Sep
08
2023
Understanding Diluted EPS

Understanding Diluted EPS

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Understanding Diluted EPS

Diluted earnings per share (EPS) is a measure of earnings per share that includes a company’s convertible securities. Convertible, or dilutive, securities are stocks or bonds that could potentially become common shares. Basic earnings per share only considers existing common shares.

Diluted EPS, then, includes in its calculation the factor of convertible bondholders, convertible preferred stockholders, and options holders potentially deciding to turn their securities into common shares. If this were to happen, the number of shares outstanding would increase, with earnings staying the same, resulting in lower earnings per share. Diluted EPS will therefore tend to be lower than basic EPS.

Basic vs. Diluted EPS

What is diluted earnings per share, and how does it differ from basic EPS? Simply put, basic EPS tends to be a higher number than diluted EPS. Basic EPS doesn’t factor in the existence of convertible securities of the impact if they were to be converted into common shares.

Instead, the most basic calculation of earnings per share only takes a company’s net income minus any preferred stock dividends and divides that number by the number of shares outstanding. Convertible securities aren’t factored into the equation.

Because of this, sometimes it’s beneficial to look at a calculation of earnings per share that assumes all possible common shares have been brought into being through existing convertible securities. Doing so gives investors a more realistic view of earnings while assuring no future surprises.

Imagine an investor doing all their homework on the fundamental analysis of a company using only basic earnings per share. EPS, which measures the value that a company delivers to individual shareholders, might look high and the stock pays a good dividend, so the investor might decide the stock is a good one to buy.

But then she learns that the company has been issuing convertible bonds to raise capital and giving new employees stock options to make working there more attractive.

All of a sudden, for some reason, bondholders decide to convert their bonds to common shares, and employees decide to exercise their stock options.

Now this investor’s shares have been diluted, since a bunch of new shares have popped into existence practically overnight. As a result, earnings per share have decreased, and dividends likely have done the same (because the same dividends now have to be paid out to additional shareholders).

If our imaginary investor had used diluted EPS in her calculations, she could have prepared for this kind of scenario at some point. But because this make-believe company created the potential for its stock to be diluted by issuing convertible securities, basic EPS did not provide the full picture.


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How to Calculate Diluted EPS

The formula for diluted EPS is a company’s net income minus any preferred stock dividends, divided by the company’s average outstanding shares minus its dilutive shares. Or:

Diluted EPS = (Net Income – Preferred Stock Dividends)/(Average Outstanding Shares – Dilutive Shares)

The diluted EPS formula is calculating the amount of earnings per share there would be if dilutive shares were to become common shares. The formula is exactly the same as that of calculating basic EPS, but with one important extra step – adding the number of dilutive shares to the number of average outstanding shares (in the bottom half of the equation).

The sum of both existing common shares and the possible dilutive shares creates a larger number on the bottom half of the equation, while the top half remains the same.

Therefore, diluted EPS tends to be lower than basic EPS, as the company’s net income (minus preferred stock dividends) is being divided by a larger number of shares.

For example, let’s say a company makes $1,000,000 in net income and pays no dividend. There are 800,000 common shares outstanding, 100,000 call options, and 100,000 convertible preferred shares.

The diluted EPS formula would yield a result of $1.00 per share in this example, as we would be dividing 1,000,000 dollars in net income by 1,000,000 total potential shares.

Basic EPS, on the other hand, would be calculated as $1,000,000 divided by the 800,000 current shares, yielding a result of $1.25 per share.

While it’s not difficult to calculate EPS and diluted EPS, many companies share the figures with investors in their earnings reports.

Recommended: What You Should Know About Earnings Calls

Why Is Diluted EPS Important?

Diluted EPS reveals what a company’s earnings per share could look like if holders of convertible securities were to decide to exercise their right to hold common shares, and it’s an important consideration during an investor’s analysis of a stock.

Since companies often issue convertible securities like stock options, convertible bonds, convertible preferred shares, a company’s earnings per share could appear higher than reality when not factoring in the potential for dilution.

Convertible securities might be held by people inside or outside of the company, and they may not be turned into shares anytime soon. But what happens when everyone decides to turn in their convertible securities for shares?

For example, if a company’s stock were to rise in price suddenly, and the company had paid several of its employees bonuses in the form of stock options, those employees might choose to exercise those options.

Now there are more common shares than before, but earnings have not increased. Therefore, in a theoretical example like this, earnings per share will have decreased.

A company issuing employee stock options isn’t always a negative thing, however. If the options keep high-quality employees, the result could be positive for the company over the long run. Using options also reduces expenses that come from paying employee salaries, which could free up capital to help the company grow.

Diluted EPS provides a more conservative earnings per share number since it shows what EPS would be in the event of more new shares coming into existence. Basic EPS could appear to be deceivingly high because it doesn’t calculate for this possibility, so it could be a less reliable indicator of when to buy, sell, or hold a stock.

Of course, there might also be times when diluted EPS is unnecessary. Young companies that are still small and growing might not have had the chance to issue any convertible securities yet, so earnings per share might look the same either way.

The Takeaway

Diluted EPS is a measurement of earnings per share that factors in the potential stock dilution that occurs when convertible securities are converted to common shares. Understanding diluted EPS is important so that investors don’t get caught off guard in the event of new common shares being created through the conversion of securities such as stock options, stock warrants, convertible bonds and convertible preferred shares.

When this happens, earnings per share decline, and those who had only been looking at basic EPS in an attempt to determine the profitability of a company will find they made a miscalculation. In some cases, the difference between basic and diluted EPS might not be that different. If a company hasn’t issued convertible securities, or has issued very few convertible securities, then not much dilution would be possible.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/Morsa Images

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

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

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.

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Sep
07
2023
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What Investors Should Know About Spread

By | Growing Wealth, invest, Investing | Comments Off on What Investors Should Know About Spread

A spread represents the difference between any two financial metrics. The type of spread depends on the type of security that’s being traded. For example, when trading bonds, the spread can refer to a difference in yields between bonds of varying maturity lengths or quality.

Further, while there are many differences between bonds and stocks — spread is just one of them. With stocks, though, spreadgenerally refers to differences in price. Specifically, it measures the gap between the bid price and the ask price. Understanding what is spread and how it works can help you more effectively shape your investment strategy.

What Is Spread in Finance?

As noted, spread is the difference between two financial measurements. When talking specifically about a stock spread, it is the difference between the bid and ask price.

The bid price is the highest price a buyer will pay to purchase one or more shares of a specific stock. The ask price is the lowest price at which a seller will agree to sell shares of that stock. The spread represents the difference between the bid price and the ask price.

A good way to visualize spread may be to think of buying a home. As a home buyer, you may have a set price that you’re willing to pay for a property, based on what you can afford and what you’ve been pre-approved for by your mortgage lender.

You search for homes and eventually find one that has everything on your wishlist. When you check the listing price, you see that the seller has it priced $10,000 above your budget. In terms of spread, the maximum amount you’re willing to offer for the home represents the bid price, while the seller’s listing price represents the ask.

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*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.

What Does Spread Mean?

Aside from stock spread, spread can have a variety of applications and meanings in the financial world.

As mentioned earlier, bond spread typically refers to differences in yield. But if you’re trading futures, the spread can measure the gap between buy and sell positions for a particular commodity. With options trading, it can refer to differences in strike prices when placing call or put options.

Spread can also be used in foreign currency markets or forex (foreign exchange market) trades to represent the difference between the costs for traders and the profits realized by dealers.

With lending, spread is tied to a difference in interest rates. Specifically, it means the difference between a benchmark rate, such as the prime rate, and the rate that’s actually charged to a borrower. So for example, if you’re getting a mortgage there might be a 2% spread, meaning your rate is 2% higher than the benchmark rate.

Bid-Ask Price and Stocks Spread

If you trade stocks online, it’s important to understand how the bid-ask price spread works and how it can affect your investment outcomes. Since spread can help gauge supply and demand for a particular stock, investors can use that information to make informed decisions about trades and increase the odds of getting the best possible price.

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

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

What Influences Stock Spreads?

There are different factors that can affect a stock’s spread, including:

•   Supply and demand. Spread can be impacted by the total number of outstanding shares of a particular stock and the amount of interest investors show in that stock.

•   Liquidity. Generally, liquidity is a measure of how easily a stock or any other security can be bought and sold or converted to cash. The more liquid an investment is, the closer the bid and ask price may be, since it can be easier to gauge an asset’s worth.

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

•   Volatility. Measuring volatility is a way of gauging price changes and how rapidly a stock’s price moves up or down. When there are wider swings in a stock’s price, i.e. more volatility, the bid-ask price spread can also be wider.

Why Pay Attention to a Stock’s Spread?

Learning to pay attention to a stock’s spread can be helpful for investors in that they may be able to use what they glean from the spread to make better decisions related to their portfolios.

In other words, when you understand how spread works for stocks, you can use that to invest strategically and manage the potential for risk. This means different things whether you are planning to buy, sell, or hold a stock. If you’re selling stocks, that means getting the best bid price; when you’re buying, it means paying the best ask price.

Essentially, the goal is the same as with any other investing strategy: to buy low and sell high.

Difference Between a Tight Spread and a Wide Spread

As discussed, a tight spread could be a signal to investors that buyers and sellers are more or less in agreement that a stock is valued correctly. A wide spread, on the other hand, may signal that there isn’t necessarily a consensus on what the stock’s value should be.

There’s no guarantee, of course, that that inclination is correct, but when looking at tight or wide spreads, it can be yet another useful piece of information to help inform decisions.

Executing Stock Trades Using Spread

If you’re using the bid-ask spread to trade stocks, there are different types of stock orders you might place. Those include:

•   Market orders. This is an order to buy or sell a security that’s executed immediately.

•   Limit orders. This is an order to buy or sell a security at a certain price or better.

•   Stop orders. A stop order, also called a stop-loss order, is an order to buy or sell a security once it hits a certain price. This is called the stop price and once that price is reached, the order is executed.

•   Buy stop orders. Buy stop orders are used to execute buy orders only when the market reaches a certain stop price.

•   Sell stop orders. A sell stop order is the opposite of a buy stop order. Sell stop orders are executed when the stop price falls below the current market price of a security.

Stop orders can help with limiting losses in your investment portfolio if you’re trading based on bid-ask price spreads. Knowing how to coordinate various types of orders together with stock spreads can help with getting the best possible price as you make trades.

Other Types of Spreads

While we’ve mostly discussed spread as it relates to stocks, there are other types of spreads, too.

Options spreads, for instance, involve buying multiple options contracts with the same underlying asset, but different strike prices or expiration dates.

Under the options spread umbrella are several spreads as well. Box spreads are one example, and they are a type of arbitrage options trading strategy in which traders use some tricks of the trade to reduce their risk as much as possible.

There’s also the debit spread, which is an options trading strategy in which a trader buys and sells an option at the same time — it’s a high-level strategy, and one that may not be suited to investors who are mostly investing in stocks or bonds.

Note, too, that there is something called a credit spread (similar to a debit spread, but its inverse) and that there are some differences traders will need to learn about before deciding to utilize a credit spread vs. debit spread as a part of their strategy. Again, options trading requires a whole new level of market knowledge and know-how, and may not be for all investors.

Investing With SoFi

The more investing terms an investor is familiar with, the better able they’ll be to invest with confidence. Spread is a term that means different things in different situations, but when it comes to stocks, spread is the difference between the bid price and ask price of a given stock. Being able to assess what a spread might mean can help inform individual trading decisions.

As you learn more about stocks, including what is spread and how it works, you can use that knowledge to create a portfolio that reflects your financial needs and goals.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

How do you read a stock spread?

A stock spread is the difference between the bid and ask price, so calculating it is a matter of subtracting the bid from the ask price. It’s typically expressed as a percentage.

What is the average spread of a stock?

The average spread of a stock ranges between 13% and 18%, but can vary wildly depending on what types of stocks or market segments are being looked at.

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.

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.

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Sep
07
2023
What Is a Credit Default Swap (CDS)?

What Is a Credit Default Swap (CDS)?

By | Financial Independence, Growing Wealth, invest, Investing | Comments Off on What Is a Credit Default Swap (CDS)?

Credit default swaps (CDS) are widely used financial derivatives, or contracts, that give investors the ability to “swap” their credit risk with another investor. They’re a popular type of investment, especially for institutional investors.

Investors use CDS for many types of credit investments, including mortgage-backed securities, junk bonds, collateralized debt obligations, corporate bonds, emerging market bonds, and municipal bonds.

Credit Default Swaps, Explained

Credit default swaps are the most common type of credit derivative, and they help investors reduce the risk that borrowers on the securities they own will default on their loans. To reduce their risk, the investor purchases a CDS from another investor, who will pay the lender back if the borrower defaults on the loan. There is generally an ongoing payment as part of the contract, which serves as an insurance policy.

The investments used to create credit-default swaps include many types of credit, such as mortgage-backed securities, junk bonds, collateralized debt obligations, corporate bonds, emerging market bonds, and municipal bonds. However, while the contract references a specific security or set of securities, it is not actually connected to it. Most CDS investors are institutional investors, such as hedge funds, due to the securities’ complex and risky nature.

Recommended: How to Intelligent Investors Handle Risk

The credit-default swap contract lays out the responsibilities of the seller in the event that the borrower experiences a credit event or defaults on their loan. Credit events can include failure to pay, bankruptcy, moratorium, repudiation, and obligation acceleration. If any of these events occur, the buyer of the CDS may terminate the contract and the seller will need to pay. The specifics of these credit events are outlined in the contract that both parties sign.

The agreement between the borrower and the lender is separate from the lender’s agreement with the CDS seller, in which the lender becomes the CDS buyer.

Here’s a credit default swap example: A company sells a $200 bond with a 20-year maturity term. An investor buys that bond from the company, who agrees to pay back the money to the investor plus interest within 20 years. However, the company can’t guarantee its ability to pay back that money and the interest. This is the risk involved in investing in a bond.

In order to mitigate the risk, the investor who bought the bond purchases a CDS, which guarantees they will get their investment back if the company defaults on the loan. Just as with other types of insurance, the CDS buyer makes regular payments, typically every quarter, on the contract. The CDS seller is usually a bank, insurance company, reporting dealer, or hedge fund.

These sellers protect themselves against risk by diversifying their sales into many different companies, industries, or sectors. If one of their sales falls through, they have income from all the others to carry on their business.

Riskier Credit Default Swaps

The higher the risk of default, the more expensive a CDS will be. Some investors use credit-default to speculate on the credit quality of a company. Essentially, people use the CDS system to place bets on the bond issuer through the CDS system.

Investors can also switch sides on CDS if they come to decide that a borrower might default. The CDS seller can buy its own CDS or sell it to another bank. This makes it extremely difficult to track the market and decide how to invest in it.


💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

The Benefits of Credit Default Swaps

The main reason that people choose to buy CDS is as an insurance policy against the risks of loans in their portfolio. Using a CDS allows the investor to transfer some of the risk to the seller of the CDS or an insurance company.

The credit risk does not disappear with a CDS, the seller simply takes on that risk. However, if the borrower defaults on their loan, the seller of the CDS will default on the contract, and the debt goes back to the buyer.

One benefit of CDS is that they enable bond investors to buy into riskier ventures than they otherwise would, since they know they have some protection. This helps funds go towards innovative and unexplored ideas, which help grow the economy and solve world problems.

Recommended: Pros and Cons of High Yield Bond Investing

Downsides of Credit Default Swaps

Although there are several benefits to credit default swaps, they have some significant downsides as well. CDS are an investment focused on managing risk, and it can be difficult to figure out which ones are safer investments due to the complexities of the market.

Introduced in 1994, the CDS market went largely unregulated until the financial crisis of 2008, and was a key contributor to the problems that led up to it. Since it wasn’t regulated, CDS sellers often did not have the money available to pay the buyer in the case of a default. Many sellers only held a fraction of what would be needed to pay back all their buyers.

As long as nobody defaulted, this system worked, but in 2008, this resulted in a massive financial meltdown. Large scale sellers of CDS, including some of the largest financial institutions in the United States were unable to make good on theirCDS contracts, creating a wave of economic effects around the world and requiring multiple bailouts by the Federal Reserve.

Dodd-Frank Reforms

After the 2008 financial crisis, regulators stepped in to try and prevent the same thing from happening again.

The Dodd-Frank Wall Street Reform Act of 2010 required the regulation of swaps by the Commodity Futures Trading Commission and the Securities and Exchange Commission. It also mandated reporting of all credit-default swaps and imposed capital requirements on CDS sellers.

The Takeaway

Credit-default swaps are complicated securities, but some institutional investors can use them to reduce the risk of other investments or to bet that another company might be close to default.

While credit-default swaps are complex investments, they may have a place in a diversified portfolio. However, due to their complexity, it may be a good idea to consult with a financial professional before diving in.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/akinbostanci

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.

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.

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Aug
15
2023
Beginners Guide to KYC

What Is Know Your Customer (KYC) for Financial Institutions?

By | Growing Wealth, invest, Investing | Comments Off on What Is Know Your Customer (KYC) for Financial Institutions?

There are banking regulations in place that are known as KYC. The definition of KYC is “know your customer,” and these rules provide guidelines for financial institutions to know more about their customers.

This isn’t just a matter of curiosity but of national security and crime prevention. Banks need to protect themselves from unwittingly participating in illicit activities.

If a criminal uses a bank for illicit purposes, such as money laundering money, the financial institution could be held accountable. It’s the bank’s responsibility to always know who their customers are. That way, they can help avoid being involved in criminal activity.

KYC plays an important role in financial institutions maintaining accurate information about their clients. KYC procedures and anti-money laundering (AML) laws can work together to minimize risk. Read on to learn more about know your customer regulations.

3 Components of KYC

There are three main parts of a KYC compliance framework: customer identification, customer due diligence, and enhanced due diligence. Each phase of the process of this kind of financial regulation gets more intensive according to the estimated risk that the potential client might pose.

Customer Identification Program (CIP)

The first of the three main KYC requirements is to identify a customer. (Incidentally, some people refer to KYC as know your client vs. know your customer.)

Organizations must verify that a potential customer’s ID is valid, real, and doesn’t contain any inconsistencies. The person must also not be on any Office of Foreign Assets Control (OFAC) sanctions lists.

An organization also needs to know if their prospective customer is “politically exposed.” A politically exposed person (PEP), such as a public figure, is thought to be more susceptible to corruption than the average individual, and is therefore considered high-risk, requiring special attention.

As part of their AML/KYC compliance program, all financial institutions are required to keep records of their Customer Identification Program (CIP) as mandated by the Financial Crimes Enforcement Network (FinCEN).

FinCEN works under the guidance of the department of Treasury and is charged with guarding the financial system against illicit activity and money laundering.

The following information will satisfy the minimum KYC requirements for a Customer Identification Program:

•   Customer name (or name of business)

•   Address

•   Date of birth (not required for businesses)

•   Identification number

For individuals, the customer’s residential address must be validated. US Postal Office boxes are not accepted. Individuals with no physical residential address can use an Army Post Office box (APO), Fleet Post Office Box (FPO), or the residential or business street address of their next of kin.

For business banking customers, the address provided for know your customer laws can be the principal place of business, a local office, or another physical location utilized by the business.

The ID number for most individuals will be their social security number or Taxpayer Identification Number (TIN).

For business entities, the number will usually be their Employer Identification number (EIN). Foreign businesses without ID numbers can be verified by alternative government-issued documents.

Recommended: Opening a Bank Account While Living in a Foreign Country

Customer Due Diligence (CDD)

Due diligence includes:

•   Collecting all relevant information on a customer from trusted sources

•   Determining what the customer will be using financial services for

•   Maintaining ongoing surveillance of the situation to further verify that customer activity remains in line with recorded customer information.

The goal of this phase of the know your customer process is to assess the risks a potential customer might pose and assign them to one of three categories — low-, medium-, or high-risk.

Several variables — including the customer’s expected cash transactions, the type of business, source of income, and location — will help determine the customer’s risk level.

Other categories for assessing risk include the customer’s business industry, whether they use a foreign or domestic account, and their past financial history. The customer is also screened against politically exposed persons (PEP) and Office of Foreign Assets Control’s (OFAC) sanctions lists.

Enhanced Due Diligence (EDD)

Enhanced due diligence (EDD) involves increased monitoring of customers deemed to be high-risk. This may include customers from high-risk third countries, those with political exposure, or those that have existing relationships with financial competitors.

Conducting enhanced due diligence on high-risk business entities requires identifying all beneficiaries of those entities when they open an account. Customers that are legal entities are those that have had legal documentation filed with a Secretary of State or other state office, and include:

•   Limited liability companies (LLC)

•   Corporations

•   Business trusts

•   General partnerships

•   Limited partnerships

•   Any other entity created via filing with a state office or formed under the laws of a jurisdiction outside of the US

On May 11, 2018, a new AML/KYC requirement came into effect. This change to KYC laws states that all banking and non-banking firms subject to the Bank Secrecy Act (BSA) must verify the identity of beneficiaries of legal entity customers when they open an account.

Firms must also develop risk profiles and continually monitor these customers. This must be done regardless of what risk category the customer falls into.

Due diligence is an ongoing process and requires financial institutions to constantly update customer profiles and monitor account activity.

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5 Key Steps Involved in Know Your Customer?

There are five main steps of complying with the know your customer rule, which is part of how banks are regulated. These include:

1. Customer Identification Program (CIP)

As mentioned above, the first step is to ensure that a prospective client’s ID is valid, real, and consistent. The address and other details must be checked. The applicant must be screened to be sure they are not on any OFAC sanctions list and their PEP status must be investigated.

2. Customer Due Diligence (CDD)

The next step of due diligence involves researching and vetting the customer’s intentions regarding the financial services they are seeking.

3. Enhanced Due Diligence (EDD)

Further scrutiny may determine that some applicants are considered risky. If the customer is deemed high-risk, additional ongoing screening is required to make sure activity doesn’t cross any lines.

4. Account Opening

If verification is successful and a client is eligible, the customer can open a bank account, with some clients requiring closer monitoring than others.

5. Annual Review

Once an account is opened, the institution will conduct an annual review of their activity. The higher the risk category a customer falls into, the more often their activities will be reviewed.

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4 Key Elements of a KYC Policy?

KYC compliance involves four key elements. When gathering KYC information, organizations must:

1. Identify Their Customers

In this step, the financial institution will gather information about the customer’s identity.

2. Verify That the Customer’s ID Is True and Valid

The identification documents will be checked against independent sources to make sure identity theft isn’t occurring

3. Understand Their Customer’s Source of Funding and Activities

In this step, a review of the customer’s activities and background can shed light on how likely it is that the client would do reputational damage or could commit crimes that involve money laundering or the financing of terrorism.

4. Monitor the Activities of Their Customers

Monitoring of customer activities is an ongoing process, particularly for high-risk clients. Most firms review clients based on their level of risk.

Low-risk clients might only be reviewed once every two or three years, moderate-risk clients every one to two years, while high-risk clients tend to be reviewed once a year or even once every six months.

Recommended: Guide to Keeping Your Bank Account Safe Online

Why Does KYC Matter?

KYC procedures matter because they are an important screening step. Their implementation can help verify customers and assess and minimize risk.

The KYC process provides guardrails and can help protect against such crimes as money laundering, terrorism funding, and other illegal activities.

Is KYC Successful?

KYC programs are seen as improving a financial institution’s reputation and integrity, though it can add a layer to a prospective client’s application process and banking life.

As the banking landscape evolves quickly with technological advances, banks are finding new ways to track customers and comply with protective KYC and other guidelines. For instance, artificial intelligence (AI) may be able to perform some of these functions.

AML vs KYC

KYC and AML are both ways that financial institutions comply with regulations designed to inhibit terrorism financing and money laundering.

•   AML is the more general practice of an institution seeking to identify and stop such activity.

•   KYC is one aspect of AML, focusing on customer identification and verification.

AML and KYC Similarities AML and KYC Differences
Designed to inhibit money laundering, including terrorism financing Focuses on customer identification
Both are implemented by financial institutions to comply with government guidelines KYC represents one aspect of larger AML procedures

The Takeaway

KYC, or know your customer, is a regulation that helps financial institutions prevent fraud by their customers. KYC involves constant check-ups and ongoing measures to ensure customer information and account profiles are kept up-to-date.

Wherever you decide to bank, know that teams are likely to be at work, ensuring compliance with KYC regulations.

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Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

What is a KYC procedure in banking?

KYC procedures in banking are regulations that involve a financial institution verifying potential clients’ identities and backgrounds and monitoring their activity if they become customers. This can be a part of the bank ensuring that it’s not being used in criminal activity such as money laundering.

Do all banks require KYC?

Yes. FinCen, or the US Financial Crimes Enforcement Network, requires financial institutions and their customers to adhere to KYC regulations.

Why is KYC mandatory in banks?

KYC is an important measure as banks work to know their customers and make sure accounts are not being used for illegal purposes. KYC regulations are one way that the government seeks to prevent money laundering and terrorism financing.

Photo credit: iStock/Andrii Yalanskyi

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Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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

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Aug
10
2023
Investing in the EV Market (Beyond Just Tesla)

How to Invest in EV Stocks

By | Growing Wealth, invest, Investing | Comments Off on How to Invest in EV Stocks

Electric vehicles (EV) have become increasingly popular since the first Tesla (TSLA) Roadster hit the highways in 2008. And as the technology matures, many investors see opportunity. The EV market has expanded well beyond Tesla to become a core strategy for automakers worldwide.

The explosion of the EVs has also created new downstream technologies, such as new batteries, charging stations, and other infrastructure.

The History of Electric Vehicles

The concept of a battery-powered automobile goes back to the 1800s. But gasoline-powered cars, including the Ford (F) Model T gasoline-powered were cheaper, and won over drivers for all of the 20th century. The tide began to turn toward the end of the 20th century, as a result of heightened environmental concerns from both drivers and the federal government.

The government encouraged the development and purchase of EVs by instituting a series of generous tax breaks. The Energy Improvement and Extension Act of 2008 offered drivers tax credits for new plug-in electric vehicles. The American Clean Energy and Security Act of 2009 also had provisions calling for the improved infrastructure for EVs.

In 2011, President Barack Obama set a goal for the United States to have a million electric vehicles on the road by 2015, and pledged $2.4 billion in federal grants to pay for the development of new EVs and batteries. Subsequent tax breaks and grants over the next five years further increased the government’s investment in EVs, as well as the related technologies and infrastructure.

That windfall supported the research and development of companies like Tesla, which took in an estimated $2.4 billion via 109 separate government grants. Tesla used that money to create eye-popping, technologically advanced cars, as well as new battery technology that increased their horsepower and their range. Drivers clamored for the new vehicle, and Tesla’s stock boomed — going from $86 at the end of 2019 to $705 by the end of 2020. As of mid-July 2023, Tesla stock was $281.38.

This incredible success story has both institutional and retail investors looking for the next Tesla, as more drivers shift to EVs and companies dedicate resources to building them.

EV investment may be more of a long-term play, rather than a day trading strategy, since it can take up to five years for automakers to design, produce, and bring to market an electric vehicle. They’re also still generally more expensive than gasoline-powered vehicles and prices may need to fall further before widespread adoption occurs. Still, President Biden announced a goal of having 50% of new vehicles electric-powered by 2030.


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EV Stocks: Automakers Who Could Challenge Tesla

Tesla is a clear leader in the EV market. It has the brand name and the incredible sales figures, plus it only makes EVs. While Tesla made a large splash in the auto industry, that industry has massive resources with which to respond, and they’re spending billions in capital expenditures to catch up.

Here are just a few major competitors who could be strong EV investments in the future.

Volkswagen

The world’s largest automaker, Volkswagen (VLKAF), which also owns the Audi and Porsche brands, sold 572,100 EVs in 2022, an increase of 26% from the year before. And Volkswagen has big plans for the EV space. The company says that by 2030, every second car the Volkswagen Group delivers is expected to be all electric.

Ford

Ford is investing $50 billion globally in electric vehicles through 2026. It plans to manufacture 600,000 EVs by the end of 2023, and 2 million by 2026. In 2022, Ford was the number two EV brand in the U.S.

General Motors

Big Detroit competitor GM (GM) is going all in on EVs, publicly stating that it’s “on its way to an all-electric future.” GM also announced that it will invest $35 billion in EVs and autonomous vehicles by 2025.

Honda

In Japan, Honda Motor Co. (HMC) announced that it would invest at least $40 billion through 2030 in order to make EV and hybrid vehicles 40% of its sales. It’s worth noting that the company is also working with GM to bring two new EVs to market in 2024.

Toyota

Toyota (TM) has been more cautious about EVs. However, in 2023, the automaker announced that it would significantly boost EV production, including 1.5 million EV sales annually by 2026, and introduce 10 new models in the U.S. and China. Toyota also said it would invest an additional $7.5 billion in EV development and production by the end of 2030.

NIO

A pure-play EV manufacturer based in China, NIO (NIO) is small, but growing. In June 2023, the company announced that it had gotten $738.5 billion in capital from a fund owned by the government of Abu Dhabi. NIO has eight EVs on its advanced EV platform known as NIO Technology 2.0. The company plans to double its EV sales in 2023.

Apple

There are also persistent rumors that Apple (AAPL) has been working on an electric vehicle since 2014. In late 2022, there were reports that the launch of the EV might come in 2026. Given the company’s deep pockets, brand reputation, and its history of game-changing design, it could make a giant splash when and if it does launch its first EV.


💡 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.

Downstream Technologies

Electric car companies aren’t the only way to invest in EV technology. Having so many new EVs on the road also opens up new investment opportunities from EV battery stocks to charging stations.

For one thing, drivers will have to charge their vehicles somewhere. And those investors will have some help from the federal government, with President Joseph Biden publicly committing to building a national network of 500,000 charging stations by 2030, including a $5 billion initiative to build charging stations on major highways from coast to coast.

Blink Charging

One charging station investment is Blink Charging (BLNK), which already has thousands of its EV chargers up and running across the United States. Its chargers are typically located near airports, hotels and healthcare facilities, where it rents space from the host locations.

ChargePoint

ChargePoint (CHPT) has been in business since 2007, and made a splash in 2017, when it took over General Electric’s 9,800 electric vehicle charging spots. It now manages more than 174,000 charging stations around the world. It also boasts a large patent portfolio.

Royal Dutch Shell

Oil company Royal Dutch Shell (RDS.A) may even deserve a look, as it plans to have around 200,000 EV charging stations globally by 2030.

Recommended: How and Why to Invest in Oil

SPACs

Because it is such a fast-growing field, there are also a number of shell companies and special purpose acquisition companies (SPACs) devoted to companies that create and manage EV-charging technology.

Recommended: A Guide to High-Risk Stocks

The Takeaway

As the automotive industry transforms, there are a host of new opportunities for major companies, new startups — and also for investors. To consider investing in EV companies you’ll need to do your own research to decide which stocks fit into your portfolio strategy. You can also get exposure to electric vehicles without investing in individual stocks by investing in mutual funds or exchange-traded funds that focus on EVs.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


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

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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.
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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

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