have a longer time horizon in which to make mistakes (and correct them).

You can also potentially afford to take more risks because even if there is a period of market volatility, you’ll likely have time to recover from any losses.

If you’re older and closer to retirement age, you can reconfigure your investments so that your risks are lower and your investments become more conservative, predictable, and less prone to significant drops in value.

As you go through life, consider creating short- and long-term goal timelines. If you keep them flexible, you can always change them as needed. But of course, you’d want to check on them regularly and the big financial picture they’re helping you create.

Short Term: Starting an Emergency Fund

Before you think about an investing portfolio, it’s wise to make sure you have enough money stashed away for emergencies. Whether you experience a job loss, an unplanned move, health problems, auto or home repairs — these, and plenty of other surprises can strike at the worst possible time.

That’s when your emergency fund comes in.

Generally, it makes sense to keep your emergency money in low-risk, liquid assets. Liquidity helps ensure you can get your money if and when you need it. Also, you don’t want to take risks with emergency money because you may not have time to recover if the market experiences a severe downturn.

Medium Term: Saving for a Major Event

It’s also possible to start an investment portfolio for a goal that’s a few years down the road: e.g., graduate school, a wedding, adoption, a big trip, a down payment on a home.

For more ambitious goals like these, you may need more growth than a savings account or certificate of deposit (CD). Learning how to build a portfolio of stocks and other assets could help you reach your goal — as long as you don’t take on too much risk.

In this case, an automated portfolio might make sense, because with a few personal inputs, it’s possible to use these so-called robo advisors to achieve a range of goals using a pre-set portfolio tailored to your goal, time horizon, and risk tolerance.

Recommended: What Is Automated Investing?

Long Term: Starting a Retirement Portfolio

One of the most common types of longer-term investing portfolios is your retirement portfolio.

How to build an investment portfolio for this crucial goal? First, think about your desired retirement age, and how much money you would need to live on yearly in retirement. You can use a retirement calculator to get a better idea of these expenses.

One of the most frequently recommended strategies for long-term retirement savings is starting a 401(k), opening an IRA, or doing both. The benefit of this type of investment account is that they have tax advantages.

Another benefit of 401(k)s and IRAs is that they help you build an investment portfolio over the long term.

Prioritizing Diversification

As mentioned above, portfolio diversification means keeping your money in a range of assets in order to manage risk. All investments are risky, but in different ways and to varying degrees. For example, by investing in lower-risk bonds as well as equities (stocks), you may help offset some of the risk of investing in stocks.

The idea is to find a balance of potential risk and reward by investing in different asset classes, geographies, industries, risk profiles.

Types of Diversification

• While diversification sounds straightforward, it can be quite complex. There are a multitude of diversification strategies. Some examples:

• Simple diversification. This refers to distributing your assets among a variety of different asset classes (e.g. stocks, bonds, real estate, etc.).

• Geographic diversification. You can target different global regions with your investments, to achieve a balance of risk and return.

Market capitalization. Investing in large-cap versus small-cap funds is another way to create a balance of equities within your portfolio.

Understanding Types of Risk

Diversification can help manage certain types of risk, but not all types of risk.

Systematic Risk

Systematic risk is considered ‘undiversifiable’ because it’s inherent to the entire market. It’s due to forces that are essentially unpredictable.

In other words: Big things happen, like economic peaks and troughs, geopolitical conflicts, and pandemics. These events will affect almost all businesses, industries, and economies. There are not many places to hide during these events, so they’ll likely affect your investments too.

One smart way to manage systematic risk: You may want to calculate your portfolio’s beta, another term for the systematic risk that can’t be diversified away. This can be done by measuring your portfolio’s sensitivity to broader market swings.

Understanding Idiosyncratic Risk

Idiosyncratic risk is different in that this type of risk pertains to a certain industry or sector. For instance, a scandal could rock a business, or a tech disruption could make a particular business suddenly obsolete.

As a result, a stock’s value could fall, along with the strength of your investment portfolio. This is where portfolio diversification can have an impact. If you only invest in three companies and one goes under, that’s a big risk. If you invest in 20 companies and one goes under, not so much.

Owning many different assets that behave differently in various environments can help smooth your investment journey, reduce your risk, and hopefully allow you to stick with your strategy and reach your goals.

4 Steps Towards Building an Investment Portfolio

Here are four steps toward building an investment portfolio:

1. Set Your Goals

The first step to building an investment portfolio is determining your investment goals. Are you investing to build wealth for retirement, to save for a down payment on a home, or another reason? Your investment goals will determine your investment strategy.

2. What Sort of Account Do You Want?

Investors can choose several kinds of investment accounts to build wealth. The type of investment accounts that investors should open depends on their investment goals and the investments they plan to make. Here are some common investment accounts that investors may consider:

Taxable vs. Tax-Deferred Accounts

• Individual brokerage account: This is a taxable brokerage account that allows investors to buy and sell stocks, bonds, mutual funds, ETFs, and other securities. This account is ideal for investors who want to manage their own investments and have the flexibility to buy and sell securities as they wish.

Gains are taxable, either as ordinary income or according to capital gains tax rules.

• Retirement accounts: These different retirement plans, such as 401(k)s, traditional, SEP and SIMPLE IRAs are all considered tax-deferred accounts. The money you contribute (or save) reduces your taxable income for that year, but you pay taxes later in retirement. These accounts have contribution limits and may restrict when and how withdrawals can be made.

Note that Roth IRAs are not tax-deferred, but they are tax advantaged accounts as well. The money you contribute is after-tax (it won’t reduce your current-year taxable income), and qualified withdrawals in retirement are tax free.

• Automated investing accounts: These accounts, also known as robo advisors, use algorithms to manage investments based on an investor’s goals and risk tolerance.

3. Choosing Investments Based on Risk Tolerance

Once you’ve set your investment goals, the next step is to determine your investments based on your risk tolerance. As discussed above, risk tolerance refers to the amount of risk you are willing to take with your investments.

Balancing Risk and Return

If you’re comfortable with higher levels of risk, you may be able to invest in more aggressive assets, such as stocks or commodities. Higher risk investments may provide bigger gains — but there are no guarantees.

If you’re risk-averse, you may prefer more conservative investments, such as bonds or certificates of deposit (CDs). Lower-risk investments are less volatile, but they generally offer a lower return.

4. Allocating Your Assets

The next step in building an investment portfolio is to choose your asset allocation. This involves deciding what percentage of your portfolio you want to allocate to different investments, such as stocks, bonds, and real estate.

Once you have built your investment portfolio, it is important to monitor it regularly and make necessary adjustments. This may include rebalancing your portfolio to ensure it remains diversified and aligned with your investment goals and risk tolerance.

The Takeaway

Building an investment portfolio is a process that depends on where a person is in their life as well as their financial goals, and their risk tolerance. Every individual should consider long-term and short-term investments and the importance of portfolio diversification when building an investment portfolio and investing in the stock market.

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

How much money do you need to start building an investment portfolio?

The amount needed to start building an investment portfolio can vary depending on your goal, but it’s possible to start with a small amount, such as a few hundred or thousand dollars. Some online brokers and investment platforms have no minimum requirement, making it possible for investors to start with very little money.

Can beginners create their own stock portfolios?

Beginners can create their own stock portfolios. Access to online brokers and trading platforms makes it easier for beginners to buy and sell stocks and build their own portfolios.

What should be included in investment portfolios?

Generally, an investment portfolio should include a mix of investments, such as stocks, bonds, mutual funds, ETFs, and cash, depending on the investor’s goals, risk tolerance, and time horizon. Regular monitoring and rebalancing are important to keep the portfolio aligned with the investor’s objectives.

What is the 60/40 portfolio rule?

The 60-40 rule refers to 60% equities (or stock) and 40% bonds. It’s a basic portfolio allocation, and as such may not be right for everyone.

What is a balanced portfolio?

A balanced portfolio ideally includes a range of asset classes in order to manage risk and potential market volatility.

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.

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 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 clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.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 risk, include the risk of loss. 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 be subject to tax consequences.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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

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.

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.
SOIN-Q125-037

Feb

2025

9 Types of Investments & Their Pros and Cons

By Pam O’Brien | Growing Wealth, Investing | No Comments

There are numerous different types of investments, ranging from stocks and bonds, to real estate and commodities. In tandem, these different types of investments can help investors build a diversified portfolio, and in effect, may help them reach their financial goals.

But having a solid understanding of the different types of investments is paramount, too, to creating and following through on an investment strategy. As such, you’ll want to at least have some baseline knowledge of each type — with that knowledge in-hand, you should hopefully be able to make financial decisions that align with your goals and strategy.

Key Points

• Investing in a variety of assets can help investors target financial goals and balance risk.

• Stocks, bonds, mutual funds, ETFs, annuities, derivatives, commodities, real estate, and private companies are common investment types.

• Each investment type offers unique benefits and drawbacks, such as stability or potentially higher returns in exchange for higher risk

• Diversification through different investments can protect against market volatility and enhance returns.

• Additional resources are available for in-depth learning about each investment type.

9 Common Types of Investments

Having different types of investments, as well as short-term vs. long-term investments can help you diversify your portfolio. All together, your portfolio should align with your financial or investment goals, and balance potential risks with potential returns — it isn’t easy, but it all starts with understanding what, exactly, you’re investing in. Here are some of the most common types of investments investors should know about.

1. Stocks

When you think of investing and investment types, you probably think of the stock market. A stock gives an investor fractional ownership of a public company in units known as shares.

Pros and Cons of Stock Investing

Here’s a brief rundown of the pros and cons of investing in stocks:

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Pros:

• If the stock goes up, you can sell it for a profit.

• Some stocks pay dividends to investors.

• Stocks tend to offer higher potential returns than bonds.

• Stocks are considered liquid assets, so you can typically sell them quickly if necessary.

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Cons:

• There are no guaranteed returns. For instance, the market could suddenly go down.

• The stock market can be volatile. Returns can vary widely from year to year.

• You typically need to hang onto stocks for longer time periods to see potential returns.

• You can lose a lot of money or get in over your head if you don’t do your research before investing.

Why Invest in Stocks?

Only publicly-traded companies trade on the stock market; private companies are privately owned. They can sometimes still be invested in, though the process isn’t always as easy and open to as many investors.

Further, investors may want to invest in stocks as stock can potentially make money in two ways: It could pay dividends if the company decides to pay out part of its profits to its shareholders, or an investor could sell the stock for more than they paid for it.

Some investors are looking for steady streams of income and therefore pick stocks because of their dividend payments. Others may look at value or growth stocks, companies that are trading below their true worth or those that are experiencing revenue or earnings gains at a faster pace.

2. Bonds

Bonds are essentially loans you make to a company or a government — federal or local — for a fixed period of time. In return for loaning them money, they promise to pay it back to you in the future and pay you interest in the meantime. That stability is one reason many investors are interested in buying bonds, though it’s important to know they are not without risk.

Different Types of Bonds

Treasurys: These are bonds issued by the U.S. government. Treasurys (sometimes stylized as “Treasuries”) can have maturities that range from one-month to 30-years, but the 10-year note is considered a benchmark for the bond market as a whole.

Municipal bonds: Local governments or agencies can also issue their own bonds. For example, a school district or water agency might take out a bond to pay for improvements or construction and then pay it off, with interest, at whatever terms they’ve established.

Corporate bonds: Corporations also issue bonds. These are typically given a credit rating, with AAA being the highest. High-yield bonds, also known as junk bonds, tend to have higher yields but lower credit ratings.

Mortgage and asset-backed bonds: Sometimes financial institutions bundle mortgages or other assets, like student loans and car loans, and then issue bonds backed by those loans and pass on the interest.

Zero-coupon bonds: Zero-coupon bonds may be issued by the U.S. Treasury, corporations, and state and local government agencies. These bonds don’t pay interest. Instead, investors buy them at a great discount from their face value, and when a bond matures, the investor receives the face value of the bond.

Pros and Cons of Bond Investing

Here’s a rundown of the pros and cons of bond investments:

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Pros:

• Bonds offer regular interest payments.

• Bonds tend to be lower risk than stocks.

• Treasurys are generally considered to be safe investments.

• High-yield bonds tend to pay higher returns and they have more consistent rates.

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Cons:

• The rate of returns with bonds tends to be much lower than it is with stocks.

• Bond trading is not as fluid as stock trading. That means bonds may be more difficult to sell.

• Bonds can decrease in value during periods of high interest rates.

• High-yield bonds are riskier and have a higher risk of default, and investors could potentially lose all the money they’ve invested in them.

Why Invest in Bonds?

When it comes to bonds vs. stocks, the former are typically backed by large companies or the full faith and credit of the government. Because of this, they’re often considered lower risk than stocks.

However, the risk of investing in bonds varies, and bonds are rated for their quality and credit-worthiness. Because the U.S. government is less likely to go bankrupt than an individual company, Treasury bonds are considered to be some of the least risky investments. Note, though, that they also tend to have lower returns.

3. Mutual Funds

A mutual fund is an investment managed by a professional. Funds often focus on an asset class, industry or region, and investors pay fees to the fund manager to choose investments and buy and sell them at favorable prices.

Index Funds

While mutual funds offer certain advantages to investors, those interested in a more passive approach may prefer index funds. Index funds are a form of passive investment, which means they’re not actively-managed, and instead, aim to track a market index, or portion of the market, such as the S&P 500 or something similar.

Pros and Cons of Investing in Mutual Funds

Here are some of the pros and cons of investing in mutual funds:

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Pros:

• Mutual funds are easy and convenient to buy.

• Since they offer portfolio diversification, they may carry less risk than individual stocks.

• A professional manager chooses the investments for you.

• You earn money when the assets in the mutual fund rise in value.

• There is potential dividend reinvestment, meaning dividends can be used to buy additional shares in the fund, which could help your investment grow.

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Cons:

• There is typically a minimum investment you need to make.

• Mutual funds typically require an annual fee called an expense ratio and some funds may also have sales charges.

• Trades are executed only once per day at the close of the market, which means you can’t buy or sell mutual funds in real time.

• The management team could be poor or make bad decisions.

• You will generally owe taxes on distributions from the fund.

Why Invest in Mutual Funds?

Investors may be interested in mutual funds because they offer a sort of out-of-the-box diversification, with exposure to many different types of securities or assets in one package. They’re also managed by a professional, which some investors may find attractive. On the other hand, they may have higher fees, and it’s always important to remember that past performance isn’t indicative of future performance, either.

4. ETFs

Exchange traded funds, or ETFs, are in some ways similar to a mutual fund, but there are key differences. One of the main differences is that ETFs can be traded on a stock exchange, giving investors the flexibility to buy and sell throughout the day. In addition, ETFs tend to be passive investments that track an underlying index. They also come in a range of asset mixes.

Pros and Cons of ETFs

Here’s a quick breakdown of the pros and cons of investing in ETFs:

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Pros:

• ETFs are easy to buy and sell on the stock market.

• They often have lower annual expense ratios (annual fees) than mutual funds.

• ETFs can help diversify your portfolio.

• They are more liquid than mutual funds.

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Cons:

• The ease of trading ETFs might tempt an investor to sell an investment they should hold onto.

• A brokerage may charge commission for ETF trades.This could be in addition to fund management fees.

• May provide a lower yield on asset gains (as opposed to investing directly in the asset).

Why Invest in ETFs?

ETFs may be an attractive choice for some investors because they may offer built-in diversification, tons of choices, and typically have lower costs or associated fees than similar products, such as mutual funds. But they’re also subject to many of the same risks as other investments.

5. Annuities

An annuity is an insurance contract that an individual purchases upfront and, in turn, receives set payments. There are fixed annuities, which guarantee a set payment, and variable annuities, which put people’s payments into investment options and pay out down the road at set intervals. There are also immediate annuities that begin making regular payments to investors right away. (Note that SoFi Invest does not offer annuities to its members.)

Pros and Cons of Investing in Annuities

Here are some of the pros and cons of annuity investments:

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Pros:

• Annuities are generally low risk investments.

• They offer regular payments.

• Some types offer guaranteed rates of return.

• May provide a supplemental investment for retirement.

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Cons:

• Annuities typically offer lower returns compared to stocks and bonds.

• They typically have high fees.

• Annuities can be complex and difficult to understand.

• It can be challenging to get out of an annuities contract.

Why Invest in Annuities?

Investors may like that there are so many different types of annuities to invest in, and the fact that they can offer guaranteed and predictable payments, tax-deferred growth, and low-stress management. However, they do often have lower interest payments compared to bonds, there can be penalties for early withdrawals, and associated fees.

6. Derivatives

There are several types of derivatives, but two popular ones are futures and options. Futures contracts are agreements to buy or sell something (a security or a commodity) at a fixed price in the future.

Meanwhile, in options trading, buyers have the right, but not the obligation, to buy or sell an asset at a set price. A derivatives trading guide can be helpful to learn more about how these investments work.

Pros and Cons of Options Trading

Here are some of the pros and cons to derivative investments:

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Pros:

• Derivatives allow investors to lock in a price on a security or commodity.

• They can be helpful for mitigating risk with certain assets.

• They have the potential to provide returns when an investor sells them.

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Cons:

• Derivatives can be very risky and are best left to traders who have experience with them.

• Trading derivatives is very complex.

• Because they expire on a certain date, the timing might not work in your favor.

Why Investors Trade Options

Trading options is a fairly high-level investment activity — it’s not for everyone. There can be significant risks, and options trading strategies can be complex. That said, trading options has the potential to be profitable for experienced investors.

7. Commodities

A commodity is a raw material — such as oil, gold, corn, or coffee. Trading commodities has a reputation for being risky and volatile. That’s because they’re heavily driven by supply and demand forces. Say for instance, there’s a bad harvest of coffee beans one year. That might help push up prices. But on the other hand, if a country discovers a major oil field, that could dramatically depress prices of the fuel.

Pros and Cons of Commodity Trading

Here are some pros and cons of commodity trading:

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Pros:

• Commodities can diversify an investor’s portfolio.

• Commodities tend to be more protected from the volatility of the stock market than stocks and bonds.

• Prices of commodities are driven by supply and demand instead of the market, which can make them more resilient.

• Investing in commodities can help hedge against inflation because commodities prices tend to rise when consumer prices do.

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Cons:

• Commodities are considered high-risk investments because the commodities market can fluctuate based on factors like the weather. Prices could plummet suddenly.

• Commodities trading is often best left to investors experienced in trading in them.

• Commodities offer no dividends.

• An investor could end up having to take physical possession of a commodity if they don’t close out the position, and/or having to sell it.

Why Invest in Commodities?

Investors have several ways they can gain exposure to commodities. They can directly hold the physical commodity, although this option is very rare for individual investors (Imagine having to store barrels and barrels of oil).

So, many investors wager on commodity markets via derivatives — financial contracts whose prices are tied to the underlying raw material. For instance, instead of buying physical bars of precious metals to invest in them, a trader might use futures contracts to make speculative trades on gold or silver. Another way that retail investors may get exposure to commodities is through exchanged-traded funds (ETFs) that track prices of raw materials.

That said, there are risks associated with commodities trading, and investors may want to ensure that it aligns with their investment strategy and goals before getting started.

8. Real Estate

Owning real estate, either directly or as part of real estate investment trust (REIT) investing or limited partnerships, gives you a tangible asset that may increase in value over time. If you become invested in real estate outside of your own home, rent payments can be a regular source of income. However, real estate can also be risky and labor-intensive.

Pros and Cons of Investing in Real Estate

Consider these pros and cons of investing in real estate (REITs, in particular):

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Pros:

• Real estate is a tangible asset that tends to appreciate in value.

• There are typically tax deductions and benefits, depending on what you own.

• Investing in real estate, such as through a REIT, can help diversify your portfolio.

• By law, REITs must pay 90% of their income in dividends.

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Cons:

• Real estate is typically illiquid, although REIT investments offer more liquidity than property.

• There are constant ongoing expenses and work needed to maintain a property.

• REITs are generally very sensitive to changes in interest rates, especially rising rates.

• With a REIT, dividends are taxed at a rate that’s usually higher than the rate for many other investments.

Why Invest in Real Estate?

Investing in real estate may help diversify a portfolio, generate recurring cash flow (from rent, or dividends), or enable ownership of a tangible asset that may increase in value over time. However, investments may be subject to changes in the real estate market, such as rising and falling interest rates and regulatory changes, and are often better suited for longer-term investments.

9. Private Companies

Only public companies sell shares of stock, however private companies do also look for investment at times — it typically comes in the form of private rounds of direct funding. If the company you invest in ends up increasing in value, that can pay off, but it can also be risky.

Pros and Cons of Investing in Private Companies

Here are some pros and cons of investing in private companies:

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Pros:

• Potential for good returns on your investment.

• Lets investors get in early with promising startups and/or innovative technology or products.

• Investing in private companies can help diversify your portfolio.

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Cons:

• You could lose your money if the company fails.

• The value of your shares in the company could be reduced if the company issues new shares or chooses to raise additional capital. Your shares may then be worth less (this is known as dilution).

• Investing in a private company is illiquid, and it can be very difficult to sell your assets.

• Dividends are rarely paid by private companies.

• There could be potential for fraud since private company investment tends to be less regulated than other investments.

Tips for Investing in IPOs

Investing in companies that are going public for the first time via an IPO can be attractive to investors who think the company has potential — IPO investing is fairly popular, but can be risky. With that in mind, if you do want to invest in companies going public, you’ll want to do your homework, and review filings and disclosures the company has filed with regulators, and anything else you might come across that could help inform your decision.

And remember, too, that IPO investing is generally considered high risk – a hot new stock can lose steam just as easily as it can gain it.

Investment Account Options

An investor can put money into different types of investment accounts, each with their own benefits. The type of account can impact what kinds of returns an investor sees, as well as when and how they can withdraw their money.

401(k)

A 401(k) plan is a retirement account provided by your employer. You can often put money into a 401(k) account via a simple payroll deduction, and in a traditional 401(k), your contribution isn’t taxed as income. Many employers will also match your contributions to a certain point. The IRS puts caps on how much you can contribute to a 401(k) annually.

Pros and Cons of 401(k)s

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Pros:

• Contributions you make to a 401(k) can reduce your taxable income. The money is not taxed until you withdraw it when you retire.

• Contributions can be automatically deducted from your paycheck.

• Your employer may provide matching funds up to a certain limit.

• You can roll over a 401(k) if you leave your job.

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Cons:

• There is a cap on how much you can contribute each year.

• Most withdrawals before age 59 ½ will incur a 10% penalty.

• You must take required minimum distributions (RMDs) from traditional 401(k) plans when you reach a certain age. (Roth 401(k)s are not subject to RMDs during the account holder’s lifetime.)

• You may have limited investment options.

IRA

IRA stands for “individual retirement account” — so it isn’t tied to an employer. There are IRS guidelines for IRAs, but, essentially, they’re retirement accounts for individuals. IRAs allow people to set aside money for retirement without needing an employer-backed 401(k).

With a traditional IRA, individuals contribute pre-tax dollars to the account, up to the annual limit. Those contributions are tax-deferred, meaning you don’t need to pay taxes on those funds (and their earnings) until they’re withdrawn in retirement. With a Roth IRA, however, you can contribute after-tax dollars up to the annual limit. Those funds and their earnings are not subject to taxes when qualified withdrawals are made.

Pros and Cons of IRAs

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Pros:

• IRA accounts are tax advantaged: Earnings grow tax-deferred for traditional IRAs and tax-free free for Roth IRAs.

• You can choose how the money is invested, giving you more control.

• Those aged 50 and over can contribute an extra $1,000 in catch-up contributions.

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Cons:

• Relatively low annual contribution limits ($7,000 in both 2024 and 2025).

• There is a 10% penalty for most early withdrawals before age 59 ½.

Brokerage Accounts

A brokerage account is a taxed account through which you can buy most of the investments discussed here: stocks, bonds, ETFs. Some brokerage firms charge fees on the trades you make, while others offer free trading but send your orders to third parties to execute — a practice known as payment for order flow. Investors can be taxed on any realized gains.

You might also consider enlisting the help of a wealth manager or financial advisor who can provide financial planning and advice, and then manage your portfolio and wealth. Typically, these advisors are paid a fee based on the assets they manage.

There are even a number of investment options out there not listed here — like buying into a venture capital firm if you’re a high-net-worth individual or putting funding into your own business.

Pros and Cons of Brokerage Accounts

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Pros:

• Offer flexibility to invest in a wide range of assets.

• Brokerage accounts provide the potential for growth, depending on your investments. However, all investments come with risks that include the potential for loss.

• You can contribute as much as you like to a brokerage account.

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Cons:

• You must pay taxes on your investment income and capital gains in the year they are received.

• Investments in brokerage accounts are not tax deductible.

• There is a risk that you could lose the money you invested.

The Takeaway

It might still seem overwhelming to figure out what kinds of investments will help you achieve your goals. There are different investment strategies and finding the right one can depend on where you are in your career, what your financial goals are and how far away retirement is. Options such as index funds and ETFs may help provide immediate diversification, while a financial professional can help advise you on how you might build your portfolio so that it aligns with your objectives.

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 is the most common investment type?

Stocks are one of the most common and well-known types of investments. A stock gives an investor fractional ownership of a public company in units known as shares.

How do I decide when to invest?

Some prime times to start investing include when you have a retirement fund at work that you can contribute to and that your employer may contribute matching funds to (up to a certain amount); you have an emergency fund of three to six months’ worth of money already set aside and you have additional money to invest for your future; there are financial goals you’re ready to save up for, such as buying a house, saving for your kids’ college funds, or investing for retirement. Please remember you need to consider your investment objectives and risk tolerance when deciding the “right” time to start investing.

Should I use multiple investment types?

Yes. It’s wise to diversify your portfolio. That way, you’ll have different types of assets which will increase the chances that some of them will do well even when others don’t. This will also help reduce your risk of losing money on one single type of investment. In short, having a diverse mix of assets helps you balance risk with return. However, diversification does not eliminate all risk.

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q424-097

Dec

2024

What Is a Pattern Day Trader?

By Inyoung Hwang | Financial Independence, invest, Investing | Comments Off

September 2025: In a significant move this month, the Board of Governors of the Financial Industry Regulatory Authority (FINRA) passed amendments to replace its current day trading and pattern day trading rules, one of which requires pattern day traders to keep a minimum of $25,000 in net equity in their margin accounts. If approved by the SEC, this long-standing limit could be replaced with the current maintenance margin rule. Changing the pattern day trading margin requirement would allow many more retail investors to day trade, a high-stakes, high-risk endeavor.

A pattern day trader is actually a designation created by the Financial Industry Regulatory Authority (FINRA), and it refers to traders who day trade a security four or more times within a five-day period.

Because of their status, there are certain rules and stipulations that apply only to pattern day traders, which brokerages and investing firms must adhere to. Read on to learn more about pattern day traders, what rules apply to them, and how they’re different from regular day traders.

Key Points

• A pattern day trader is classified as someone who executes four or more day trades within a five-day period, exceeding 6% of their total trading activity.

• Investors identified as pattern day traders must maintain a minimum balance of $25,000 in their margin accounts to meet regulatory requirements set by FINRA.

• Engaging in pattern day trading can yield profits, but it also carries significant risks, especially when utilizing margin accounts, which can amplify both gains and losses.

• The Pattern Day Trader Rule was established to limit excessive risk-taking among individual traders, requiring firms to impose stricter trading restrictions on active day traders.

• Being designated as a pattern day trader may lead to account restrictions, including a 90-day trading freeze if the minimum balance requirement is not met.

Pattern Day Trader, Definition

The FINRA definition of a pattern day trader is clear: A brokerage or investing platform must classify investors as pattern day traders if they day trade a security four or more times in five business days, and the number of day trades accounts for more than 6% of their total trading activity for that same five-day period in a margin account.

When investors are identified as pattern day traders, they must have at least $25,000 in their trading account. Otherwise, the account could get restricted per FINRA’s day-trading margin requirement rules.

How Does Pattern Day Trading Work?

Pattern day trading works as the rules stipulate: An investor or trader trades a single security at least four times within a five business day window, and those moves amount to more than 6% of their overall trading activity.

Effectively, this may not look like much more than engaging in typical day trading strategies for the investor. The important elements at play are that the investor is engaging in a flurry of activity, often trading a single security, and using a margin account to do so.

Remember: A margin account allows the trader to borrow money to buy investments, so the brokerage that’s lending the trader money has an interest in making sure they can repay what they owe.

Example of Pattern Day Trading

Here is how pattern day trading might look in practice:

On Monday, you purchase 10 shares of Stock A using a margin account. Later that day, you sell the 10 shares of Stock A. This is a day trade.

On Tuesday, you purchase 15 shares of stock A in the morning and then sell the 15 shares soon after lunch. Subsequently, you purchase 5 shares of stock A, which you hold only briefly before selling prior to the market close. You have completed two day trades during the day, bringing your running total — including Monday’s trades — to three.

On Thursday, you purchase 10 shares of stock A and 5 shares of stock B in the morning. That same afternoon, you sell the 10 shares of stock A and the 5 shares of stock B. This also constitutes two day trades, bringing your total day trades to five during the running four-day period. Because you have executed four or more day trades in a rolling five business day period, you may now be flagged as a pattern day trader.

Note: Depending on whether your firm uses an alternative method of calculating day trades, multiple trades where there is no change in direction might only count as one day trade. For example:

• Buy 20 shares of stock A

• Sell 15 shares of stock A

• Sell 5 shares of stock A

If done within a single day, this could still only count as one day trade.

Do Pattern Day Traders Make Money?

Yes, pattern day traders can and do make money — if they didn’t, nobody would engage in it, after all. But pattern day trading incurs much of the same risks of day trading. Day traders run the risk of getting in over their heads when using margin accounts, and finding themselves in debt.

This is why it’s important for aspiring day traders to make sure they have a clear and deep understanding of both margin and the use of leverage before they give serious thought to trading at a high level.

It’s the risks associated with it, too, that led to the development and implementation of the Pattern Day Trader Rule, which can have implications for investors.

What Is the Pattern Day Trader Rule?

The Pattern Day Trader Rule established by FINRA requires that an investor have at least $25,000 cash and other eligible securities in their margin account in order to conduct four or more day trades within five days. If the account dips below $25,000, the investor will need to bring the balance back up in order to day trade again.

Essentially, this is to help make sure that the trader actually has the funds to cover their trading activity if they were to experience losses.

Note that, according to FINRA, a day trade occurs when a security is bought and then sold within a single day. However, simply purchasing shares of a security would not be considered a day trade, as long as that security is not sold later on that same day, per FINRA rules. This also applies to shorting a stock and options trading.

The PDT Rule established by FINRA requires that an investor have at least $25,000 in their margin account in order to conduct four or more day trades within five days. But merely day trading isn’t enough to trigger the PDT Rule.

All brokerage and investing platforms are required by FINRA, a nongovernmental regulatory organization, to follow this rule. Most firms provide warnings to their clients if they are close to breaking the PDT rule or have already violated it. Breaking the rule may result in a trading platform placing a 90-day trading freeze on the client’s account. Brokers can allow for the $25,000 to be made up with cash, as well as eligible securities.

Some brokerages may have a broader definition for who is considered a “pattern day trader.” This means they could be stricter about which investors are classified as such, and they could place trading restrictions on those investors.

A broker can designate an investor a pattern day trader as long as the firm has a “reasonable basis” to do so, according to FINRA guidelines.

Why Did FINRA Create the Pattern Day Trader Rule?

FINRA and the Securities and Exchange Commission (SEC) created the PDT margin rule during the height of the dot-com bubble in the late 1990s and early 2000s in order to curb excessive risk-taking among individual traders.

FINRA and the Securities and Exchange Commission (SEC) created the PDT margin rule amidst the heyday of the dot-com bubble in order to curb excessive risk taking among individual traders.

FINRA set the minimum account requirement for pattern day traders at $25,000 after gathering input from a number of brokerage firms. The majority of these firms felt that a $25,000 “cushion” would alleviate the extra risks from day trading. Many firms felt that the $2,000 for regular margin accounts was insufficient as this minimum was set in 1974, before technology allowed for the electronic day trading that is popular today.

Investing platforms offering brokerage accounts are actually free to impose a higher minimum account requirement. Some investing platforms impose the $25,000 minimum balance requirement even on accounts that aren’t margin accounts.

Pattern Day Trader vs Day Trader

As discussed, there is a difference between a pattern day trader and a plain old day trader. The difference has to do with the details of their trading: Pattern day traders are more active and assume more risk than typical day traders, which is what catches the attention of their brokerages.

Essentially, a pattern day trader is someone who makes a habit of day trading. Any investor can engage in day trading — but it’s the repeated engagement of day trading that presents an identifiable pattern. That’s what presents more of a risk to a brokerage, especially if the trader is trading on margin, and which may earn the trader the PDT label, and subject them to stricter rules.

Does the Pattern Day Trader Rule Apply to Margin Accounts?

As a refresher: Margin trading is when investors are allowed to make trades with some of their own money and some money that is borrowed from their broker. It’s a way for investors to boost their purchasing power. However, the big risk is that investors end up losing more money than their initial investment.

Investors trading on margin are required to keep a certain cash minimum. That balance is used as collateral by the brokerage firm for the loan that was provided. The initial minimum for a regular margin account is $2,000 (or 50% of the initial margin purchase, whichever is greater). Again, that minimum moves up to $25,000 if the investor is classified as a “pattern day trader.”

FINRA rules allow pattern day traders to get a boost in their buying power to four times the maintenance margin excess — any extra money besides the minimum required in a margin account. However, most brokerages don’t provide 4:1 leverage for positions held overnight, meaning investors may have to close positions before the trading day ends or face borrowing costs.

If an investor exceeds their buying power limitation, they can receive a margin call from their broker. The investor would have five days to meet this margin call, during which their buying power will be restricted to two times their maintenance margin. If the investor doesn’t meet the margin call in five days, their trading account can be restricted for 90 days.

Does the Pattern Day Trader Rule Apply to Cash Accounts?

Whether the Pattern Day Trader Rule applies to other types of investing accounts, like cash accounts, is up to the specific brokerage or investing firm. The primary difference between a cash account vs. a margin account is that with cash accounts, all trades are done with money investors have on hand. Some trading platforms only apply the PDT rule to margin accounts and don’t apply it to cash accounts.

However, some platforms may adhere to FINRA rules that govern margin accounts even if they don’t offer margin trading. This means that a $25,000 minimum balance of cash and other securities must be kept in order for an investor to do more than four day trades in a five-business-day window.

Investors with cash accounts also need to be careful of free riding violations. This is when an investor buys securities and then pays for the purchase by using proceeds from a sale of the same securities. Such a practice would be in violation of the Federal Reserve Board’s Regulation T and result in a 90-day trading freeze.

Pros of Being a Pattern Day Trader

The pros to being a pattern day trader are somewhat obvious: High-risk trading goes along with the potential for bigger rewards and higher profits. Traders also have a short-term time horizon, and aren’t necessarily locking up their resources in longer-term investments, either, which can be a positive for some investors.

Also, the use of leverage and margin allows them to potentially earn bigger returns while using a smaller amount of capital.

Cons of Being a Pattern Day Trader

The biggest and most obvious downside to being a pattern day trader is that you’re contending with a significant amount of risk. Using leverage and margin to trade compounds that risk, too, so day trading does require thick skin and the ability to handle a lot of risk. (Make sure to consider your risk tolerance and investment objectives before engaging in day trading.) Given the intricacies of day trading, it can also be more time and research intensive.

Tips to Avoid Becoming a Pattern Day Trader

Here are some steps investors can take to avoid getting a PDT designation:

1. Investors can call their brokerage or trading platform or carefully read the official rules on what kind of trading leads to a “Pattern Day Trader” designation, what restrictions can potentially be placed, and what types of accounts are affected.

2. Investors can keep a close count of how many day trades they do in a rolling five-day period. It’s important to note that buying and selling during premarket and after-market trading hours can cause a trade to be considered a day trade. In addition, a large order that a broker could only execute by breaking up into many smaller orders may constitute multiple day trades.

3. Investors can consider holding onto securities overnight. This will help them avoid making a trade count as a day trade, although with margin accounts, they may not have the 4:1 leverage afforded to them overnight.

4. If an investor wants to make their fourth day trade in a five-day window, they can make sure they have $25,000 in cash and other securities in their brokerage account the night before to prevent the account from being frozen.

5. Investors can open a brokerage account with another firm if they’ve already hit three day trades over five days with one trading platform. However, it’s good to keep in mind that the PDT rule is meant to protect investors from excessive risk taking.

It’s also important to know that taking time to make wise or careful investment decisions could be in the investor’s favor.

The Takeaway

Pattern day traders, as spelled out by FINRA guidelines, are traders who trade a security four or more times within five business days, and their day trades amount to more than 6% of their total trading activity using a margin account.

Being labeled a pattern day trader by a brokerage can trigger the PDT Rule, which means that the trader needs to keep at least $25,000 in their margin account. While day trading can reap big rewards, it also has big risks — and that’s something that brokerages are keenly aware of, and why they may choose to have stricter requirements for pattern day traders.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, from 4.75% to 9.50%*

FAQ

What happens if you get flagged as a pattern day trader?

If you’re labeled as a pattern day trader, your brokerage may require you to keep at least $25,000 in cash or other assets in your margin account as a sort of collateral.

Do pattern day traders make money?

Yes, some pattern day traders make money, which is why some people choose to do it professionally. But many, perhaps most, lose money, as there is a significant amount of risk that goes along with day trading.

What is the pattern day trader rule?

The Pattern Day Trader Rule was established by FINRA, and requires traders to have at least $25,000 in their margin account in order to conduct four or more day trades within five days. If the account dips below $25,000 the trader needs to deposit additional funds.

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q424-035

May

2024

How Often Should You Rebalance Your Portfolio?

By Michael Flannelly | Growing Wealth, invest, Investing | No Comments

Rebalancing your portfolio refers to tweaking the specific mix of assets and investments an investor owns. Once an investor has put together their portfolio, they’ll be faced with the question of how often to rebalance that portfolio to maintain an ideal mix of stocks, bonds, and other assets, in order to maintain a degree of diversification.

Generally, investors can rebalance their portfolios as often or as little as they want. It all depends on individual circumstances and goals.

What Is Portfolio Rebalancing?

Portfolio rebalancing is a way to adjust the asset mix of investments. It means realigning the assets of a portfolio’s holdings to match an investor’s desired asset allocation.

The desired allocation of investments in an investor’s portfolio — a combination of assets like stocks, bonds, mutual funds, commodities, and real estate — should be made with individual risk tolerance and financial goals in mind.

For example, an investor with a conservative risk tolerance might build a portfolio more heavily weighted towards less volatile assets, like bonds. The conservative investor may have a portfolio with 60% bonds and 40% stocks. In contrast, a younger investor may be more comfortable with riskier assets and build a portfolio with more stocks. The younger investor’s portfolio may have an asset allocation of 70% stocks and 30% bonds.

Over time, however, the different asset classes will likely have varying returns. So the amount of each asset changes — one stock or fund might have such high returns it eventually grows to be a more significant portion of the portfolio than an investor wants.

For example, if the younger investor aims to have 70% stocks and stock prices go up drastically during a year, the portfolio may consist of 80% stocks. That’s when it could be time for the investor to rebalance to maintain the target allocation of stocks.

💡 Quick Tip: Did you know that the term robo advisor is a little misleading? An auto investing account isn’t a robot and typically doesn’t offer personalized investment advice. But it does use sophisticated technology to suggest investment options that may suit your goals and risk level.

Why You Should Consider Rebalancing Your Portfolio

Investors may want to rebalance their portfolios as a method to maintain their target asset allocation. This can help investors stay on track to reach long-term financial goals.

The target asset allocation is a plan outlining the percentage of each asset class an investor wants to hold in their portfolio. A target asset allocation is based on investor goals and risk tolerance.

It might be tempting to think that if a specific asset has outperformed, one should keep a higher portion of their portfolio in that asset and not rebalance. But if an investor doesn’t rebalance, the portfolio may eventually drift away from the target asset allocation. This might be a problem because it can change the amount of risk in a portfolio.

How Often Do You Need to Rebalance Your Portfolio?

Investors can rebalance their portfolios whenever they want, depending on personal preferences. However, some investors rebalance their portfolios at set time points, whether monthly, quarterly, or annually.

For many people, it makes sense to use these time markers to examine the asset allocation of their portfolios and decide if their investments need adjusting. This time-based approach makes it easier to get in the habit of rebalancing.

The downside of rebalancing at set calendar points is that investors may risk rebalancing needlessly. For example, if an investor’s portfolio drifted just 1% from stocks to bonds at the end of the quarter doesn’t mean they should rebalance. Rebalancing a portfolio with little asset drift might lead to unnecessary transaction costs and other investment fees.

In contrast, other investors rebalance at set allocation points — when the weights of assets in a portfolio change a certain amount. An investor may rebalance a portfolio when the target asset allocation drifts a certain percentage, like 5% or 10%.

Determining how often an investor should rebalance their portfolio also depends on how active they want to be in their investment management and what stage of life they’re in — maybe those closer to retirement will want to rebalance more frequently as a risk-avoidance strategy.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

How to Rebalance Your Portfolio

An investor can rebalance a portfolio themselves by selling some assets that are above the target asset allocation and using the proceeds to buy up securities that are below the target allocation.

Investors who plan to rebalance their portfolios should keep track of quarterly and monthly statements from their brokerage and retirement accounts. These statements will give an investor a sense of the value of a portfolio and the overall asset allocation. Once the investor has a handle on rebalancing to reach a target allocation, they’ll need to buy and sell shares or securities to maintain their ideal asset allocation.

However, there can be a fine line between prudent rebalancing and potentially harmful overtrading. While many people like to be involved and actively manage their portfolios, the downside is that active trading can lead to trading at the wrong time. Further, buying and selling shares may incur fees, which eats into the gains or any strategy an investor is trying to execute by rebalancing.

Different Types of Portfolio Rebalancing

There are several ways to rebalance investments for different goals and life stages. Three major strategies include rebalancing to ensure investments are still diversified, using so-called “smart beta” strategies, and rebalancing retirement accounts.

Rebalancing for Diversification

The most basic form of rebalancing is maintaining a diversified portfolio. Over time, a portfolio can become less diverse, as different assets have different rates of return and make up a more significant percentage of the invested money. This is where rebalancing comes in.

For example, assume an investor has a $100,000 portfolio composed of $60,000 in stocks and $40,000 in bonds. After one year, the value of the stock holdings increased by 30%, while the bonds grew by 5%. This portfolio now has a value of $120,000: $78,000 worth of stocks — 65% of the portfolio — and $42,000 worth of bonds — 35% of the portfolio. In this case, the investor would sell enough stocks to get back down to 60% of the portfolio, or $72,000, and buy bonds to get the allocation up to 40%, or $48,000.

An investor would likely have more detailed and sophisticated allocation goals in the real world, but this example illustrates how some simple arithmetic can guide rebalancing.

Smart Beta Rebalancing

Another approach to asset allocation is known as smart beta, a strategy that combines passive index investing with more discretionary active investing strategies. Smart beta rebalancing is typically done by portfolio managers of mutual funds and exchange-traded funds (ETFs).

With passive index investing, an investor buys a fund consisting of stocks that track the performance of a benchmark index, like the whole S&P 500. The stocks in these index funds are weighted based on their market capitalization. The managers of the index funds handle the rebalancing of holdings when market caps shift.

Smart beta is rules-based, like index investing. But instead of tracking a benchmark index weighted towards market cap, funds with smart beta strategies hold securities in areas of the market where managers think there are inefficiencies. Additionally, smart beta funds consider volatility, quality, liquidity, size, value, and momentum when weighting and rebalancing holdings. In this way, smart beta adds an element of active investing to passive investing. And as with index investing, investors can employ a smart beta strategy by buying smart beta mutual funds or ETFs, though they come with higher fees.

Rebalancing Retirement Accounts

In many cases, retirement savings are in investment accounts. Investors need to be aware of the allocation and balances of their retirement accounts, whether they’re 401(k)s, IRAs, or a combination thereof.

The principles at play are similar to any portfolio rebalancing, but investors need to consider changing risk tolerance as they get closer to retirement. Generally, investors will adopt a more conservative target asset allocation as they near retirement. Target date funds typically work by automatically rebalancing over time from stocks to bonds as investors get closer to retirement.

For investors to stay on top of this themselves, they’ll need to know how they want their investments allocated each year as they get closer to retirement and then use quarterly or annual rebalancing to buy and sell securities to hit those allocation targets.

The Takeaway

Rebalancing an investment portfolio can help investors stay on track to meet their long-term goals. By ensuring that there is a steady mix of assets in their portfolio, they can stay on top of their investments to work with their risk tolerance and financial needs.

There are ways investors can rebalance their portfolios on their own and use different strategies. Rebalancing, allocation, and diversification are important concepts for investors to understand, and may help investors generate returns aligned with their goals over the long term when used wisely.

See why SoFi is this year’s top-ranked robo advisor.

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.

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

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.

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

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.
SOIN-Q224-1885866-V1

May

2024

Active vs Passive Investing: Differences Explained

By AJ Smith | Growing Wealth, invest, Investing | No Comments

Key Points

• Active investing strategies often underperform the market over time, while passive strategies tend to outperform.

• Active funds typically have higher fees, which can lower returns, while passive funds have lower fees.

• Active investing relies on human intelligence and skill to capture market upsides, while passive investing relies on algorithms to track market returns.

• Active investing is generally less tax efficient, while passive investing is typically more tax efficient.

• Passive investing may be less tied to market volatility, while active investing is more vulnerable to market shocks.

Active investing vs. passive investing generally refers to the two main approaches to structuring mutual fund and exchange-traded fund (ETF) portfolios. Active investing is a strategy where human portfolio managers pick investments they believe will outperform the market — whereas passive investing relies on a formula to mirror the performance of certain market sectors.

Which approach is better, active investing vs. passive? There seems to be no end to this debate, but there are factors that investors can consider — especially the difference in cost. Because active investing typically requires a team of analysts and investment managers, these funds are more expensive and come with higher expense ratios. Passive funds, which require little or no involvement from live professionals because they track an index, cost less.

Also, there is a body of research demonstrating that indexing typically performs better than active management. When you add in the impact of cost — i.e. active funds having higher fees — this also lowers the average return of many active funds. Following are a few more factors to consider when choosing active investing vs. passive strategies.

Active vs Passive Investing: Key Differences

The following table recaps the main differences between passive and active strategies.

Active Funds	Passive Funds
Many studies show the vast majority of active strategies underperform the market on average, over time.	Most passive strategies outperform active ones over time.
Higher fees can further lower returns.	Lower fees don’t impact returns as much.
Human intelligence and skill may capture market upsides.	A passive algorithm captures market returns, which are typically higher on average.
Typically not tax efficient.	Typically more tax efficient.
Potentially less tied to market volatility.	Tied to market volatility and more vulnerable to market shocks.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Active Investing Definition

What is active investing? Active investing is a strategy where an investor attempts to beat the market by trading individual stocks, bonds, or other securities.

With active investing, either an individual investor could be the one trading securities in their own portfolios, or portfolio managers of actively managed exchange-traded funds (ETFs) and mutual funds could be the one buying and selling assets to outperform the market or a specific sector.

Active investors and actively-managed funds often trade stocks and securities to profit in the short term. Short-term trading, like day trading, can be difficult as it requires the investor to be an expert on the financial markets and the factors impacting stock prices. It also requires the investor to have a good deal of discipline, as short-term stock picking can be a volatile and risky endeavor.

Active Investing Pros and Cons

Active investing is what live portfolio managers do; they analyze and then select investments based on their growth potential. Active strategies have a number of pros and cons to consider when comparing them with passive strategies.

Pros and Cons of Active Investing
Pros	Cons
May be fun to follow the market and make your own investment decisions	Difficult to beat the market
May profit in up, down, and sideways markets	Time consuming
Can tailor a strategy based on your goals and risk tolerance	Higher fees and commissions

Pros

• One potential advantage of having a real person crunching numbers and making investment decisions is that they may be able to spot market opportunities and take advantage of them. A computer algorithm is not designed to pivot the way a human can, which might benefit the performance of an actively managed ETF or mutual fund.

• Whereas a passive strategy is designed to follow one market sector index (e.g. the performance of large cap U.S. companies via the S&P 500® index), an active manager can be more creative and is not limited to a single sector.

• The number of actively managed mutual funds in the U.S. stood at about 6,585 as of June 2023 vs. 517 index funds, according to Statista. Given that there are many more active funds than passive funds, investors may be able to select active managers who have the kind of track record they are seeking.

Cons

• The chief downside of active investing is the cost. Hedge funds and private equity managers are one example, charging enormous fees (sometimes 10%, 15%, 20% of returns) for their investing acumen.

But even standard actively managed funds, which may charge 1% or 1.5% or even 2% annually, are far higher than the investment fees of most passive funds, where the annual expense ratio might be only a few basis points.

• The majority of active strategies don’t generate higher returns over the long haul. According to the well-known SPIVA (S&P Indices vs. Active) 2022 year end scorecard report, 95% of U.S. active equity funds underperformed their respective S&P indexes over the last two decades. So investors who are willing to pay more for the insight and skill of a live manager may not reap the rewards they seek.

• A professional manager may create more churn in an actively managed fund, which could lead to higher capital gains tax.

Passive Investing Definition

Passive investing strategy is when an investor buys and holds a mix of assets for an extended period. Many passive investors will invest in passively-managed index funds, which attempt to replicate the performance of a benchmark index. Passive investors are not necessarily trying to beat the market.

Passive Investing Pros and Cons

The term “passive investing” may not have a strong positive connotation, yet the funds that follow an indexing strategy typically do well vs. their active counterparts.

Pros

• Passive strategies are more transparent. Because index funds simply track an index like the S&P 500 or Russell 2000, there’s really no mystery how the constituents in the fund are selected nor the performance of the fund (both match the index).

• As noted above, index funds outperformed 79% of active funds, according to the SPIVA scorecard.

• Passive strategies are generally much cheaper than active strategies.

• Passive strategies can be more tax efficient as there is generally much less turnover in these funds.

Cons

• Because passive funds use an algorithm to track an existing index, there is no opportunity for a live manager to intervene and make a better or more nimble choice. This could lead to lost opportunities.

• Passive strategies are more vulnerable to market shocks, which can lead to more investment risk.

Which Should You Pick: Active or Passive Investing?

Deciding between active and passive strategies is a highly personal choice. It comes down to whether you believe that the active manager you pick could be among the few hundred who won’t underperform their benchmarks; and that the skill of an active manager is worth paying the higher investment costs these strategies command.

You could also avoid treating the active vs. passive investing debate as a forced dichotomy and select the best funds in either category that suit your goals.

The Takeaway

Active vs. passive investing is an ongoing debate for many investors who can see the advantages and disadvantages of both strategies. Despite the evidence suggesting that passive strategies, which track the performance of an index, tend to outperform human investment managers, the case isn’t closed.

After all, passive investing may be more cost efficient, but it means being tied to a certain market sector — up, down, and sideways. That timing may or may not work in your favor. Active investing costs more, but a professional may be able to seize market opportunities that an indexing algorithm isn’t designed to perceive.

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FAQ

What is the difference between active and passive investing?

The main difference between active and passive investing is that active investing is when a portfolio manager — or the investor themselves — manages their portfolio, buying and selling investments to try to outperform the market. Passive investing is when an investor buys assets and holds onto them for a long period. Passive investing usually means investing in index funds, which track the performance of an index.

What are the examples of active funds?

According to a Morningstar February 2024 analysis, some examples of actively managed ETFs include the Avantis U.S. Equity ETF (AVUS), the Capital Group Dividend Value ETF (CGDV), and the Dimensional Core U.S. Equity 1 ETF (DCOR). Note that these are just examples. An investor should always do their own research before making any investments.

Does active investing have high risk?

Active investing is considered higher risk. Active investors and actively-managed funds often trade stocks and securities to profit in the short term. Short-term trading typically requires knowledge about financial markets and the factors impacting stock prices. It can be volatile and risky.

Should I invest in active or passive funds?

Deciding whether to invest in active or passive funds is a personal choice that only you can make. It depends on your personal situation, goals, and risk tolerance, among other factors. In general, passive investing is better for beginners, and active investing is better for experienced investors with knowledge of the market and who understand the risk involved.

Are ETFs active or passive?

ETFs can be active or passive. Passive ETFs track indexes such as the S&P 500 and may make sense for investors pursuing a buy and hold strategy. Active ETFs rely on portfolio managers to select and allocate assets in an effort to try to outperform the market.

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