May
12
2023
When to Count Your Home Equity as Part of Your Net Worth

When to Count Your Home Equity as Part of Your Net Worth

By | Budgeting & Goals, Growing Wealth, relay | Comments Off on When to Count Your Home Equity as Part of Your Net Worth

Your home may be your largest asset, but should you include it in your net worth calculations? In some situations, it’s a good idea, and in others, not so much.

Some say you should list all assets as part of your net worth, including your home. Others contend that you have to live somewhere, and any money you have tied up in your home is essentially earmarked for that purpose.

Generally, though, when using tools to tap your home equity, you may want to include your house as part of your net worth. But when calculating retirement savings, it’s a no-go.

Recommended: Does Net Worth Include Home Equity?

How to Calculate Net Worth

At its most basic, net worth is everything you own minus everything you owe.

To calculate your net worth, tally the value of all or your assets, including bank accounts, investments, and perhaps the value of your home or vacation home. Then subtract all of your debts, including any mortgage, student loans, car loans, and credit card balances.

If the resulting figure is negative, it means that your debts outweigh your assets. If positive, the opposite is true.

There is no one net worth figure that everyone should be aiming for. Your net worth, though, can be a personal benchmark against which you can measure your financial progress.

For example, if your net worth continues to move into negative territory, you know that it is time to tackle debts. Hopefully, you’ll see your net worth grow, which can give you some idea that your savings plan is working or your assets are increasing in value.

Your home may, strangely, function as both an asset and a liability. Your home equity—the part of the home you actually own—can be an asset. But your lender may still own part of your home. In that case, mortgage debt is a liability.

As you track your home value and other assets to take your financial pulse, you may find that your home is simultaneously your biggest asset and biggest liability.

Check your score with SoFi Insights

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Recommended: What Credit Score Is Needed to Buy a Car?

When to Include Your Home in Net Worth

Generally speaking, you may want to include your home as part of your total assets and net worth when you want to leverage the value of the equity you have stored there.

You can tap the equity in your home with a number of financial products. Here’s a look:

Home Equity Loan

A home equity loan allows you to borrow money that is secured by your home. You may be able to borrow up to 85% of the equity you have built up. For example, if you have $100,000 in home equity, you may have access to an $85,000 loan.

The actual amount you are offered will also be based on factors such as income, credit score, and the home’s market value.

You repay the lump-sum loan with fixed monthly payments over a fixed term.

As with home improvement loans, which are personal loans not secured by the property, you can use a home equity loan to pay for home renovations.

Or you can use a home equity loan for goals unrelated to your house, like paying for a child’s college education or consolidating higher-interest debt.

Just remember that if you fail to repay the loan, the lender can foreclose on your home to recoup its money.

Recommended: What Is The Difference Between Transunion and Equifax?

Home Equity Line of Credit

A home equity line of credit (HELOC) is not a loan but rather a revolving line of credit. You may be able to open a credit line for up to 85% of your home equity.

You can borrow as much as you need from your HELOC at any time. Accounts will often have checks or credit cards you can use to take out money. You make payments based on the amount you actually borrow, and you cannot exceed your credit limit.

HELOCs use your home as collateral. If you make late payments or fail to pay at all, your lender may seize your home.

💡 Dive deeper: Guide to How Home Equity Lines of Credit Work

Traditional Refinance

A traditional mortgage refinance replaces your old mortgage with a new loan. People typically choose this path to lower their interest rate or monthly payments.

They may also want to pay off their mortgage faster by changing their 30-year mortgage to a 15-year mortgage, for example, reducing the amount of interest they pay over the life of the loan.

How do net worth and home equity come into play? One important metric lenders use when deciding whether you qualify for a mortgage refinance is your loan-to-value ratio (LTV), how much you owe on your current mortgage divided by the value of your home.

The more equity you have built in your home, the lower your LTV, which can help you secure a refinanced loan and influences the interest rate of the loan.

Cash-Out Refinance

A cash-out refinance replaces your mortgage with a new loan for more than the amount of money you still owe on your house.

The difference between what you owe and the new loan amount is given to you in cash, which you can use to pursue a number of financial needs like paying off debt or making home renovations.

Your cash-out amount will typically be limited to 80% to 90% of your home equity, and interest rates are typically a little bit higher thanks to the higher loan amount.

Recommended: Cash-Out Refinance vs HELOC (Home Equity Line of Credit)

Reverse Mortgage

A home equity conversion mortgage, the most common kind of reverse mortgage, allows homeowners 62 and older to take out a loan secured by their home.

Borrowers do not make monthly payments. Interest and fees are added to the loan each month, and the loan is repaid when the homeowner no longer lives there, usually when the homeowner sells the house or dies, at which point the loan must be paid off by the person’s estate.

Recommended: Should I Sell My House Now or Wait

When Not to Include Your Home in Net Worth

There are a few instances when it doesn’t make sense to include your home in your net worth, or you aren’t allowed to.

Retirement Savings

If you’re using your net worth to get a sense of your retirement savings, it may not make sense to include your home, especially if you plan to live there when you retire.

Your retirement savings represent potential income you will draw on to cover your living expenses. Your home does not produce a stream of income on its own, unless you tap your equity using one of the methods above.

Applying for Student Aid

A family’s net worth can have an impact on eligibility for federal student aid. The more assets a family has, the more that need-based aid may be reduced.

However, the equity in a family’s primary residence is a nonreportable asset on the Free Application for Federal Student Aid (FAFSA®). Most colleges use only the FAFSA to decide aid.

Several hundred colleges, usually selective private ones, use a form called the CSS Profile, which does ask applicants to report home equity, though a number of schools, such as Stanford, Harvard, Princeton, and MIT, have moved to exclude home equity from their considerations for aid.

When Becoming an Accredited Investor

An accredited investor may participate in certain securities offerings that the average investor may not, such as private equity or hedge funds. Accredited investors are seen to be financially sophisticated enough, or wealthy enough, to shoulder the risk involved with such investments.

To become an accredited investor, you must have earned more than $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years, or you have a net worth over $1 million. However, you cannot include the value of your primary residence in your net worth.

The Takeaway

Whether or not you include your home in your net worth will depend largely on what you’re trying to accomplish. If you plan to tap your equity, then it is an important figure to include. But it’s not always included when it comes to things like student aid or retirement income.

While your mind is on home equity, maybe you’ve thought about a cash-out refinance, or maybe it’s time to sell and buy anew.

If you’re curious about a home financing or mortgage refinancing options, see what SoFi offers.

It takes two minutes to check your rate.

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Mar
08
2023
Is It a Good Idea To Use a Personal Loan for Investing?

Is It a Good Idea to Use a Personal Loan for Investing?

By | Budgeting & Goals, Financial Independence, Growing Wealth, Investing, personal_loan | Comments Off on Is It a Good Idea to Use a Personal Loan for Investing?

While a person could theoretically use a personal loan to invest, it is generally not a great idea. That’s because there are a number of risks associated with using a personal loan for investment. For one, there’s always the risk that you could lose the money you invest, which could make it challenging to repay the loan. And then there’s the fact that taking on debt to invest involves paying interest. Depending on the rate you qualify for, you could end up paying more in interest than you make in returns from investing.

If you’re considering using personal loans to invest, it’s important to understand the potential downsides. Weigh those against any possible gains to see if it actually makes sense for you.

Can You Use Personal Loans to Invest?

Personal loans allow you to borrow a lump sum of money that you can use for virtually any purpose. Some of the most common uses for personal loans include home improvements, debt consolidation, vehicle purchases, medical bills, and emergency expenses. You can also generally use a personal loan for investing, unless the lender specifies otherwise. While personal loans typically allow for flexibility in how the money can be used, lenders have the option to impose restrictions.

So why would someone use personal loans to invest anyway? There are different reasons for doing so. For some, personal loans for investing could make sense if:

•   They don’t have other cash available to invest.

•   Shifts in the market have created a buying opportunity they’d like to capitalize on.

•   Personal loan interest rates are low compared to the return potential for investments.

•   They can afford to make the payments on a personal loan.

When Using a Personal Loan to Invest Might Make Sense

Ultimately, whether you should consider using personal loans for investing may hinge on your investment goals, timeline for investing, and risk tolerance. There are some situations where it could make sense.

1. You Can Qualify for the Lowest Rates, Based on Credit

One of the most important factors that lenders consider when approving personal loan applications is credit. Specifically, your credit scores and credit reports will come under scrutiny. The higher your credit score, the lower your interest rate on a loan is likely to be. If you’re interested in using personal loans for investments then getting the best rate matters.

Why? While you might be earning returns on your investments, you’re paying some of them back to the lender in the form of loan interest. So it makes sense to angle for the lowest rates possible, which are generally offered to those with good to excellent credit.

2. You May Be Able to Pay the Loan Off Early

Being able to pay the loan off ahead of schedule could help you save money on interest charges. Given those potential savings, think about your budget and what you might realistically be able to afford to pay each month to get the loan paid off early.

But be aware that doing so could trigger a prepayment penalty. While SoFi personal loans don’t have any prepayment penalties, for instance, other lenders may charge them. If you get stuck paying a prepayment penalty that could wipe out any interest savings associated with paying the loan off early.

3. You’re Confident About Your Return Potential

Some financial experts might say that personal loans for investing only make sense when the investments are guaranteed to get a return that outpaces what’s paid in interest on the loan. But trying to predict a stock or exchange-traded fund’s future performance is an inexact science and not a recommended practice.

For that reason, it’s important to consider how confident you are about an investment paying off. This is where you may need to do some research to understand what an investment’s risk/reward profile looks like, how well it’s performed in the past, what’s happening with the market currently, and where it might be headed next.

In other words, you’ll want to perform some due diligence before using loans for investments. Looking at both the upsides and the potential investing risks can help with deciding if you should move forward with your personal loan plans.

When You Might Think Twice About Using Personal Loans for Investing

While there may be some upsides to using personal loans for investments, there are some potential drawbacks to weigh as well. Don’t let your dreams of investing success cloud the realities of the risks involved.

1. You Don’t Qualify for the Best Rates

When using personal loans for investing, the math becomes important, since any interest you pay has to be justified by the returns you earn. Even if you’re investing in something that you’re sure is going to result in a sizable gain, you still have to consider how interest will cut into those gains.

If you don’t have great credit then any returns you realize may be overshadowed by the interest you’re paying to the lender. Before applying for a personal loan, it’s helpful to check your credit reports and scores to see where you stand. This can help you gauge what type of interest rates you’re most likely to qualify for if you do decide to go ahead with a loan.

Also know that the total interest cost increases the longer you pay on the loan. If you’re considering a two-year, three-year, or even five-year repayment term, make sure to keep that in mind.

2. You Have a Lower Risk Tolerance

Investments aren’t risk-free, and some are riskier than others. If you’re taking on debt to invest in the market, you have to be reasonably sure that your investment will pay off. In the meantime, you need to be comfortable with the risk that involves.

The stock market moves in cycles, and volatility can affect stock prices from day to day. So it’s good to understand how you typically react to volatility and what level of risk is acceptable to you before taking out a personal loan. If the idea of being stuck with a loan for an investment that doesn’t pan out isn’t something you can stomach, it may not be right for you.

Likewise, you may want to take a pass on a personal loan if you’d be investing in something that you don’t fully understand or haven’t thoroughly researched.

3. Your Income or Expenses Could Change

Taking out a personal loan means you’re committing to repaying that money. While you might be able to afford the payments now, that may not be true if your income or expenses change down the line.

Something investors might not like to think about, but that is a risk, is the possibility that the market doesn’t perform favorably. What happens if there’s a loss on the investment and you have to find other funds to make the personal loan payments? The reality is, even if the investment doesn’t provide the return that’s expected, the lender will still expect payments on that personal loan.

Before applying for a personal loan, ask yourself whether you’d still be able to keep up with the payments if your income were to decrease, your other expenses were to go up, or the investment didn’t see the return you thought it would. If you don’t have an emergency fund in place, for instance, how would you manage the loan payments? Would you have to sell the investment to make a loan payment? Could you borrow money from friends or family?

Thinking about these kinds of contingencies can help you decide if a personal loan for investing is the best way to go.

What to Consider With Personal Loans for Investing

Before taking out a personal loan for investing, there are a few things to keep in mind. For instance, consider factors like:

•   How much you can afford to pay each month toward a personal loan

•   How much you need or want to borrow

•   What the current personal loan interest rates are

•   Which rates you’re most likely to qualify for based on your credit history

•   Any fees a lender may charge, such as origination fees or application fees

•   Whether you’ll be able to repay the loan early and if so, what prepayment penalty might be involved

Beyond credit scores, also consider what else is needed to get approved for a personal loan. For instance, lenders may look at your debt-to-income ratio, employment history, and intended use for the loan proceeds.

Also think about how you want to invest the money. If you’re interested in trading stocks or ETFs, for example, you may want to choose an online brokerage that charges $0 commission fees for those trades. The fewer fees you pay to your brokerage, the more of your investment returns you get to keep.

Awarded Best Online Personal Loan by NerdWallet.
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The Takeaway

Using personal loans for investments carries some definite risks. It’s a strategy to steer clear of if you don’t qualify for the best rate on your loan, you have a lower risk tolerance, or your income or expenses could change down the road. Only in select circumstances could it make sense — though remember there’s no guarantee of any investment returns.

As such, personal loans are likely better left for other purposes, such as covering emergency expenses or making necessary home repairs. If you are considering getting a personal loan, make sure to shop around to find the right offer. Personal loans from SoFi, for instance, offer competitive interest rates.

SoFi’s Personal Loan was named NerdWallet’s 2023 winner for Best Online Personal Loan overall.

Photo credit: iStock/jacoblund

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Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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May
23
2022
Money Market Account vs. Savings Account

Money Market Account vs. Savings Account: What’s the Difference?

By | Budgeting & Goals, Growing Wealth, money | Comments Off on Money Market Account vs. Savings Account: What’s the Difference?

If you’re wondering how money market vs savings accounts stack up, it’s wise to learn about how the access, interest, fees, and deposit requirements may vary. These two financial products both offer good ways to stash cash for future goals, but — depending on your particular needs and situation — one may work better than the other.

Money market and savings accounts offer a secure place to keep money you don’t necessarily plan to spend right away. You’ll earn interest, though there may be limits on how often you can make withdrawals. Both kinds of accounts can also be FDIC-insured.

So how do you decide whether a money market or savings account is best? Let us help. We’ll review the following to help you know where to park your moolah:

•  What a money market account is

•  What a savings account is

•  The differences between a money market and a savings account

•  How to know when to use a savings or a money market account

•  The risks with each kind of account

Let’s dig in!

What Is a Money Market Account?

A money market account is a type of deposit account offered by banks and credit unions. These accounts can also be referred to as money market deposit accounts, money market savings accounts, or by their acronym, MMAs.

So how does a money market account work?

Money market accounts allow you to deposit money and earn interest on those deposits. The interest rate and annual percentage yield (APY) earned can depend on the bank and the terms of the account. If you need to withdraw money from a money market account, you will probably find quite a lot of flexibility. You may be able to do it via ACH transfer, debit card, check, or ATM withdrawal.

While Federal Reserve rules limiting you to six withdrawals per month from a money market account have been suspended, banks can still impose withdrawal limits. If you exceed the allowed number of withdrawals, your bank can charge an excess withdrawal fee for each transaction over the limit.

What Is a Savings Account?

A savings account is also a deposit account that can be used to hold money you don’t plan to spend right away. Banks and credit unions can pay interest to savers, though there can be a significant difference in rates from one financial institution to the next. Online search tools will quickly and conveniently show you some options.

Can you spend money from a savings account? Technically, a savings account is meant for funds you’ll eventually spend. For example, you might open a savings account to hold money for emergency expenses or a wedding you’re planning. But you typically can’t spend freely from a savings account the way you would a checking account.

Access is typically somewhat limited. Savings accounts usually don’t come with a debit card, ATM card, or checks. If you need to take money from savings, you might need to visit a branch if your account is held at a traditional bank or transfer funds from savings to checking online or over the phone. And again, banks can limit the number of withdrawals you’re allowed to make per month.

Differences Between Money Market and Savings Account

Both money market and savings accounts are interest-bearing deposit account options. We’ve just noted another similarity: They can both be subject to monthly withdrawal limits. But now, let’s take a closer look at the differences between money market vs. savings accounts. This intel may help you decide which kind of account best suits your particular needs.

Access and Flexibility

A money market account can offer an advantage over a savings account when it comes to how you can access your money. Depending on the bank, your options for making deposits and withdrawals might include:

•  Debit card

•  ATM card

•  Paper checks

•  Electronic transfers

•  Remote deposit capture (for mobile check deposit)

•  Teller withdrawals/deposits

Access to a savings account, on the other hand, is usually limited to electronic or teller transactions. With online banks, ACH transfers to and from a linked account at an external bank, wire transfers, mobile check deposit, or mailed paper checks may be your only option for making deposits or withdrawals. That can be a little less convenient for some people.

Account Opening

A number of banks allow you to open both money market and savings accounts online — a nice convenience. However, there may be differences in the minimum deposit requirement. Generally, money market accounts tend to require a higher minimum deposit to open.

So instead of being able to open a new account with $1 (which may be the case with a savings account), you might need $100, $1,000, or more instead. Again, how much cash you’ll need to open a money market account vs. savings acct can depend on the bank.

Interest and Fees

Money market accounts and savings accounts can also differ when it comes to the interest you can earn and the fees you might pay. If you put a regular savings account vs. money market account from an online bank side by side, for example, the regular savings account is more likely to offer a lower rate and APY. In addition, it’s more likely to charge a monthly maintenance fee.

An online money market account, on the other hand, may have no monthly maintenance fee at all. Rates may be tiered, with banks paying a higher rate and APY as your balance increases.

When You Should Use a Savings Account

A savings account could be a good fit if you want a safe place to set aside money for future expenses. Maybe you are gathering funds to landscape your yard next spring. Or perhaps you just want to be prepared and several months’ worth of living expenses stashed away in case of emergency (which is a very good idea). You might opt for a savings account vs. money market account if you don’t necessarily need a debit card, ATM card, or checks to access funds.

Where you decide to open a savings account can depend on your needs and personal banking preferences. Online banks may appeal to you if you’re looking for long-term savings account options that pay the best interest rates and charge the fewest fees. On the other hand, you might choose a regular savings account at a brick-and-mortar bank instead if you want to be able to get cash at a teller or drive-thru in a pinch. It’s your call!

Ready for a Better Banking Experience?

Open a SoFi Checking and Savings Account and start earning 4.20% APY on your cash!

When You Should Use a Money Market Account

Money market accounts definitely have their appeal, too. They are attractive if you need a low-risk option to put cash away for a rainy day or until you’re ready to spend it on a planned expense. For example, you might consider opening a money market account if you’re saving toward any of these goals:

•  Down payment on a home

•  New (or used) car

•  Vacation

•  Wedding

•  Education expenses

•  Home renovations or repairs

In any of those scenarios, a money market account could offer convenience if you need to write a check or use your debit card to pay for something. If you’re upgrading your kitchen, for example, you could write a check to your contractor from your money market account.

Potential Risks of Using a Money Market or Savings Account

Ready to take a look at the potential downsides of having a money market or savings account? In general, you don’t have too much to worry about. Money market accounts and savings accounts are both quite low-risk since these products can be FDIC-insured. FDIC insurance applies in the rare event that a bank fails. In that case, protection extends up to $250,000 per depositor, per account ownership type, per financial institution.

That said, there are some potential drawbacks to these accounts. Being aware of the risks is of course a good idea as you choose the best type of savings account..

Money Market Account

Here are some of the main risks associated with money market accounts:

•  Monthly maintenance fees may apply if your balance falls below the required minimum.

•  Interest rates are not fixed, so you’re not guaranteed to earn a higher APY.

•  Additional withdrawals from a money market account may trigger fees.

Savings Account

Consider these risks before opening a savings account:

•  Interest rates may be well below what you could get with a money market account (though typically online banks offer a higher APY than traditional ones).

•  Accessing cash in an emergency may be difficult if you don’t have an ATM card and/or your money is at an online bank.

•  You may be penalized for withdrawals over and above your limit.

The Takeaway

Money market accounts and savings accounts can both offer ways to earn interest on your money. Whether you’ll benefit more from a money market account vs. savings account can depend on how much you plan to keep in the account, the interest rate and APY you’re hoping to earn, and how you’d like to be able to access your money. Those fine points can make the difference between growing your money in a way that’s frustrating or fabulous.

On the topic of fabulous: Banking with SoFi can help take your money to the next level. With our high yield bank accounts, you’ll earn a competitive APY when you sign up with direct deposit. What’s more, we don’t whittle away your dough with fees. It’s our policy to not charge any monthly, minimum balance, or overdraft fees.

Better banking is here with up to 4.20% APY on SoFi Checking and Savings.

FAQ

Is a money market better than a savings account?

A money market account might be better than a savings account for people who want to be able to make purchases from the account using a debit card, write checks against their balances or withdraw cash at an ATM. When comparing money market vs. savings accounts, it’s important to compare the accessibility, fees, interest rates, and other features.

Can you lose your money in a money market account?

Money market accounts are some of the safest places to keep your money. Even if your bank fails, which happens rarely, you’d still be protected by FDIC coverage up to the applicable limit.

Do you get taxed on money market accounts?

Interest earned in a money market account is considered to be taxable by the IRS. If your money market account earns interest for the year, your bank will send you a Form 1099-INT to report interest income. The bank will also send a copy of this form to the IRS on your behalf.

Photo credit: iStock/akinbostanci

SoFi members with direct deposit can earn up to 4.20% annual percentage yield (APY) interest on Savings account balances (including Vaults) and up to 1.20% APY on Checking account balances. There is no minimum direct deposit amount required to qualify for these rates. Members without direct deposit will earn 1.20% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. These rates are current as of 4/25/2023. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
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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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Feb
08
2021

ETF Tax Efficiency: Advantages Over Mutual Funds

By | Growing Wealth, invest, Investing | Comments Off on ETF Tax Efficiency: Advantages Over Mutual Funds

There’s no denying that exchange-traded funds (ETFs) are popular. According to the New York Stock Exchange’s most recent quarterly ETF report , as of December 31, 2020 there were 2,391 ETF listed in the U.S. Those funds hold a total of $5.49 trillion in assets, with an average of $111.5 billion transactional daily value.

Investors primarily turn to ETFs because of the returns. The average annual 10-year return for the benchmark SPDR S&P 500 ETF stands at above 14% at the end of 2020. (That said, as always past performance is not a guarantee of future success.)

There is another major benefit of ETFs—they’re a good tax-limitation tool.

In a 2019 Morningstar report on investment funds and taxes, analysts conclude that 84% of all ETF portfolio assets were steered toward specially-focused funds that closely follow market-cap weighted indexes. Such funds historically have low investor turnover, which in turn curbs capital gains and fund distributions, and thus reduces excess “taxable events.”

ETFs & Mutual Funds: How They Differ

When it comes to understanding ETFs vs mutual funds, it’s often best to start with a simple explanation for each.

Both mutual funds and ETFs invest in a group or “basket” of underlying stocks, bonds, commodities, and other financial assets, on behalf of fund shareholders. But ETFs trade on a daily basis much like stocks and bonds. Mutual funds do not.

Mutual funds offer investors a menu of various share classes where they can invest their money. Given the wider assets selection options available, a mutual fund investor may see more fund fees to compensate for that expanded menu. Given their low trading structure, ETF fees are usually lower than mutual funds, resulting in a lower expense ratio.

ETF Tax Advantages Over Mutual Funds

Tax-wise, The IRS treats ETFs and mutual funds the same. When either fund model sells securities that have appreciated in value, it creates a capital gain—or capital appreciation on the investment—which is taxable under U.S. law.

ETF fund managers make trades for a variety of reasons. For example, an asset can be bought and sold for strategic reasons (i.e. to properly allocate assets or to avoid “style drift” when a fund slides away from its target strategy.) Trades also must be made upon shareholder redemptions—when they redeem some or all of the assets they’ve invested in the fund.

The more trades made by ETF fund managers, the more taxable events occur. Consequently, for fund managers and investors, the goal is to find ways to keep those taxes from accumulating.

An ETF’s structure can help curb the negative impact of taxes, in the following ways.

Lower Capital Gains Impact

Since the IRS considers capital gains a taxable event, a major goal with any fund investment is to reduce the impact of capital gain payouts to shareholders at year end.

ETFs typically accumulate fewer capital gains than mutual funds. When a mutual fund has to redeem assets back to shareholders, it must sell assets to create the money needed to pay out those redemptions, resulting in capital gains. But when an ETF shareholder wants to sell shares, they can easily do so by trading the ETF to another investor—just like a stock transaction. That, in turn, creates no capital gains impact for the ETF—and adds a major tax advantage for ETF investors.

Index Tracking Tax Benefits

Since many ETFs are structured to track a particular index, trades are made only when there are changes in the underlying index (like when the S&P 500 or the Russell 2000 index experience significant fluctuations that require some ETF stabilization.) Fewer transactions generally means lower taxes.

The Use of “Creation Units”

ETFs are built to trade differently than mutual funds. With ETFs, fund managers can leverage so-called “creation units”—blocks of shares—to buy and sell fund securities. These units enable fund managers to buy or sell assets collectively, instead of individually. That means fewer trades and fewer taxable trade execution events.

Downsides of ETFs and Taxes

Though ETF tax efficiency is generally better than that of mutual funds, that doesn’t mean ETFs come with no tax risks. There are a few taxable events that bear watching for investors.

Distributions and dividends

Just like any investment vehicle, ETFs can come with regular distributions and dividends, which are usually taxable.

Increased Trade Activity on Actively Managed Funds

Though most ETFs simply follow an investment index, there are some actively managed ETFs. With actively-managed funds, more trades are made, which may lead directly to a more onerous tax bill.

High Trading Costs

Since ETFs are traded like stocks, the fees that come with buying and selling ETF assets usually trigger trading costs that are akin to trading stocks—and those fees can be high. Historically, brokerage trading fees are among the highest fees in the investment industry, which isn’t great news for ETF investors. Even if investors do save on taxes, those savings can potentially be mitigated or even wiped out by high ETF trading costs.

The Takeaway

Exchange traded funds offer ample potential tax benefits to savings-minded investors—especially in key areas like capital gains, expense ratios, redemptions, and trading frequency.

SoFi Invest® offers investors an easy, low-cost way to diversify their portfolio with ETFs. Investors can choose from a variety of ETFs designed specifically for ambitious investors with long-term goals for their investments.

Find out how SoFi Invest ETFs can be a part of your financial portfolio.

SoFi Invest®
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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.
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