InvestGen Archives | Page 2 of 64

Oct

2024

5 Common Recession Fears and How to Cope

By Matthew Zeitlin | Growing Wealth, invest, Investing, Life & Career | Comments Off

Millions of Americans are anxious about recessions and economic downturns, which often involve job-losses and tightening budgets. Not to mention, investment portfolios tend to take a hit, too. These worries are normal, and fortunately there are ways to cope in the short-term.

The first step to handling that anxiety is overcoming the fear itself. While it’s normal to be worried about a recession — how long it might last, how dire the consequences might be — the truth is that the economy is cyclical. It expands and contracts, and recessions are a natural part of the order.

5 Common Recession Fears

Some investors choose to stick to their strategies or mantras during a recession. Of course, you can always carry on with your online stock trading even during a recession, but whether you choose to do that is up to you. But it’s not always so simple for every investor.

That’s because when it comes to making financial decisions, emotions are rarely your friend – that includes fear, doubt, and anxiety. With that in mind, here are some of the most common recession-related fears people often grapple with during times of economic uncertainty.

1. What If This Recession Lasts for Many Years?

While it’s possible that a recession could last for a long time, it helps to have some historical context.

Since the end of World War II, there have been 12 recessionary periods — including the short, sharp decline in early 2020 sparked by the pandemic. While that one only lasted a couple of months, U.S. recessions have averaged about 11 months in duration.

There have been outliers: Notably, the Great Recession of 2008 lasted for 18 months; and the Great Depression of the 1930s lasted about four years, although the repercussions extended that financial crisis until 1938.

That said, bull markets tend to last longer than bear markets. Equally important to remember is that every financial crisis has also informed new monetary policy and new fiscal tools that help protect consumers and investors.

2. What If Unemployment Soars?

It’s true that the potential for job loss is higher during a recession, when companies may be forced to lay off some of their workforce. While this is a common occurrence — as demand for goods lessens and output drops, companies typically need to cut expenses — there is a potential upside.

Unemployment numbers tend to lag a bit; joblessness typically rises to its highest level at certain points during the recession, and recovers to prior levels after the recession has ended. This means that some workers may have a window of opportunity to either look for new jobs now, or shore up their savings (in case of a layoff).

Be open and flexible to changes in responsibility. Lower your expectations around raises and bonuses. Try to bring value to the company, by going above and beyond, or by learning a new skill.

Make connections with your coworkers and network with people in your industry. It might be helpful to spruce up your resume too. That way, should you be laid off you can hit the ground running.

Take advantage of the shift to the gig economy, e.g. becoming your own boss, and relying on various income streams rather than a single full-time job. Not only are part-time positions becoming more common, it’s possible that your employer may be open to a gig arrangement, rather than completely letting go of a qualified employee.

A common rule of thumb is to keep three to six months’ worth of income in an emergency fund.

Recommended: Discover your ideal emergency fund amount with our emergency fund calculator.

3. What If You Lose Your Savings?

Emergency savings are important in any circumstances, as life is full of curveballs and unpredictable expenses. To that end, it’s smart to keep at least one month’s worth of expenses in a rainy day fund — three to six months is better, of course, but always have a cushion for life’s inevitable emergencies.

A recession can hit your savings hard. But it’s better to spend down your emergency fund than to panic and make financial moves you’ll later regret. At all costs, try to avoid the following:

• Covering expenses with your credit card, and incurring debt that you have to pay off at high interest rates.

• Taking out a home equity loan. While the interest rates may be lower on these loans, it’s still an additional monthly expense. And if your home value dips, you could put yourself in a precarious position when you need to sell.

• Taking a loan from your 401(k). While borrowing from a 401(k) has its pros and cons, and a loan is usually better than taking an early withdrawal, there are still a number of risks. The biggest being: If you do get laid off, the entire loan could be due within a 12-month period.

In short: Build up your savings while you can, especially if you’re concerned about losing your job. And don’t be afraid to spend some or even all of that emergency money if things go south. That’s what the money is there for.

4. What If You Can’t Cover All Your Bills?

A recession can mean that money is tight, and that your bills may go up. If a job loss is looming, you may have real fears of being able to cover your expenses. Fortunately, one area where you have some control is how much money you spend.

The first step in lowering your expenses is to get to know them, especially the bills and subscriptions you pay automatically (or are on an auto-renewal system).

Take a look at your current spending habits by examining your bank statements (you can usually get a transaction history right on your phone). You don’t have to read through months of expenditures. What you spend in one month is probably similar to what you spend any other month (despite some seasonal differences).

As you examine what, where, and why you spend, note that some expenses are easier to control than others. Here are some common areas where it’s often possible to make cutbacks:

• Food (eating out, snacks) and groceries are generally the biggest household expenses, after mortgage or rent — but they’re also easy to rein in.

• Utilities (e.g. use less gas, oil, electricity).

• Clothing and other “nice-to-haves” (limit spending to necessities).

• Subscriptions (you’re likely paying for several streaming or music services you rarely use; it’s easy to forget what you signed up for a year ago).

• Examine your insurances. Sometimes you can lower premiums by switching providers or calling and asking for a discount.

Once you trim your expenses, you may realize there are other ways you can cut back that aren’t on the above list — but not everyone has these options. You could change your commute to save money. You could take on a roommate who can split expenses.

5. What If Your Investments Lose Value?

It’s likely that your retirement account(s) and investment portfolio could lose value when the markets are down, or fluctuating. As discussed above, you don’t want to react strongly and pull your money out of the market impulsively. That’s when you lock in losses that can be hard to recover from.

If you have a financial advisor, or you’re thinking of working with one, you may want to discuss sooner rather than later how well-diversified your portfolio is. Diversification can help protect against volatility in some cases. But portfolio diversification is ideally something you do before a recession sets in.

A better approach during a recession is to stay the course. Continue to invest; continue to save for retirement. Rather than impulsively change your financial behavior, intentionally keep doing what you’ve always done. One way to do this is by using a robo advisor, which incorporates highly sophisticated technology that uses automation to help you stick to your own plan. You’ll likely find yourself in better shape when the recession ebbs and the markets rise once more.

The Takeaway

It’s natural to feel worried about the onset of a recession. Most people have fears about how long a recession could last and what the possible consequences could be in terms of their jobs, their bills, their long-term savings and even retirement.

That said, there are a number of ways to cope. While headlines may sound dire, the reality of a recession is that it may not last as long as you fear. Also, it can take some time for ordinary people to feel the impact. That can give you time to be proactive, including giving your job options (and spending habits) a careful review, beefing up your emergency savings, and reminding yourself to stay calm above all.

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Sep

2024

What Is a Bear Market? Characteristics and Causes, Explained

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

A bear market is defined as a broad market decline of 20% or more from recent highs, which lasts for at least two months. Although bear markets make for dramatic headlines, the truth is that bull markets tend to last much longer — the average bear market typically ends within a year.

While most investors might know the difference between a bull and a bear market, it’s important to know some of the characteristics of bear markets in order to understand how different market conditions may impact your portfolio and your investment choices.

What Is a Bear Market?

Investors and market watchers generally define a bear market as a drop of 20% or more from market highs. So, when investors refer to a bear market, it usually means that multiple broad market indexes, such as the Standard & Poors 500 Index (S&P 500), Dow Jones Industrial Average (DJIA), and others, fell by 20% or more over at least two months.

Note, though, that 20% is a somewhat arbitrary barometer, but it’s a common enough standard throughout the financial world.

The term bear market can also be used to describe a specific security. For example, when a particular stock drops 20% in a short time, it can be said that the stock has entered a bear market. Bear markets are the opposite of bull markets, the latter of which is when the market is seeing a broad increase in asset values.

Bear markets are often associated with economic recessions, although this isn’t always the case. As economic activity slows, people lose jobs, consumer spending falls, and business earnings decline. As a result, many companies may see their share prices tumble or stagnate as investors pull back.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Why Is It Called a Bear Market?

There are a variety of explanations for why “bear” and “bull” have come to describe specific market conditions. Some say a market slump is like a bear going into hibernation, versus a bull market that keeps charging upward.

The origins of the term bear market may also have come from the so-called bearskin market in the 18th century or earlier. There was a proverb that said it is unwise to sell a bear’s skin before one has caught the bear. Over time the term bearskin, and then bear, became used to describe the selling of assets.

Characteristics of a Bear Market

There are two different types of bear markets:

• Regular bear market or cyclical bear market: The market declines and takes a few months to a year to recover.

• Secular bear market: This type of bear market lasts longer and is driven more by long-term market trends than short-term consumer sentiment. A cyclical bear market can happen within a secular bear market.

History of Bear Markets

The most recent U.S. bear market began in June 2022, largely sparked by rising interest rates and inflation. The bear market officially ended on June 8, 2023, lasting about 248 trading days, according to Dow Jones Market Data, and resulting in a market drop of around 25%.

Including the most recent bear market, the S&P 500 Index posted 13 declines of more than 20% since World War II. The table below shows the S&P 500’s returns from the highest point to the lowest point in a downturn. Bear markets average a decline of 32.4%, and generally last around 355 days.

Bear markets have occurred as close together as two years and as far apart as nearly 12 years. A secular bear market refers to a longer period of lower-than-average returns; this could last 10 years or more. A secular bear market may include minor rallies, but these don’t take hold.

A cyclical bear market is more likely to last a few weeks to a few months and is more a function of market volatility.

Peak (Start)	Trough (End)	Return	Length (in days)
May 29, 1946	May 17, 1947	-28.78%	353
June 15, 1948	June 13, 1949	-20.57%	363
August 2, 1956	October 22, 1957	-21.63%	446
December 12, 1961	June 26, 1962	-27.97%	196
February 9, 1966	October 7, 1966	-22.18%	240
November 29, 1968	May 26, 1970	-36.06%	543
January 11, 1973	October 3, 1974	-48.20%	630
November 28, 1980	August 12, 1982	-27.11%	622
August 25, 1987	December 4, 1987	-33.51%	101
March 27, 2000	Sept. 21, 2001	-36.77%	545
Jan. 4, 2002	Oct. 9, 2002	-33.75%	278
October 9, 2007	Nov. 10, 2008	-51.93%	408
Jan. 6, 2009	March 9, 2009	-27.62%	62
February 19, 2020	March 23, 2020	-34%	33
June 2022	June 8, 2023	-25%	248
Average		-34%	401

Source: Seeking Alpha/Dow Jones Market Data as of June 8, 2023.

What Causes a Bear Market?

Usually bear markets are caused by a loss of consumer, investor, and business confidence. Various factors can contribute to the loss of consumer confidence, such as changes to interest rates, global events, falling housing prices, or changes in the economy.

When the market reaches a high, people may feel that certain assets are overvalued. In that instance, people are less likely to buy those assets and more likely to start selling them, which can make prices fall.

When other investors see that prices are falling, they may anticipate that the market has reached a peak and will start declining, so they may also sell off their assets to try and profit on them before the decline. In some cases panic can set in, leading to a mass sell-off and a stock market crash (but this is rare).

Is a Recession the Same as a Bear Market?

No. Bear market conditions can lead to or preempt recessions if the market slump lasts long enough. But this isn’t always the case.

What Is a Bear Market Rally

Things can get tricky if there is a bear market rally. This happens when the market goes back up for a number of days or weeks, but the rise is only temporary. Investors may think that the market decline has ended and start buying, but it may in fact continue to decline after the rally. Sometimes the market does recover and go back into a bull market, but this is hard to predict.

If the bear market continues on long enough then it becomes a recession, which can go on for months or years. That said, it’s not always the case that a bear market means there will be a recession.

Once asset prices have decreased as much as they possibly can, consumer confidence begins to rise again, and people start buying. This reverses the bear market trend into a bull market, and the market starts to recover and grow again.

Example of a Bear Market

The most recent bear market occurred in June of 2022, when the S&P 500 closed 21.8% lower than its high on Jan. 3, 2022.

While the Nasdaq and the Dow showed a similar pattern in early 2022, the decline of those markets didn’t cross the 20% mark that signals official bear market territory.

Bear Market vs Bull Market

A bull market is essentially the opposite of a bear market. As consumer confidence increases, money goes into the markets and they go up.

A bull market is defined as a 20% rise from the low that the market hit in a bear market. However, the parameters of a bull market are not as clearly defined as they are for a bear market. Once the bottom of the bear market has been reached, people generally feel that a bull market has started.

Investing Tips During a Bear Market

There are a few different bear market investing strategies one can use to both prepare for a bear market and navigate through one.

1. Reduce Higher-Risk Investments

When preparing for a bear market, it’s a good idea to reduce higher-risk holdings such as growth stocks and speculative assets. One can move money into cash, gold, bonds, or other less risky investments to try and reduce the risk of losses if the market goes down.

These safe investments tend to perform better than stocks during a bear market. Types of stocks that tend to weather bear markets well include consumer staples and healthcare companies.

2. Diversify

Another investing strategy is diversification. Rather than having all of one’s money in stocks, distribute your investments across asset classes, e.g. precious metals, bonds, crypto, real estate, or other types of investments.

This way, if one type of asset goes down a lot, the others might not go down as much. Similarly, one asset may increase a lot in value, but it’s hard to predict which one, so diversifying increases the chances that one will be exposed to the upward trend, and you’ll see a gain.

3. Save Capital and Reduce Losses

During a bear market, a common strategy is to shift from growing capital into saving it and reducing losses. It may be tempting to try and pick where the market has hit the bottom and start buying growth assets again, but this is very hard to do. It’s safer to invest small amounts of money over time using a dollar-cost averaging strategy so that one’s investments all average out, rather than trying to predict market highs and lows.

4. Find Opportunities for Future Growth

However, in a broad sense if the market is at a high and assets are clearly overvalued, this may not be the best time to buy. And vice versa if assets are clearly undervalued it may be a good time to buy and grow one’s portfolio. A bear market can be a good time to identify assets that might grow in the next bull market and start investing in them.

5. Short Selling

A very risky strategy that some investors take is short selling in anticipation of a bear market. This involves borrowing shares and selling them, then hoping to buy them back at a lower price. It’s risky because there is no guarantee that the price of the shares will fall, and since the shares are borrowed, typically using a margin account, they may end up owing the broker money if their trade doesn’t work out as they hope.

Overall, it’s best to create a long-term investing strategy rather than focusing on short-term trends and making reactive decisions to market changes. It can be scary to watch one’s portfolio go down, especially if it happens fast, but selling off assets because the market is crashing generally doesn’t turn out well for investors.

The Takeaway

Bear markets can be scary times for investors, but even a prolonged drop of 20% or more isn’t likely to last more than a few months, according to historical data. In some cases, bear markets present opportunities to buy stocks at a discount (meaning, when prices are low), in the hope they might rise.

Also there are strategies you can use to reduce losses and prepare for the next bull market, including different types of asset allocation. The point is that whether the markets are considered bearish or bullish, any time can be a good time to invest.

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FAQ

How long do bear markets last?

Bear markets may last a few months to a year or more, but most bear markets end within a year’s time. If they go on longer than that they typically become recessions. And while a bear market can end in a few months, it can take longer for the market to regain lost ground.

When was the last bear market?

The most recent bear market started in June of 2022, when the S&P 500 fell from record highs in January for more than two months.

Photo credit: iStock/Morsa Images

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Sep

2024

A Beginner’s Guide to Investing in Your 20s

By Michael Flannelly | Debt Payoff, invest, Terminology | No Comments

Deciding how to invest money in your 20s can seem overwhelming at first; many people have differing opinions or goals, and it’s hard to know where to start. But remember that you don’t need to have a lot of money upfront to be a successful and savvy investor.

Perhaps the most important thing is to start investing early, even if your initial investments are small. Here are a few different strategies for investing money in your 20s.

Think About Financial Goals

When determining your financial goals, you may want to break down short-, medium-, and long-term milestones. You want to ask yourself what you want from your money and figure out when you’ll need to use the money. For example, the money you save for a medium-term goal, like a down payment on your first home, should be treated differently than the retirement savings you won’t touch for 40 or more years.

So, you may want to start buying stocks right away, but you may also want to give some strategic thought as to how that may fit into your overall financial goals.

If you have not earmarked savings for a specific financial goal, take some time to think about what purpose you’d like to apply it to. A great first saving goal is to have three to six months of living expenses in an emergency fund. After that, it might be good to turn your attention toward savings and investing for longer-term goals, like retirement.

Decide Where to House Your Money

When deciding how to invest money in your 20s, it can help to think about immediate, mid-term, and long-term financial needs. Once you have outlined some money goals, you could consider setting up your accounts. The type of account you open often depends on when you need the money.

Where to Put Immediate Money

Food, bills, rent, and everything else you must pay for on a month-to-month basis are immediate needs. Often people keep this money — along with a cushion so as not to overdraft their account — in an online bank account. These types of accounts allow you to withdraw money instantaneously, generally without penalties, making them ideal for your immediate financial needs.

Where to Put Mid-term Money

Mid-term money is any money you might need in the next couple of years, such as a travel fund, wedding fund, or home down payment savings. It might make sense to keep this money in a high-yield savings account, which provides a better return on your money than traditional savings accounts.

High-yield savings accounts, along with other cash equivalents like certificates of deposits (CDs) and money market accounts, are usually considered to be lower-risk investments (though CDs are not helpful for emergency funds because of the early termination penalties).

Where to Put Mid- to Long-term Money

For money you’ll use in five to 20 years, you may be prepared to take slightly more risk than a high-yield savings account. You might choose to keep the money in your high-yield savings account or in CDs, or a online brokerage account where you can invest that money in stocks, bonds, mutual funds, or other asset classes. You can also do a combination of the different types of accounts.

Longer-term savings options, like a tax-advantage 529 plan, can also be appropriate if you’d like to start planning for higher education needs for current or future children.

Where to Put Long-Term Money

Think of long-term money as cash you won’t need for several decades. A retirement account is a great example of an appropriate place to hold long-term money. Retirement plans like a Traditional IRA, Roth IRA, or a 401(k) account can offer significant tax benefits.

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Potential Assets to Invest in During Your 20s

One important thing to understand about investing in your 20s is the tradeoff between risk and reward when implementing your investing strategy. You cannot have one without the other. With this risk and reward calculation in mind, you need to determine what asset classes you might consider when investing in your 20s.

Stocks

A stock is a tiny piece of ownership in a publicly-traded company. When you invest in a stock, you could earn money through capital appreciation, dividends, or a combination of the two.

Stocks can be volatile because prices fluctuate according to supply and demand forces as they trade on an open exchange. Even though stocks can be volatile and experience losses, they tend to provide positive returns over time. The S&P 500 index has had an average annual growth rate of 10.3% from 1957 through the end of 2023.

Bonds

Although not risk-free, experts generally consider bonds less risky (though not risk-free) than stocks because they are a contract that comes with a stated rate of return. Bonds backed by the U.S. government, called treasury bonds, are the safest within the category of bonds because it is unlikely that the U.S. government will go bankrupt.

Bonds are debt investments, meaning investors fund the debt of some entity. The money you earn on that investment is the interest they pay you for borrowing your money. In addition to treasuries and corporate bonds, there are municipal bonds, which state and local governments issue, and mortgage- and asset-backed bonds, which are bundles of mortgages or other financial assets that pass through the interest paid on mortgages or assets.

Mutual Funds and Exchange-Traded Funds

Some investors might want to utilize mutual funds or exchange-traded funds (ETFs) to gain exposure to certain asset classes.

A fund is essentially a basket of investments — stocks, bonds, another investment type, or a combination thereof. Funds are helpful because they provide immediate diversification: safety against the risk of having too much money invested in one stock, sector, or any other single asset.

Funds are either actively or passively managed. A fund that is passively managed is attempting to track a specific index. An actively managed fund is maintained with a hands-on approach to determine investments in a portfolio. ETFs tend to be passively managed, but there are many actively managed ETFs funds on the market. Mutual funds can be either passively or actively managed.

Tips for Investing In Your 20s

Once you’ve become familiar with the basics of investing, it’s time to put that knowledge into action. These tips can help you shape a strategy for how to invest money in your 20s and beyond.

Gauge Your Personal Risk Tolerance

One of the key things to remember about investing in your 20s is that time is on your side. You have a significant time horizon window to allow your portfolio to recover from bouts of inevitable stock market volatility. Because of this, you could take more risks with your investments to try and achieve higher rewards.

Getting to know your personal risk preferences can help you decide where and how to invest in your 20s to achieve your investment goals. It’s also important to understand how risk tolerance matches your risk capacity and appetite.

Risk tolerance means the level of risk you’re comfortable taking. Risk capacity is the level of risk you prefer to take to reach your investment goals, while risk appetite is the level of risk you need to hit those milestones. When you’re younger, playing it too safe with your portfolio might mean missing out on significant investment returns.

Know the Difference Between Asset Allocation and Asset Location

asset allocation when investing in your 20s

People often invest in a combination of stocks and bonds, which is easy to do using mutual funds and ETFs. One strategy for investing in your 20s is to invest a higher allocation of your long-term investments in stocks and less in bonds, slowly moving into more bond funds the closer you get to retirement. This big picture decision is called asset allocation.

But asset allocation is only part of the picture. One might also consider asset location: the types of accounts where you’re putting your money, like savings accounts, an online brokerage account, a 401k, or an IRA.

Asset location matters when it comes to investing money in your 20s because it can maximize tax advantages if you’re utilizing a 401k or IRA. But these retirement accounts also have restrictions and penalties for withdrawing money. So if you want to be able to access your investments quickly, an online brokerage may be a complimentary investing account.

Take Advantage of Free Money

One of the simplest ways to start investing in your 20s is to enroll in your workplace retirement plan like a 401k.

Once you’ve enrolled in a plan, consider contributing at least enough to get the full company match if your employer offers one. If you don’t, you could be leaving money on the table.

And if you can’t make the full contribution to get the match right away, you can still work your way up to it by gradually increasing your salary deferral percentage. For example, you could raise your contribution rate by 1% each year until you reach the maximum deferral amount.

Don’t Be Afraid of Investment Alternatives

Stocks, bonds, and mutual funds can all be good places to start investing in your 20s. But don’t count out other alternative investments outside these markets.

Real estate is one example of an alternative investment that can be attractive to some investors. Investing in real estate in your 20s doesn’t necessarily mean you have to own a rental property, though that’s one option. You could also invest in fix-and-flip properties, real estate investment trusts (REITs), or crowdfunded real estate investments.

Adding alternative investments such as real estate, cryptocurrency, and commodities to your portfolio may improve diversification and could create some insulation against risk.

Learn more: What Are Alternative Investments?

The Takeaway

Learning how to invest money in your 20s doesn’t happen overnight. And you may still be fuzzy on how certain parts of the market work as you enter your 30s or 40s. But by continually educating yourself about different investments and investing strategies, you can gain the knowledge needed to guide your portfolio toward your financial goals.

One thing to know about investing in your 20s is that consistency can pay off in the long run. Even if you’re only able to invest a little money at a time through 401k contributions or by purchasing partial or fractional shares of stock, those amounts can add up as the years and decades pass.

If you’re ready to start saving and investing for your financial goals, the SoFi investment app can help. With SoFi Invest®, you can begin building a portfolio of stocks, and ETFs for as little as $5 to meet all the critical financial goals and milestones in your life.

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Sep

2024

Guide to Options Trading for Beginners

By Inyoung Hwang | Growing Wealth, invest, Investing | Comments Off

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

An option is a financial instrument whose value is tied to an underlying asset; this is known as a derivative. Instead of buying an asset, such as company stock, outright, an options contract allows the investor to potentially profit from price changes in the underlying asset without actually owning it.

Because options contracts may be much cheaper to come by than the underlying asset, trading options can offer investors leverage that may result in significant gains if the market moves in the right direction. But options are very risky, and also can result in steep losses. That’s why investors must meet certain criteria with their brokerage firm before being able to trade options.

What Is Options Trading?

Knowing how options trading works requires understanding what an option is, and what the advantages, disadvantages, and risks of options trading may be.

What Are Options?

Buying an option is simply purchasing a contract that represents the right but not the obligation to buy or sell a security at a fixed price by a specified date.

• The options buyer (or holder) has the right, but not the obligation to buy or sell a certain asset, like shares of stock, at a certain price by a specific date (the expiration date of the contract). Buyers pay a premium for each options contract; this is the total price of the option.

• The options seller (or writer), who is on the opposite side of the trade, has the obligation to buy or sell the underlying asset at the agreed-upon price, aka the strike price, if the options holder exercises their contract.

Options buyers and sellers may use options if they think an asset’s price will go up (or down), to offset risk elsewhere in their portfolio, or to increase the profitability of existing positions. There are many different options-trading strategies.

💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

Why Are Options Called Derivatives?

An option is considered a derivative instrument because it is based on the underlying asset: An options holder doesn’t purchase the asset, just the options contract. That way, they can make trades based on anticipated price movements of the underlying asset, without having to own the asset itself.

In stock options, one options contract typically represents 100 shares.

Other types of derivatives include futures, swaps, and forwards. Options that exist for futures contracts, such as the S&P 500 index or oil futures, are also popular derivatives.

What is the difference between trading using margin vs. options? Having a margin account does offer investors leverage for other trades (e.g. trading stocks). But while a brokerage may require you to have a margin account in order to trade options, you can’t purchase options contracts using margin. That said, an options seller (writer) might be able to use margin to sell options contracts.

Recommended: What Are Derivatives?

What Are Puts and Calls?

There are two main types of options: calls vs. puts.

Call Options 101

When purchased, call options give the options holder the right to buy an asset.

Here’s how a call option might work. The options buyer purchases a call option tied to Stock A with a strike price of $40 and expiration three months from now. Stock A is currently trading at $35 per share.

If Stock A appreciates to a value higher than $40 per share, the option holder may choose to exercise the contract, or sell their option for a premium. If the value of Stock A goes up, the value of the call option should, all else being equal, also go up.

The opposite would also be true. If shares of Stock A go down, the value of the call should, all else being equal, go down.

If the options holder wanted to exercise their call option, with American-style options they have until the expiration date to do so (with European-style options, the option must be exercised on the expiration date). When they exercise, they can buy 100 shares at the strike price.

Put Options 101

Meanwhile, put options give holders the right to sell an asset at a specified price by a certain date.

Here’s how a put trade might work. A trader buys a put option tied to Stock B with a strike price of $45 and expiration three months from now. Stock B is currently trading at $50 per share.

If the price of Stock B falls to $44, below the strike price, the options holder can exercise the put. Alternatively, the value of the option would likely also rise in this scenario, as owners of Stock B might look to lock in profits and sell shares before the stock falls further. A scenario like that may give the option holder the choice of selling the option itself for a profit.

What Is the Put-Call Ratio?

A stock’s put-call ratio is the number of put options traded in the market relative to calls. It is one measure that investors look at to determine sentiment toward the shares. A high put-call ratio indicates bearish market sentiment, whereas a low one signals more bullish views.

💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

Options Trading Terminology

• The strike price is the price at which the option holder can exercise the contract. If the holder decides to exercise the option, the seller is obligated to fulfill the contract.

• With American-style options the expiration is the date by which the contract needs to be exercised. The closer an option is to its expiration, the lower the value of the contract. That is what’s called the time value.

• Premiums reflect the value of an option; it’s the current market price for that option contract.

• Call options are considered in the money, when the shares of the underlying stock trade above the strike price. Put options are in the money when the underlying shares are trading below the strike price.

• Options are at the money when the strike price is equal to the price of the asset in the market. Contracts that are at the money tend to see more volume or trading activity, as holders look to exercise the options.

• Options are out of the money when the underlying security’s price is below the strike price of a call option, or above the strike price of a put option. For example, if shares of Stock C are trading at $50 each and the call option’s strike price is $60, the contracts are out of the money.

For an out-of-the-money put option, the shares of Stock C may be trading at $60, while the put’s strike price is $50, so therefore, not yet exercisable.

“The Greeks” in Options Trading

Traders use a range of Greek letters to gauge the value of options. Here are some of the Greeks to know:

• Delta measures the impact of the price of the underlying asset on the option’s value.

• Beta measures how much a single stock moves relative to the overall stock market.

• Gamma tracks the sensitivity of an option’s Delta.

• Theta is the sensitivity of the option to time.

• Vega is the sensitivity of the option to implied volatility.

• Rho is the sensitivity of the option to interest rates.

How to Trade Options

The market for stock options is typically open from 9:30am to 4pm ET, Monday through Friday, while futures options can usually be traded almost 24 hours.

This is how you may get started trading options:

1. Pick a Platform

Log into your investment account with your chosen brokerage.

2. Get Approved

Your brokerage may base your approval on your trading experience. Trading options is riskier than trading stocks because losses can be steeper. That’s why not all investors should trade options.

3. Place Your Trade

Decide on an underlying asset and options strategy and place your trade.

4. Manage Your Position

Monitor your position to know whether your options are in, at or out of the money.

Basic Options Trading Strategies

Options offer a way for holders to express their views of an asset’s price through a trade. But traders may also use options to hedge or offset risk from other assets that they own. Here are some important options trading strategies to know:

Long Put, Long Call

In simple terms, if the buyer purchases an option — be it a put or a call — they are ‘long’. A long put or long call position means the holder owns a put or call option.

• A holder with a long call strategy effectively locks in a lower purchase price for the underlying asset in case it increases in value.

• A holder with a long put strategy effectively locks in a higher sales price for the underlying asset in case it decreases in value.

Covered and Uncovered Calls

If an options writer sells call options on a stock or other underlying security they also own outright, the options are referred to as covered calls. The selling of options helps the writer generate an additional stream of income while committing to sell the shares they own for the predetermined price if the option is exercised.

Uncovered calls, or naked calls, also exist, when options writers sell call options without owning the underlying asset. However, this is a much riskier trade since the exercising of the option would oblige the options seller to buy the underlying asset in the open market, in order to sell the stock to the option buyer.

Note that the seller wants the option to stay out of the money so that they can keep the premium (which is how the seller makes money).

Spreads

Option spread trades involve buying and selling an equal number of options for the same underlying asset but at different strikes or expirations.

A bull spread is a strategy in which a trader expects the price of the underlying asset to appreciate.

A bearish spread is a strategy in which a trader expects a decline in the price of the underlying asset.

Horizontal spreads involve buying and selling options with the same strike prices but different expiration dates. Vertical spreads are created through the simultaneous buying and selling of options with the same expiration dates but different strike prices.

Straddles and Strangles

Strangles and straddles in options trading allow traders to profit from a move in the price of the underlying asset, rather than the direction of the move.

In a straddle, a trader buys both calls and puts with the same strike prices and expiration dates. The options buyer would pocket a profit if the asset price posts a big move, regardless of whether it rises or falls.

In a strangle, the holder also buys both calls and puts but with different strike prices.

Pros & Cons of Options Trading

Like any other type of investment, or investment strategy, trading options comes with certain advantages and disadvantages that investors should consider before going down this road.

Pros of Options Trading

• Options trading is complex and involves risks, but for experienced investors who understand the fundamentals of the contracts and how to trade them, options can be a useful tool to make investments while putting up a smaller amount of money upfront.

• The practice of selling options to collect income can also be a way for writers who are seeking income to collect premiums consistently. This was a popular strategy particularly in the years leading up to 2020 as the stock market tended to be quiet and interest rates were low.

• Options can also be a useful way to protect a portfolio. Some investors offset risk with options. For instance, buying a put option while also owning the underlying stock allows the options holder to lock in a selling price, for a specified period of time, in case the security declines in value, thereby limiting potential losses.

Cons of Options Trading

• A key risk in trading options is that losses can be outsized relative to the cost of the contract. When an option is exercised, the seller of the option is obligated to buy or sell the underlying asset, even if the market is moving against them.

• While premium costs are generally low, they can still add up. The cost of options premiums can eat away at an investor’s profits. For instance, while an investor may net a profit from a stock holding, if they used options to purchase the shares, they’d have to subtract the cost of the premiums when calculating the stock profit.

• Because options expire within a specific time window, there is only a short period of time for an investor’s thesis to play out. Securities like stocks don’t have expiration dates.

Advantages and Disadvantages of Options Trading
Pros	Cons
Additional income	Potential outsized losses
Hedging portfolio risk	Premiums can add up
Less money upfront than owning an asset outright	Limited time for trades to play out

The Takeaway

Options are derivative contracts on an underlying asset (an options contract for a certain stock is typically worth 100 shares). Options are complex, high-risk instruments, and investors need to understand how they work in order to avoid steep losses.

When an investor buys a call option, it gives them the right but not the obligation to buy the underlying asset by the expiration date. When an investor buys a put option, it gives them the right but not the obligation to sell the underlying asset by the expiration date.

The contracts work differently for options sellers/writers.

The seller or writer of a call option has the obligation to sell the underlying asset at the agreed strike price to the options holder, if the holder chooses to exercise the option on or before the expiration.

The seller of a put option has the obligation to buy the shares of the underlying asset from the put option holder at the agreed strike price.

Qualified investors who are ready to try their hand at options trading, despite the risks involved, might consider checking out SoFi’s options trading platform. The platform’s user-friendly design allows investors to trade through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors.

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

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For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Exchange Traded 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 email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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

SOIN0423010

Sep

2024

Interest Rates FAQ: How the Federal Funds Rate Impacts Your Savings

By Justin Jaffe | Growing Wealth, money, Terminology | Comments Off

The federal funds rate is a key interest rate set by the Federal Reserve, and likely the most closely watched indicator of where the U.S. economy may be headed next. Changes to the federal funds rate provide insight into the Fed’s position on monetary policy and how it plans to respond to economic factors, including inflation and employment levels.

In September, 2024, the Fed announced a rate cut of 50 basis points (a half percentage point), lowering the federal funds rate to 4.75% to 5%. This was the first rate cut made in four years, marking a pivotal shift from the Fed’s policy of holding higher interest rates in place to battle the persistent inflation that followed COVID-19 rate cuts.

The Fed also signaled rates could drop an additional 50 basis points by the end of 2024, with more to follow, as it drives toward a more neutral rate.

Changes to the federal funds rate almost invariably create a ripple effect of changes throughout the economy, impacting interest rates on loans, mortgages, and savings. Here’s a closer look at the Federal Reserve and how its economic outlook and policies can impact your accounts.

Learn more: SoFi’s Liz Young Thomas Looks at the Fed’s September Statement

Q: What Is the Federal Reserve?

A: The Federal Reserve System was founded by Congress in 1913, with the primary goal of promoting the stability of the U.S. banking system. Since then, the Fed’s mandate and methods have evolved — today the work includes regulating financial institutions, directing monetary policy, managing inflation, and keeping employment rates high. And one of the key levers it pulls to those ends is adjusting the federal funds rate.

Q: What Is the Federal Funds Rate?

A: The federal funds rate is a benchmark interest rate that guides the interest rates U.S. banks use when lending excess reserves to other banks overnight. Banks frequently borrow money from one another to ensure they have sufficient reserves to cover consumer withdrawals and other commitments. While changes to the federal funds rate most immediately impact the rates banks use for overnight lending, they influence consumer interest rates as well.

The federal funds rate is set by the Federal Open Market Committee (FOMC), an arm of the Federal Reserve System responsible for setting a range of monetary policies that can influence inflation, economic growth, and the job market. The FOMC is made up of 12 members who meet approximately every six weeks to review their stance on economic policies, including whether they should adjust the federal funds rate.

Q: What Factors Influence the Fed’s Rate?

A: The FOMC determines interest rate policy based on a wide range of economic indicators including inflation, employment levels, and durable goods orders data, which can provide insight into the economic health of a variety of industries such as technology, transportation, and manufacturing.

When these market indicators suggest that the economy is languishing, the FOMC may reduce the federal funds rate to make borrowing less expensive in the hopes of boosting economic activity. More money in consumers’ pockets typically means more spending and more money streaming into the economy.

When prices are rising too quickly, the FOMC may increase its interest rate, making it more expensive to borrow. That can slow spending and, in theory, help keep inflation in check.

Q: How Does the Fed Influence My Savings APY?

A: As mentioned above, the federal funds rate directly influences the interest rates banks use to borrow from or lend money to one another. But secondary effects eventually impact the wider economy, including the interest rates banks and financial institutions use when lending money through credit cards, personal loans, and mortgages. It can also affect the annual percentage yield, or APY, for savings accounts.

A federal rate decrease should eventually translate into lower interest rates when you borrow money to buy a house or car. It may also lead to a lower APY on your savings account.

When the federal rate increases, on the other hand, it becomes more expensive to borrow money, and savings account APYs typically increase.

Because savings account APYs are variable, they tend to rise or fall in the wake of federal rate changes. There are some types of savings accounts with rates that are fixed for a period of time — such as fixed-rate certificates of deposits (CDs). However, federal funds rate changes influence the rates financial institutions offer their customers for new CDs.

Q: Do Other Factors Influence My Savings APY?

A: Federal funds rate changes have a substantial influence on saving account APYs — but they are not the only factor.

Some banks offer high-yield savings accounts with APYs that are considerably higher than the national average rate. Online-only banks and credit unions generally have less overhead than traditional brick-and-mortar banks, which may allow them to offer higher APYs.

Competition among banks for consumer deposits may also drive changes to the APYs they offer. Larger banks tend to be less dependent on deposits than those with a smaller regional presence, for example, so those smaller banks may offer higher rates to attract depositors.

Even among these different scenarios, however, the Fed’s interest rate adjustments can still influence whether these banks’ APY rates rise or fall over time.

Q: How Has the Fed Adjusted Rates Recently?

A: After the economic crisis of 2008, the Fed upheld a near-zero rate policy for seven years as the economy normalized. Rates began to tick up gradually in 2015 until the COVID-19 pandemic upended the economy in 2020. The FOMC followed with two steep rate cuts to encourage economic activity, at the time, bringing interest rates down to historic lows.

This maneuver worked, but also contributed to the highest inflation rate the U.S. had seen in decades. In response, the Fed initiated a series of fund rate increases, culminating in a rate of 5.25% to 5.50% in July 2023 — the highest rate in 23 years — which the Fed held in place in a bid to inch inflation toward its 2% target.

September, 2024, however, marked a major pivot in the Fed’s policy as they announced their first rate cut in four years: an aggressive 50 basis points, bringing the federal funds rate down to 4.75% to 5%, with additional rate cuts expected to be announced in upcoming FOMC meetings.

Federal Funds Target Rate (2015-2024)

Source: Federal Reserve Bank of St. Louis

Q: When Will the Next Rate Change Come?

A: The FOMC typically convenes eight times per year. Though it does not necessarily adjust rates at every meeting, the outcome of these meetings is always watched closely, due to the broad impact rate changes have on the national and even global economy. Given that the Federal Reserve’s September 2024 rate drop is expected to be the first in a series of cuts, investors and consumers will almost certainly be closely monitoring the FOMC’s next moves.

In addition, banks and financial institutions sometimes adjust their own interest rates ahead of FOMC meetings, especially when economic conditions or signals from the Fed suggest a rate change may be forthcoming. The Fed publishes the schedule of FOMC meetings on its website.

The Takeaway

While the FOMC sets the federal funds rate to directly influence the rates banks use to lend money to each other, the rate has a broader effect on the U.S. economy, impacting many financial services and products including personal loans, mortgages, and savings accounts.

Photo credit: iStock/Sadeugra

This content is provided for informational and educational purposes only and should not be construed as financial advice.

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

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

SOBNK-Q324-111

5 Common Recession Fears and How to Cope

5 Common Recession Fears

1. What If This Recession Lasts for Many Years?

2. What If Unemployment Soars?

3. What If You Lose Your Savings?

4. What If You Can’t Cover All Your Bills?

5. What If Your Investments Lose Value?

The Takeaway

What Is a Bear Market? Characteristics and Causes, Explained

What Is a Bear Market?

Why Is It Called a Bear Market?

Characteristics of a Bear Market

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.

History of Bear Markets

What Causes a Bear Market?

Is a Recession the Same as a Bear Market?

What Is a Bear Market Rally

Example of a Bear Market

Bear Market vs Bull Market

Investing Tips During a Bear Market

1. Reduce Higher-Risk Investments

2. Diversify

3. Save Capital and Reduce Losses

4. Find Opportunities for Future Growth

5. Short Selling

The Takeaway

FAQ

How long do bear markets last?

When was the last bear market?

A Beginner’s Guide to Investing in Your 20s

Think About Financial Goals

Decide Where to House Your Money

Where to Put Immediate Money

Where to Put Mid-term Money

Where to Put Mid- to Long-term Money

Where to Put Long-Term Money

Boost your retirement contributions with a 1% match.

SoFi IRAs now get a 1% match on every dollar you deposit, up to the annual contribution limits. Open an account today and get started.

Potential Assets to Invest in During Your 20s

Stocks

Bonds

Mutual Funds and Exchange-Traded Funds

Tips for Investing In Your 20s

Gauge Your Personal Risk Tolerance

Know the Difference Between Asset Allocation and Asset Location

Take Advantage of Free Money

Don’t Be Afraid of Investment Alternatives

The Takeaway

Guide to Options Trading for Beginners

What Is Options Trading?

What Are Options?

Why Are Options Called Derivatives?

What Are Puts and Calls?

Call Options 101

Put Options 101

What Is the Put-Call Ratio?

Options Trading Terminology

“The Greeks” in Options Trading

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.

How to Trade Options

1. Pick a Platform

2. Get Approved

3. Place Your Trade

4. Manage Your Position

Basic Options Trading Strategies

Long Put, Long Call

Covered and Uncovered Calls

Spreads

Straddles and Strangles

Pros & Cons of Options Trading

Pros of Options Trading

Cons of Options Trading

The Takeaway

Interest Rates FAQ: How the Federal Funds Rate Impacts Your Savings

Q: What Is the Federal Reserve?

Q: What Is the Federal Funds Rate?

Q: What Factors Influence the Fed’s Rate?

Q: How Does the Fed Influence My Savings APY?

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