Apr
02
2024

Can a Roth IRA Be Used for College Expenses?

By | Going to College, invest, Investing | Comments Off on Can a Roth IRA Be Used for College Expenses?

A Roth IRA can be used to pay for college expenses, and it is possible to do so without incurring taxes or penalties. However, there are disadvantages of using a Roth IRA for college, and it’s important to weigh the pros and cons.

A Roth IRA is designed to help individuals save for retirement. While you can also use a Roth IRA for college expenses, you’ll want to understand the potential ramifications.

Here’s what you need to know about using a Roth IRA for college, plus other college savings options, to help make the best decision for your situation.

Can You Use a Roth IRA for College?

You can use a Roth IRA to help pay for college. However, as mentioned, a Roth IRA is primarily a vehicle for saving for retirement. You contribute after-tax dollars to the account (meaning you pay taxes on the contributions in the year you make them), and the money in the Roth IRA grows tax-free. You can generally withdraw the funds tax-free starting at age 59 ½. However, if you withdraw the money early, you may be subject to a 10% penalty.

But there are some ways to make early withdrawals from your Roth IRA to help pay for college without being penalized. Because you contribute to a Roth IRA with after-tax dollars, you can withdraw the contributions (but not the earnings) you’ve made to a Roth at any time without paying a penalty. You could then use those contributions to help pay for college.

Just be aware that there are annual contribution limits to a Roth IRA. In tax year 2023, you can contribute up to $6,500 (or $7,500 if you’re 50 or older), and in 2024 you can contribute up to $7,000 ($8,000 for those 50 or older). How much you’ve contributed will affect how much you have in contributions to withdraw, of course.

Another way to use a Roth IRA to pay for college without being penalized is by taking advantage of one of the Roth IRA exceptions that allow you to withdraw money from your account early. One of the exceptions is for qualified higher education expenses.

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

Do You Have To Pay Penalties if You Use a Roth IRA for College?

Typically, if you take out money from your Roth IRA before age 59 ½ , you will be subject to taxes and penalties. However, IRA withdrawal rules grant a few exceptions to this rule, and one of the exceptions is for qualified higher education expenses.

If you pay qualifying higher education expenses to a qualified higher education institution for your child, yourself, your spouse, or your grandchildren, you won’t have to pay the 10% penalty for withdrawing funds from a Roth IRA. Qualified higher education expenses include things like tuition, fees, books and supplies. However, you will still have to pay taxes on any earnings you withdraw from your Roth IRA.

Pros and Cons of Using a Roth IRA for College

Whether using a Roth IRA for college is right for you depends on your particular situation. Here are the pros and cons you’ll want to consider.

Pros of Tapping Into a Roth IRA for College

Advantages of using a Roth IRA for college expenses include:

•   You might not have to borrow as much money to pay for college. Using a Roth IRA for college expenses may reduce the need for student loans. And for some students, using money from a Roth IRA might make the difference between being able to afford to attend college or not.

•   You won’t be penalized for withdrawing the money. Because of the exception for qualified higher education expenses, you can take out the money to pay for those expenses without having to pay the 10% penalty.

•   If you withdraw just your contributions, you won’t owe taxes on that money.

Cons of Tapping Into a Roth IRA for College

These are the drawbacks of using a Roth IRA to pay for college:

•   Your retirement savings will take a hit. This is the biggest disadvantage of using the money in a Roth IRA for college. While there are other ways to help cover the cost of college, there are generally fewer options to help you save for retirement if you spend your Roth IRA funds on college expenses.

•   Because of possible compounding returns, even a few thousand dollars withdrawn from your Roth IRA today might mean missing out on tens of thousands of dollars of potential growth by the time you’re ready to retire years from now.

•   Eligibility for financial aid could be affected. Another possible downside of using a Roth IRA for college is that the money you withdraw generally counts as income on the FAFSA (Federal Application for Federal Student Aid). That may limit financial aid you could receive, including grants and loans.

Roth IRA vs 529 for College

Before you decide to use a Roth IRA for college savings, you might want to consider a 529 plan. With a 529, you can save money for your child to go to college and withdraw the funds tax-free as long as they’re used for qualified higher education expenses.

A 529 plan has more generous contribution limits than a Roth IRA does, and other extended family members may also contribute to the plan. In addition, while 529 contributions aren’t deductible at the federal level, many states provide tax benefits for 529s.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Which College Expenses Can a Roth IRA Be Used For?

According to the IRS, a Roth IRA can be used to pay for qualified higher education expenses. These qualified expenses include tuition, fees, books and supplies, and equipment required for enrollment or attendance.

The Takeaway

It’s possible to use a Roth IRA to help pay for qualified higher education expenses, and you typically won’t be subject to a penalty for doing so. However, taking funds out of your Roth IRA means you won’t have that money available for retirement. You’ll also lose out on any gains that may have compounded throughout the years. That could impact your retirement savings or even delay your retirement date.

Instead of using a Roth IRA for college, you may want to consider other ways to save for college that might better fit your financial needs, such as a 529 plan. That way you can save for both college and retirement.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

Can you use a Roth IRA for college?

Yes, it is possible to use a Roth IRA for college expenses. If you withdraw money from a Roth IRA for qualified higher education expenses, you generally will not be subject to the 10% early withdrawal penalty. Tuition, fees, books, supplies, and equipment needed for enrollment or attendance are usually considered qualified expenses.

Is a Roth IRA better than a 529 for college?

Deciding whether to use a 529 plan or a Roth IRA for college will depend on your specific financial situation. In many cases, a 529 plan may make more sense than a Roth IRA for college savings. You can generally contribute more to a 529 plan each year than you can to a Roth IRA, there are tax advantages to the plan, and other relatives can also contribute to it. Plus, by using a 529, you won’t be taking money from your retirement savings.

Can I withdraw from my IRA for college tuition without penalty?

Yes, you can use a Roth IRA to pay for college tuition without penalty in most cases because tuition is generally considered a qualified higher education expense. However, to avoid taking money from your retirement savings, you may want to consider other college saving options instead, such as a 529 plan.

Photo credit: iStock/Tempura

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

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.

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

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

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 [email protected]. 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.

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Apr
02
2024

Catch-Up Contributions, Explained

By | invest, Investing, Preparing for Retirement | Comments Off on Catch-Up Contributions, Explained

Catch-up contributions allow individuals 50 and older to contribute additional money to their workplace retirement savings plans like 401(k)s and 403(b)s, as well as to individual retirement accounts (IRAs).

Catch-up contributions are designed to help those approaching retirement age save more money for their retirement as they draw closer to that time.

Learn how catch-up contributions work, the eligibility requirements, and how you might be able to take advantage of these contributions to help reach your retirement savings goals.

What Is a Catch-Up Contribution?

A catch-up contribution is an additional contribution individuals 50 and older can make to a retirement savings plan beyond the standard allowable limits. In addition to 401(k)s, 403(b)s, and IRAs, catch-up contributions can also be made to Thrift Savings Accounts, 457 plans, and SIMPLE IRAs.

Catch-up contributions were created as a provision of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001. They were originally planned to end in 2010. However, catch-up contributions became permanent with the Pension Protection Act of 2006.

The idea behind catch-up contributions is to help older individuals who may not have been able to save for retirement earlier in their careers, or those who experienced financial setbacks, to “catch up.” The additional contributions could increase their retirement savings and improve their financial readiness for their golden years.

While employer-sponsored retirement plans are not required to allow plan participants to make catch-up contributions, most do. In fact, nearly all workplace retirement plans offer catch-up contributions, according to a 2023 report by Vanguard.

💡 Quick Tip: Want to lower your taxable income? Start saving for retirement with an IRA account. The money you save each year in a Traditional IRA is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).

Catch-Up Contribution Limits: 2023-2024

Each year, the IRS evaluates and modifies contribution limits for retirement plans, primarily taking the effects of inflation into account. The standard annual contribution limit for a 401(k) in 2023 is $22,500, and $23,000 for 2024. For a traditional or Roth IRA, the standard contribution limit is $6,500 in 2023, and for 2024 the limit is $7,000.

Catch-up contributions can be made on top of those amounts. Here are the catch-up contribution limits for 2023 and 2024 for some retirement savings plans.

Plan 2023 Catch-Up Limit 2024 Catch-Up Limit
IRA (traditional or Roth) $1,000 $1,000
401(k) $7,500 $7,500
403(b) $7,500 $7,500
SIMPLE IRA $3,500 $3,500
457 $7,500 $7,500
Thrift Savings Account $7,500 $7,500

This means that you can make an additional $7,500 in catch-up contributions to your 401(k) for a grand total of up to $30,000 in 2023 and $30,500 in 2024. And with traditional and Roth IRA catch-up contributions of $1,000 for both years, you can contribute up to $7,500 in 2023 and $8,000 in 2024 to your IRA.

Catch-Up Contribution Requirements

In order to take advantage of catch-up contributions, individuals need to be age 50 or older — or turn 50 by the end of the calendar year. If eligible, they can make catch-up contributions each year after that if they choose to — up to the annual contribution limit.

Certain retirement plans may have other allowances for catch-up eligibility. For instance, with a 403(b), in addition to the catch-up contributions for participants based on age, employees with at least 15 years of service may be able to make additional contributions, depending on the rules of their employer’s plan.

To maximize the advantages of catch-up contributions, it’s a good idea to become familiar with the rules of your plan as part of your retirement planning strategy.

Benefits of Catch-Up Contributions

There are a number of benefits to making catch-up contributions to eligible retirement plans.

•   Increased retirement savings: By helping to make up for earlier periods of lower contributions to your retirement savings plan, catch-up contributions allow you to increase your savings and potentially grow your nest egg in the years closest to retirement.

•   Possible tax benefits: Making catch-up contributions may help lower your taxable income for the year you make them. That’s because contributions to 401(k)s and traditional IRAs are made with pre-tax dollars, giving you a right-now deduction. And contributions beyond the standard limits could lower your taxable income for the year even more. (Of course, you will pay tax on the money when you withdraw it in retirement, but you may be in a lower tax bracket by then.)

•   Additional security: Making catch-up contributions may give you an extra financial cushion as you approach retirement age. And those contributions may add up in a way that could surprise you. For instance, if you contribute an additional $7,500 to your retirement account from age 50 to 65, assuming an annualized rate of return of 7%, you could end up with more than $200,000 extra in your account.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

How to Make Catch-Up Contributions

To make catch-up contributions to an employer-sponsored plan, contact your plan’s administrator or log into your account online. The process is typically incorporated into a retirement savings plan’s structure, and you should be able to easily indicate the amount you want to contribute as a catch-up.

To make IRA catch-up contributions, contact your IRA custodian (typically the institution where you opened the IRA) to start the process. In general, you have until the due date for your taxes (for example, April 15, 2024 for your 2023 taxes) to make catch-up contributions.

Finally, keep tabs on all your retirement plan contributions, including catch-ups, to make sure you aren’t exceeding the annual limits.

The Takeaway

For those 50 and up, catch-up contributions can be an important way to help build retirement savings. They can be an especially useful tool for individuals who weren’t able to save as much for retirement when they were younger. By contributing additional money to their 401(k) or IRA now, they can work toward a goal of a comfortable and secure retirement.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

Do you get employer match on catch-up contributions?

It depends on whether your plan allows employer matching for catch-up contributions. Not all plans do. Even if your employer does match catch-up contributions, they might set a limit on the total amount they will match overall. Check with your plan administrator to find out what the rules are.

Are catch-up contributions worth it?

Catch-up contributions can be beneficial to older workers by helping them potentially build a bigger retirement nest egg. These contributions may be especially helpful for those who haven’t been able to save as much for retirement earlier in their lifetime. Making catch-up contributions might also provide them with tax benefits by lowering their taxable income so that they could possibly save even more money.

How are catch-up contributions taxed?

For retirement savings plans like 401(k)s and traditional IRAs, catch-up contributions are typically tax deductible, lowering an individual’s taxable income in the year they contribute. However, catch-up contributions to Roth IRAs are made with after-tax dollars. That means you pay taxes on the money you contribute now, but your withdrawals are generally tax-free in retirement.

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

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.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

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

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Apr
01
2024

How to Invest in Real Estate: 7 Ways for Beginners

By | Financial Independence, invest, Investing | Comments Off on How to Invest in Real Estate: 7 Ways for Beginners

Real estate investing can be an effective way to hedge against the effects of inflation in a portfolio while generating a steady stream of income. When it comes to how to invest in real estate, there’s no single path to entry.

Where you decide to get started can ultimately depend on how much money you have to invest, your risk tolerance, and how hands-on you want to be when managing real estate investments.

Why Invest in Real Estate?

Real estate investing can yield numerous benefits, for new and seasoned investors alike. Here are some of the main advantages to consider with property investments.

•   Real estate can diversify your portfolio, allowing you to better balance risk and rewards.

•   Provides the opportunity to generate investment returns outside of owning securities such as stocks, ETFs, or bonds.

•   Historically, real estate is often seen as a hedge against inflation, since property prices tend to increase in tandem with price increases for other consumer goods and services.

•   Owning real estate investments can allow you to generate a steady stream of passive income in the form of rents or dividends.

•   Rental property ownership can include some tax breaks since the IRS allows you to deduct ordinary and necessary expenses related to operating the property.

•   Real estate may appreciate significantly over time, which could result in a sizable gain should you decide to sell it. However, real estate can also depreciate in value, leading to a possible loss or negative return. Investors should know that the real estate market is different than the stock market, and adjust their expectations accordingly.

There’s one more thing that makes real estate investing for beginners particularly attractive: There are many ways to do it, which means you can choose investments that are best suited to your needs and goals.

💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.

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now for the rest of us.

Start trading funds that include commodities, private credit, real estate, venture capital, and more.

7 Ways to Invest in Real Estate

Real estate investments can take different forms, some of which require direct property ownership and others that don’t. As you compare different real estate investments, here are some important things to weigh:

•   Minimum investment requirements

•   Any fees you might pay to own the investment

•   Holding periods

•   Past performance and expected returns

•   Investment-specific risk factors

With those things in mind, here are seven ways to get started with real estate investing for beginners.

1. Real Estate Investment Trusts (REITs)

A real estate investment trust (REIT) is a company that owns and operates income-producing properties. The types of properties you might find in a REIT include warehouses, storage facilities, shopping centers, and office space. A REIT may also own mortgages or mortgage-backed securities.

REITs allow investors to enjoy the benefits of property ownership without having to buy a building or land. Specifically, that means steady income as REITs are required to pay out 90% of taxable income annually to shareholders in the form of dividends. Most REIT dividends are considered to be ordinary income for tax purposes.

Many REITs are publicly traded on an exchange just like a stock. That means you can buy shares through your brokerage account if you have one, making it relatively easy to add REITs to your portfolio. Remember to consider any commission fees you might pay to trade REIT shares in your brokerage account.

2. Real Estate Funds

Real estate funds are mutual funds that own a basket of securities. Depending on the fund’s investment strategy, that may include:

•   Individual commercial properties

•   REITs

•   Mortgages and mortgage-backed securities

Mutual funds also trade on stock exchanges, just like REITs. One of the key differences is that mutual funds are not required to pay out dividends to investors, though they can do so.

Instead, real estate funds aim to provide value to investors in the form of capital appreciation. A real estate fund may buy and hold property investments for the long term, in anticipation of those investments increasing in value over time.

Investing in a real estate fund vs. REIT could offer broader exposure to a wider range of property types or investments. A REIT, for instance, may invest only in hotels and resorts whereas a real estate mutual fund may diversify with hotels, office space, retail centers, and other property types.

3. REIT ETFs

A REIT ETF or exchange-traded fund is similar to a mutual fund, but the difference is that it trades on an exchange just like a stock. There’s also a difference between REIT ETFs and real estate mutual funds regarding what they invest in. With a REIT ETF, holdings are primarily concentrated on real estate investment trusts only.

That means you could buy a single REIT ETF and gain exposure to 10, 20 or more REITs in one investment vehicle.

Some of the main advantages of choosing a REIT ETF vs. real estate funds or individual REITs include:

•   Increased tax efficiency

•   Lower expense ratios

•   Potential for higher returns

A REIT ETF may also offer a lower minimum investment than a REIT or real estate fund, which could make it suitable for beginning investors who are working with a smaller amount of capital.

But along with those advantages, investors should know about some of the potential drawbacks:

•   ETF values may be sensitive to interest rate changes

•   REIT ETFs may experience volatility related to property trends

•   REIT ETFs may be subject to several other types of risk, such as management and liquidity risk more so than other types of ETFs.

As always, investors should consider the risks along with the potential advantages of any investment.

4. Real Estate Crowdfunding

Real estate crowdfunding platforms allow multiple investors to come together and pool funds to fund property investments. The minimum investment may be as low as $500, depending on which platform you’re using, and if you have enough cash to invest you could fund multiple projects.

Compared to REITs, REIT ETFs, or real estate funds, crowdfunding is less liquid since there’s usually a required minimum holding period you’re expected to commit to. That’s important to know if you’re not looking to tie up substantial amounts of money for several years.

You’ll also need to meet a platform’s requirements before you can invest. Some crowdfunding platforms only accept accredited investors. To be accredited, you must:

•   Have a net worth over $1 million, excluding your primary residence, OR

•   Have an income of $200,000 ($300,000 if married) for each of the prior two years, with the expectation of future income at the same level

You can also qualify as accredited if you hold a Series 7, Series 65, or Series 82 securities license.

5. Rental Properties

Buying a rental property can help you create a long-term stream of income if you’re able to keep tenants in the home. Some of the ways you could generate rental income with real estate include:

•   Buying a second home and renting it out to long-term tenants

•   Buying a vacation home and renting it to short-term or seasonal tenants

•   Purchasing a multi-unit property, such as a duplex or triplex, and renting to multiple tenants

•   Renting a room in your home

But recognize the risks or downsides associated with rental properties, too:

•   Negative cash flow resulting from tenancy problems

•   Problem tenants

•   Lack of liquidity

•   Maintenance costs and property taxes

Further, the biggest consideration with rental properties usually revolves around how you’re going to finance a property purchase. You might try for a conventional mortgage, an FHA loan if you’re buying a multifamily home and plan to live in one of the units, a home equity loan or HELOC if you own a primary residence, or seller financing.

Each one has different credit, income, and down payment requirements. Weighing the pros and cons of each one can help you decide which financing option might be best.

6. Fix and Flip Properties

With fix-and-flip investments, you buy a property to renovate and then resell it for (ideally) a large profit. Becoming a house flipper could be lucrative if you’re able to buy properties low, then sell high, but it does take some knowledge of the local market you plan to sell in.

You’ll also have to think about who’s going to handle the renovations. Doing them yourself means you don’t have to spend any money hiring contractors, but if you’re not experienced with home improvements you could end up making more work for yourself in the long run.

If you’re looking for a financing option, hard money loans are one possibility. These loans let you borrow enough to cover the purchase price of the home and your estimated improvements, and make interest-only payments. However, these loans typically have terms ranging from 9 to 18 months so you’ll need to be fairly certain you can sell the property within that time frame.

7. Invest in Your Own Home

If you own a home, you could treat it as an investment on its own. Making improvements to your property that raise its value, for example, could pay off later should you decide to sell it. You may also be able to claim a tax break for the interest you pay on your mortgage.

Don’t own a home yet? Understanding what you need to qualify for a mortgage is a good place to start. Once you’re financially ready to buy, you can take the next step and shop around for the best mortgage lenders.

How to Know If Investing in Real Estate Is a Good Idea for You

Is real estate investing right for everyone? Not necessarily, as every investor’s goals are different. Asking yourself these questions can help you determine where real estate might fit into your portfolio:

•   How much money are you able and willing to invest in real estate?

•   What is your main goal or reason for considering property investments?

•   If you’re interested in rental properties, will you oversee their management yourself or hire a property management company? How much income would you need them to generate?

•   If you’re considering a fix-and-flip, can you make the necessary commitment of time and sweat equity to get the property ready to list?

•   How will you finance a rental or fix-and-flip if you’re thinking of pursuing either one?

•   If you’re thinking of choosing REITs, real estate crowdfunding, or REIT ETFs, how long do you anticipate holding them in your portfolio?

•   How much risk do you feel comfortable with, and what do you perceive as the biggest risks of real estate investing?

Talking to a financial advisor may be helpful if you’re wondering how real estate investments might affect your tax situation, or have a bigger goal in mind, like generating enough passive income from investments to retire early.

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

The Takeaway

Real estate investing is one of the most attractive alternative investments for portfolio diversification. While you might assume that property investing is only for the super-rich, it’s not as difficult to get started as you might think. Keep in mind that, depending on how much money you have to invest initially and the degree of risk you’re comfortable taking, you’re not just limited to one option when building out your portfolio with real estate.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

How Can I Invest in Property With Little Money?

If you don’t have a lot of money to invest in property, you might consider real estate investment trusts or real estate ETFs for your first investments. REITs and ETFs can offer lower barriers to entry versus something like purchasing a rental property or a fix-and-flip property.

Is Real Estate Investing Worth It?

Real estate investing can be worth it if you’re able to generate steady cash flow and income, hedge against inflation, enjoy tax breaks, and/or earn above-average returns. Whether investing in real estate is worth it for you can depend on what your goals are, how much money you have to invest, and how much time you’re willing to commit to managing those investments.

Is Investing in Real Estate Better Than Stocks?

Real estate tends to have a low correlation with stocks, meaning that what happens in the stock market doesn’t necessarily affect what happens in the property markets. Investing in real estate can also be attractive for investors who are looking for a way to hedge against the effects of inflation over the long term.

Is Investing in Real Estate Safer Than Stocks?

Just like stocks, real estate investments carry risk meaning one isn’t necessarily safer than the other. Investing in both real estate and stocks can help you create a well-rounded portfolio, as the risk/reward profile for each one isn’t the same.

Photo credit: iStock/Pheelings Media
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

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

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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 [email protected]. 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.

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.


An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

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Apr
01
2024

Private Credit vs. Private Equity: What’s the Difference?

By | Family Finances, invest, Investing | Comments Off on Private Credit vs. Private Equity: What’s the Difference?

Private credit and private equity investments offer investors opportunities to build their portfolios in substantially different ways. With private credit, investors make loans to businesses and earn returns through interest. Private equity represents an ownership stake in a private company or a public company that is not traded on a stock exchange.

Each one serves a different purpose, which can be important for investors to understand.

What Does Private Credit and Private Equity Mean?

Private equity and private credit are two types of alternative investments to the stocks, bonds, and mutual funds that often make up investor portfolios. Alternative investments in general, and private equity or credit in particular, can be attractive to investors because they can offer higher return potential.

However, investors may also face more risk.

💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.

Alternative investments,
now for the rest of us.

Start trading funds that include commodities, private credit, real estate, venture capital, and more.

Private Credit Definition

Private credit is an investment in businesses. Specifically, an investor or group of investors extends loans to private companies and delisted public companies that need capital. Investors collect interest on the loan as it’s repaid. Other terms used to describe private credit include direct lending, alternative lending, private debt, or non-bank lending.

Who invests in private credit? The list can include:

•   Institutional investors

•   High-net-worth individuals

•   Family offices or private banks

Retail investors may pursue private credit opportunities but they tend to represent a fairly small segment of the market overall. Private credit investment is expected to exceed $3.5 trillion globally by 2028.

Private Equity Definition

Private equity is an investment in a private or delisted public company in exchange for an ownership share. This type of investment generates returns when the company is sold, or in the case of a private company, goes public.

Similar to private credit, private equity investments are often the domain of private banks, or high-net-worth individuals. Private equity firms can act as a bridge between investors and companies that are seeking capital. Minimum investments may be much higher than the typical mutual fund buy-in, with investors required to bring $1 million or more to the table.

Private equity is often a long-term investment as you wait for the company to reach a point where it makes sense financially to sell or go public. One difference to note between private equity and venture capital lies in the types of companies investors target. Private equity is usually focused on established businesses while venture capital more often funds startups.

What Are the Differences Between Private Credit and Private Equity?

Private credit and private equity both allow for investment in businesses, but they don’t work the same way. Here’s a closer look at how they compare.

Investment Returns

Private credit generates returns for investors via interest, whereas private equity’s goal is to generate returns for investors after selling a company (or stake in a company) after the company has grown and appreciated, though that’s not always the case.

With private credit, returns may be more predictable as investors may be able to make a rough calculation of their potential returns. Private equity returns are less predictable, as it may be difficult to gauge how much the company will eventually sell for. But there’s always room for private equity returns to outstrip private credit if the company’s performance exceeds expectations. However, it’s important to remember that higher returns are not guaranteed.

Risk

Investing in private credit carries liquidity risk, in that investors may be waiting several years to recover their original principal. That risk can compound for investors who tie up large amounts of capital in one or two sectors of the market. Likewise, changing economic conditions could diminish returns.

If the economy slows and a company isn’t able to maintain the same level of revenue, that could make it difficult for it to meet its financial obligations. In a worst-case scenario, the company could go bankrupt. Private credit investors would then have to wait for the bankruptcy proceedings to be completed to find out how much of their original investment they’ll recover. And of course, any future interest they were expecting would be out the window.

With private equity investments, perhaps the biggest risk to investors is also that the company closes shop or goes bankrupt before it can be sold but for a different reason. In a bankruptcy filing, the company’s creditors (including private credit investors) would have the first claim on assets. If nothing remains after creditors have been repaid, private equity investors may walk away with nothing.

The nature of the company itself can add to your risk if there’s a lack of transparency around operations or financials. Privately-owned companies aren’t subject to the same federal regulation or scrutiny as publicly-traded ones so it’s important to do thorough research on any business you’re thinking of backing.

Ownership

A private credit investment doesn’t offer any kind of ownership to investors. You’re not buying part of the company; you’re simply funding it with your own money.

Private equity, on the other hand, does extend ownership to investors. The size of your ownership stake can depend on the size of your investment.

Investor Considerations When Choosing Between Private Credit and Private Equity

If you’re interested in private equity or private credit, there are some things you may want to weigh before dividing in. Here are some of the most important considerations for adding either of these investments to your portfolio.

•   Can you invest? As mentioned, private credit and equity are often limited to accredited investors. If you don’t meet the accredited investor standard, which is defined by income and net worth, these investments may not be open to you.

•   How much can you invest? If you are an accredited investor, the next thing to consider is how much of your portfolio you’re comfortable allocating to private credit or equity.

•   What’s your preferred holding period? When evaluating private credit and private equity, think about how long it will take you to realize returns and recover your initial investment.

•   Is predictability or the potential for higher returns more important? As mentioned, private credit returns are typically easy to estimate if you know the interest rate you’re earning. However, returns may be lower than what you could get with private equity, assuming the company performs well.

Here’s one more question to ask: how can I invest in private equity?

These investments may not be available in a standard brokerage account. If you’re looking for private credit opportunities you may need to go to a private bank that offers them. When private equity is the preferred option, a private equity firm is usually the connecting piece for those investments.

When comparing either one, remember to consider the minimum initial investment required as well as any fees you might pay.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

The Takeaway

Private credit and private equity can diversify a portfolio and help you build wealth, though not in the same way. Comparing the pros and cons, assessing your personal tolerance for risk and ability to invest in either can help you decide if alternative investments might be right for you.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

Invest in alts to take your portfolio beyond stocks and bonds.

FAQ

Why do investors like private credit?

Private credit can offer some unique advantages to investors, starting with predictable returns and steady income. The market for private credit continues to grow, meaning there are more opportunities for investors to add these types of investments to their portfolios. Compared to private equity, private credit carries a lower degree of risk.

How much money do you need for private equity?

The minimum investment required for private equity can vary, but it’s not uncommon for investors to need $100,000 or more to get started. In some instances, private equity investment minimums may surpass $1 million, $5 million, or even $10 million.

Can anyone invest in private credit or private equity?

Typically, no. Private credit and private equity investments most often involve accredited investors or legal entities, such as a family office. It’s possible to find private credit and private equity investments for retail investors, however, you may need to meet the SEC’s definition of accredited to be eligible.

Photo credit: iStock/shapecharge

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Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.


An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

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