Sep
02
2025
What is a Cash Account? Margin vs Cash Account

Cash Account vs Margin Account: Key Differences

By | Growing Wealth, invest, Investing | Comments Off on Cash Account vs Margin Account: Key Differences

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

A cash account requires the use of cash to buy and sell securities, whereas a margin account enables traders to borrow funds (also known as using leverage) to take bigger positions.

Trading on margin is effectively a way of taking out a loan from the brokerage, which must be repaid with interest. Investors must qualify to open a margin account; these are not available to all investors as using leverage increases the level of investment risk.

There are reasons for choosing either account, and it’s important for investors to understand them both in order to make the best decision for their own financial goals.

Key Points

•   A cash account permits the use of cash to buy securities.

•   A margin account permits qualified investors to borrow funds to take bigger positions.

•   Margin can amplify returns as well as losses, so the risk level is higher.

•   Margin loans must be repaid, with interest.

•   In addition, margin accounts are tightly regulated, and investors must be approved to use margin.

What Is a Cash Account?

A cash account is an investment account with a brokerage firm that requires investors to purchase securities using the cash balance in that account at the time of settlement. With a cash account, investors can’t borrow money from the broker, and they can’t take short positions on margin.

Securities trades in a cash account now settle in one business day (T+1), according to Securities and Exchange Commission (SEC) rules that took effect in 2024.

How Does a Cash Account Work?

Cash accounts allow both institutional and retail investors to buy securities using whatever amount of money they put into their account. For instance, if an investor deposits $3,000 into their account, they can purchase $3,000 worth of securities.

Pros and Cons of a Cash Account

The main advantage of a cash account is that investors can’t go into debt to their broker using one, as they might with a margin account. They have no borrowing ability, and thus, can only lose the amount they trade. Using a cash account to buy stocks online or through a traditional broker can provide a much simpler experience for beginner investors as well.

As for the downsides, a cash account does not allow investors to utilize leverage (as they would with a margin account) to potentially take bigger positions. Investors are more or less tied to their cash balance, and may be limited in what they can do without using margin.

Cash Account Regulations to Be Aware Of

There are several regulations that investors should keep in mind when it comes to cash accounts.

Cash Liquidation Violations

Trades generally take one business day to settle, so investors should always sell securities before purchasing new ones if they are using that money for the purchase. If there is not enough cash in the account to pay for a purchase, this is called a “cash liquidation violation,” under Regulation T.

While Reg T primarily regulates margin accounts, it also prohibits certain activity in cash accounts. For example, an investor cannot use a cash account to buy a stock then sell it before the trade settles.

Good Faith Violation

A Good Faith Violation occurs when an investor buys a security, buys another security, then sells it to cover the first purchase when they don’t have enough cash in their account to cover the purchase.

Freeriding Violation

In this type of violation, an investor doesn’t have cash in their account, and they attempt to purchase a security by selling the same security.

A Benefit of a Cash Account: Lending

One benefit of cash accounts is that investors can choose to lend money from their account to hedge funds, short sellers, and other types of investors. The account holder can earn interest or income from lending, known as securities lending or shares lending.

If a cash account holder wants to lend out cash or shares, they can let their broker know, and the broker will provide them with a quote on what borrowers will pay them. Securities that earn the highest interest rates are those in low supply and high demand for borrowers who are trading stocks.

These tend to be securities with a lower trading volume or market capitalization. If an investor lends shares of securities, they can earn interest while continuing to hold the security and earn on it as it increases in value. Account holders may need to meet minimum lending requirements.

What Is a Margin Account and How Does It Work?

Using a margin account, an investor can deposit cash, and they can also borrow money from their broker. This allows investors to use leverage to buy larger amounts of securities than a cash account allows. But if the value of the trade goes down, the investor will face a loss, plus they have to repay the margin loan.

Margin accounts also charge interest, so any securities purchased need to increase above the interest amount for the investor to start seeing a profit. Different brokers charge different interest rates, so it’s a good idea for investors to compare before choosing an account.

Usually there is no deadline to repay a margin loan, but the debt accrues interest each month, so the longer an investor waits, the more they owe. The securities held in the account act as collateral for the margin loan, so if needed they can be used to pay it off.

Recommended: What Is Margin Trading?

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Margin Account Requirements

Other requirements generally associated with margin accounts include the following:

Minimum Margin

Investors must deposit a minimum amount of cash into their account before they can start investing and borrowing. Each broker may have a different minimum, but the Financial Industry Regulatory Authority (FINRA) requires investors to have either $2,000 or 100% of the purchase amount of any securities the investor wants to buy on margin, whichever amount is lower.

Initial Margin

Under Regulation T (Reg T), which serves to limit how much investors may borrow in a margin account, investors can only borrow up to 50% of the purchase amount of securities they want to buy. For example, if an investor with $3,000 in their account wishes to purchase $6,000 worth of securities, they would be able to borrow the additional $3,000.

Maintenance Margin

Both before and after purchasing securities, investors must hold a certain amount in their account as collateral — known as maintenance margin. The investor must own at least 25% of the assets (cash or securities) in their account when they have taken out a margin loan.

If the amount in the account dips below this level, the investor may receive a margin call, requiring them to either deposit more cash into their account or sell some of their securities. This could occur if the investor withdraws too much from their account or if the value of their investments decreases. This is one of the main risks of margin accounts.

Margin Account vs Cash Account

There are some similarities between margin accounts and cash accounts, but there are some key differences in terms of the monetary requirements that investors should consider when choosing which type of brokerage account works best for them.

The type of account you choose will have an impact on the amount of money you’re able to invest, and the risk level that accompanies it.

The accounts can be equated to a debit card vs. a credit card. A debit card requires the user to have funds available in their account to pay for anything they buy, while a credit card allows a user to spend and pay back the expense later.

Similarities Between Margin and Cash Accounts

Both are brokerage accounts that allow investors to purchase securities, bonds, certain mutual funds, stocks, and other assets in addition to holding cash. (You typically can’t have a margin account in a retirement account such as an IRA or Roth IRA.)

Differences Between Margin and Cash Accounts

Margin accounts allow investors to borrow from their broker and typically require a minimum deposit to get started investing, while cash accounts don’t. However, margin accounts usually don’t come with additional fees.

On the other hand, cash account holders may only purchase securities with cash or settled funds, and cash accounts don’t allow short selling, or shorting stocks.

Should You Choose a Margin Account or a Cash Account?

Although being able to borrow money with a margin account has benefits in terms of potential gains, it is also risky. Cash accounts tend to be easier to maintain.

Reasons to Consider a Cash Account

•  For this reason, cash accounts may provide an option for beginner investors, who may find it easier to invest only the money they have. For example, with a cash account, the value of securities can rise and fall, and the investor doesn’t have to deposit any additional funds into their account or sell securities at a loss.

•  Cash accounts may be an option for long-term investors, since investments in a margin account may go down and force the investor to have to sell some of them or deposit cash to maintain a high enough balance in their account. This could result in an investor being forced to sell a security at a loss and missing its potential price recovery.

•  Investors may also choose a cash account if they want to “set it and forget it,” meaning they invest in securities that they don’t want to keep an eye on all the time since they will never owe the broker more money than they invested — as discussed.

The risk level on a cash account will always be lower than with a margin account, and there are less risky ways to increase returns than by using margin.

Reasons to Consider a Margin Account

On the other hand, for investors interested in day trading, margin accounts may be a great choice, since they allow the investor to double their purchasing power. They also allow investors to short trade. Margin account holders can borrow money to withdraw to pay for any life expenses that need to be paid off in a rush.

Since there is no deadline to pay off the loan, the investor can pay it back when they can, unless the value of the stocks fall. Traders can also borrow money to buy stocks when the market is down or to help prevent paying capital gains taxes, but this requires more experience and market knowledge.

Margin accounts provide flexibility for investors, who can choose to use them in exactly the same way as a cash account.

The Takeaway

The main difference between cash accounts and margin accounts is that margin accounts allow investors to borrow money from their brokers, amplifying potential trades and risk. This can have advantages and disadvantages, and depending on their specific strategy and goals, investors should consider these before deciding to use one or the other.

Both cash and margin accounts are commonplace in the investing space, and investors are likely to run across both — and figure out which is a best fit for their strategy. It may be beneficial to speak with a financial professional for guidance.

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.

FAQ

Can you trade options on cash and margin accounts?

Yes, but advanced options trading strategies require a margin account to trade. For example, buying options may not require margin because the main risk is losing the premium paid, but selling certain types of options may require margin as collateral.

Should a beginner use a cash or margin account?

It may be more straightforward for a beginner to start out using a cash account to invest, as they’re simpler and involve less risk than a margin account. If a beginner uses a margin account without a proper understanding of margin, they could find themselves owing their broker money.

Can you have a cash account and a margin account at the same time?

Yes, you can have cash and margin accounts at the same time, often at the same brokerage. It’s possible to also have different types of accounts at different brokerages or on different investment platforms.

Photo credit: iStock/PeopleImages

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.

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.

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

SOIN-Q325-107

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Aug
20
2025
Should I Use a Dividend Reinvestment Plan?

Dividend Reinvestment Plans: How DRIP Investing Works

By | Growing Wealth, Investing | No Comments

When investors hold dividend-paying securities, they may want to consider using a dividend reinvestment plan, or DRIP, which automatically reinvests cash dividends into additional shares, or fractional shares, of the same security.

Using a dividend reinvestment strategy can help acquire more dividend-paying shares, which can add to potential compound gains. But companies are not obligated to keep paying dividends, so there are risks.

It’s also possible to keep the cash dividends to spend or save, or use them to buy shares of a different stock. If you’re wondering whether to use a dividend reinvestment program, it helps to know the pros and cons.

Key Points

•   Dividend reinvestment plans (DRIPs) allow investors to reinvest cash dividends into more shares of the same securities.

•   DRIPs can be offered by companies or through brokerages, with potential discounts on share prices, or no commissions.

•   There are two types of DRIPs: company-operated DRIPs and DRIPs through brokerages.

•   Reinvesting dividends through a DRIP may lead to greater long-term returns due to compounding.

•   However, DRIPs have limitations, such as tying up cash, risk exposure, and limited flexibility in choosing where to reinvest funds.

What Is Dividend Reinvestment?

Dividend reinvestment plans typically use the cash dividends you receive to purchase additional shares of stock in the same company, rather than taking the dividend as a payout.

When you initially buy a share of dividend-paying stock, or shares of a mutual fund that pays dividends, you typically have the option of choosing whether you’d want to reinvest your dividends automatically to buy stocks or more shares, or take them as cash.

Numerous companies, funds, and brokerages offer DRIPs to shareholders. And reinvesting dividends through a DRIP may come with a discount on share prices, for example, or no commissions.

Recommended: Dividends: What They Are and How They Work

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What Is a Dividend Reinvestment Plan?

Depending on which securities you invest in, you may have the option to enroll in a Dividend Reinvestment Plan or DRIP. This type of plan, offered by numerous companies and brokerages, allows you to automatically reinvest dividends as they’re paid out into additional shares of stock.

Note that some brokerages offer what’s called synthetic DRIPs: meaning, even if the company itself doesn’t offer a dividend reinvestment program, the brokerage may enable you to reinvest dividends automatically in the same company stock.

How DRIPs Help Build Wealth Over Time

Reinvesting dividends can, in some cases, help build wealth over time.

•   The shares purchased using the DRIP plan are bought without a commission, and sometimes at a slight discount to the market price per share, which can lower the cost basis and potentially add to gains.

•   Using a dividend reinvestment plan effectively offers a type of compounding, because buying new shares will provide more dividends as well, which can again be reinvested.

That said, shares bought through a DRIP plan cannot be traded like other shares in the market; they must be sold back to the company.

In that sense, investors should bear in mind that participating in a dividend reinvestment plan also benefits the company, by providing it with additional capital. If your current investment in the company is aligned with your financial goals, there may be no reason to reinvest dividends in additional shares, and risk being overweight in a certain company or sector.


💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Types of Dividend Reinvestment Plans

There are two main types of dividend reinvestment plans. They are:

Company DRIPs

With this type of plan, the company operates its own DRIP as a program that’s offered to shareholders. Investors who choose to participate simply purchase the shares directly from the company, and DRIP shares can be offered to them at a discounted price.

Some companies allow investors to do full or partial reinvestment, or to purchase fractional shares.

DRIPs through a brokerage

Many brokerages also provide dividend reinvestment as well. Investors can set up their brokerage account to automatically reinvest in shares they own that pay dividends.

Partial DRIPs

In some cases a company or brokerage may allow investors to reinvest some of their dividends and take some in cash to be used for other purposes. This might be called a partial DRIP plan.

DRIP Example

Here’s a dividend reinvestment example that illustrates how a company-operated DRIP works.

If you own 20 shares of a stock that has a current trading value of $100 per share, and the company announces that it will pay $10 in dividends per share of stock, then the company would pay you $200 in dividends that year.

If you choose to reinvest the dividends, you would own 22 shares of that stock ($200 in dividends/$100 of current trading value = 2 new shares of stock added to your original 20). These new shares would also pay dividends.

If, instead, you wanted cash, then you’d receive $200 to spend or save, and you’d still have the initial 20 shares of the stock.

If you wanted to reinvest part of your dividends through the DRIP plan, you might be able to purchase one share of stock for $100, and take $100 in cash. Again, not all companies offer flexible options like this, so it’s best to check.

Long-Term Compounding With DRIPs

Again, reinvesting dividends in additional company shares can create a compounding effect: The investor acquires more shares that also pay dividends, which can then be taken as cash or reinvested once again in more shares of the same company.

That said, there are no guarantees, as companies are not required to pay dividends. In times of economic distress, some companies suspend dividend payouts.

In addition, if the value of the stock declines, or it no longer makes sense to keep this position in your portfolio, long-term compounding may seem less appealing.

Pros and Cons of DRIPs

If you’re wondering whether to reinvest your dividends, it’s a good idea to weigh the advantages and disadvantages of DRIPs.

Pros of Dividend Reinvestment Plans

One reason to reinvest your dividends is that it may help to position you for higher long-term returns, thanks to the power of compounding returns, which may hold true whether investing through a company-operated DRIP, or one through a brokerage.

Generally, if a company pays the same dividend amount each year and you take your dividends in cash, then you’ll keep getting the same amount in dividends each year (assuming you don’t buy any additional shares).

But if you take your dividends and reinvest them through a DRIP, then you’ll have more shares of stock next year, and then more the year after that. Over a period of time, the dividend amount you might receive during subsequent payouts could also increase.

An important caveat, however: Stock prices aren’t likely to stay exactly the same for an extended period of time.

Plus, there’s no guarantee that dividends will be paid out each period; and even if they are, there is no way to know for sure how much they’ll be. The performance of the company and the general economy can have a significant impact on company profitability and, therefore, typically affect dividends given to shareholders.

There are more benefits associated with DRIPs:

•   You may get a discount: Discounts on DRIP shares can be anywhere from 1% to 10%, depending on the type of DRIP (company-operated) and the specific company.

•   Zero commission: Most company-operated DRIP programs may allow you to buy new shares without paying commission fees. However, many brokerages offer zero-commission trading outside of DRIPs these days, too.

•   Fractional shares: DRIPs may allow you to reinvest and purchase fractional shares, rather than whole shares that may be at a pricier level than you wish to purchase. This may be an option with either a company-operated or brokerage-operated DRIP.

•   Dollar-cost averaging: Dollar-cost averaging is a strategy investors use to help manage price volatility, and lower their cost basis. You invest the same amount of money on a regular basis (every week, month, quarter) no matter what the price of the asset is.

Cons of Dividend Reinvestment Plans

Dividend reinvestment plans also come with some potential negatives.

•   The cash is tied up. First, reinvesting dividends puts that money out of reach if you need it. That can be a downside if you want or need the money for, say, home improvements, a tuition bill, or an upcoming vacation.

•   Risk exposure. There are a few potential risk factors of reinvesting dividends, including being overweight in a certain sector, or locking up cash in a company that may underperform.

If you’ve been reinvesting your dividends, and the stock portion of your portfolio has grown, using a DRIP could inadvertently put your allocation further out of whack, and you may need to rebalance your portfolio.

•   Flexibility concerns. Another possible drawback to consider is that when your dividends are automatically reinvested through a DRIP, they will go right back into shares of stock in the company or fund that issued the dividend.

Though some company-operated DRIPs do give investors options (such as full or partial reinvestment), that’s not always the case.

•   Less liquidity. When you use a company-operated DRIP, and later wish to sell those shares, you must sell them back to the company or fund, in many cases. DRIP shares cannot be sold on exchanges. Again, this will depend on the specific company and DRIP, but is something investors should keep in mind.



💡 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.

Cash vs Reinvested Dividends

Should I reinvest dividends or take cash instead? How you approach this question can depend on several things, including:

•   Your short-term financial goals

•   Long-term financial goals

•   Income needs

Taking dividends in cash can provide you with ongoing income. That may be important to you if you’re looking for a way to supplement your paychecks during your working years, or for other income sources if you’re already retired.

As mentioned earlier, you could use that cash income to further a number of financial goals. For instance, you might use cash dividend payouts to pay off debt, fund home improvements or put your kids through college. Or you may use it to help pay for long-term care during your later years.

Cash may also be more attractive if you’re comfortable with your current portfolio configuration and don’t want to purchase additional shares of the dividend stocks you already own.

On the other hand, reinvesting dividends automatically through a DRIP could help you to increase your savings for retirement. This assumes, of course, that your investments perform well and that the shares you own don’t decrease or eliminate their dividend payout over time.

Tax Consequences of Dividends

One thing to keep in mind is that dividends — whether you cash them out or reinvest them — are not free money. Dividend income is taxed in the year they’re paid to you (unless the dividend-paying investment is held in a tax-deferred account such as an IRA or 401(k) retirement account).

•   Qualified dividends are taxed at the more favorable capital gains rate.

•   Non-qualified, or ordinary dividends are taxed as income.

Each year, you’ll receive a tax form called a 1099-DIV for each investment that paid you dividends, and these forms will help you to determine how much you owe in taxes on those earnings.

Dividends are considered taxable whether you take them in cash or reinvest them through a DRIP. The value of the reinvestment is considered taxable.

The exception to that rule is for funds invested in retirement accounts, such as an online IRA, as the money invested in these accounts is tax-deferred. If you have received or believe you may receive dividends this year, it can make sense to get professional tax advice to see how you can minimize your tax liability.

How DRIPs Affect Cost Basis

When dividends are reinvested to buy more shares of the same security, the DRIP creates a new tax lot. This can make calculating the total cost basis of your share holding more complicated. It may be worth considering working with a professional in that case, to ensure that you end up paying the right amount of tax when you sell shares.

The complexity around calculating the cost basis is another reason some investors reinvest dividends within tax-deferred accounts. In this case, the overall cost basis doesn’t matter, as withdrawals from a tax-deferred account — such as a traditional IRA or 401(k) — would be simply taxed as income.

Should You Reinvest Dividends?

Reinvesting dividends through a dividend reinvestment plan is partly a short-term decision, and mostly a long-term one.

Factors to Consider Before Reinvesting

If you need the cash from the dividend payouts in the near term, or have doubts about the market or the company you’d be reinvesting in (or you’d rather purchase another investment), you may not want to use a DRIP.

If on the other hand you don’t have an immediate need for the cash, and you can see the value of compounding the growth of your shares in the company over the long haul, reinvesting dividends could make sense.

If taxes are a concern, it might be wise to consider the location of your dividend-paying shares.

The Takeaway

Using a dividend reinvestment plan (DRIP) is a strategy investors can use to take their dividend payouts and purchase more shares of the company’s stock. However, it’s important to consider all the scenarios before you decide to surrender your cash dividends to an automatic reinvestment plan.

While there is the potential for compound growth, and using a DRIP may allow you to purchase shares at a discount and with no transaction fees, these dividend reinvestment plans are limiting. You are locked into that company’s stock during a certain market period, and even if you decided to sell, you wouldn’t be able to sell DRIP shares on any exchange but back to the company.

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.

FAQ

How do you set up a dividend reinvestment plan?

There are two ways to set up a dividend reinvestment plan. First, you can set up an automatic dividend reinvestment plan with the company or fund whose shares you own. Or you can set up automatic dividend reinvestment through a brokerage. Either way, all dividends paid for the stock will automatically be reinvested into more shares of the same stock.

Can you calculate dividend reinvestment rates?

There is a very complicated formula you can use to calculate dividend reinvestment rates, but it’s typically much easier to use an online dividend reinvestment calculator instead.

What’s the difference between a stock dividend and a dividend reinvestment plan?

A stock dividend is a payment made from a company to its shareholders (people who own shares of their company’s stock). A dividend reinvestment plan allows investors to reinvest the cash dividends they receive from their stocks into more shares of that stock.

Are dividend reinvestments taxed?

Yes, dividend reinvestments are taxed as income in the case of ordinary dividends. Qualified dividends are taxed at the more favorable capital gains rate. Dividends are subject to tax, even when you don’t take the cash but reinvest the payout in an equivalent amount of stock.

What are the benefits of using DRIPs for long-term investing?

One potential benefit of using a DRIP long term is that there may be a compounding effect over time, because you’re buying more shares, which also pay dividends, which can also be reinvested in more shares. This strategy could prove risky, however, if the company suspends dividends or if you become overweight in that company or sector.

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.

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Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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

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SOIN-Q325-059

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Aug
11
2025
Cyclical vs. Non-Cyclical Stocks: Investing Around Economic Cycles

Cyclical vs Non-Cyclical Stocks: Investing Around Economic Cycles

By | Growing Wealth, invest, Investing | Comments Off on Cyclical vs Non-Cyclical Stocks: Investing Around Economic Cycles

Cyclical investing means understanding how various stock sectors react to economic changes. A cyclical stock is one that’s closely correlated to what’s happening with the economy at any given time. The performance of non-cyclical stocks, however, is typically not as closely tied to economic movements.

Investing in cyclical stocks and non-cyclical stocks may help to provide balance and diversification in a portfolio. This in turn may help investors to better manage risk as the economy moves through different cycles of growth and contraction.

Key Points

•   Cyclical stocks tend to perform well during periods of economic growth, while non-cyclical stocks may thrive during economic contractions.

•   Cyclical stocks exhibit higher volatility and sensitivity to economic changes.

•   Non-cyclical stocks focus on essential goods, which may offer stability regardless of market conditions.

•   Economic cycles include expansion, peak, contraction, and trough phases.

•   Cyclical investing strategies may involve sector rotation and regular reallocation.

Cyclical vs Non-Cyclical Stocks

There are some clear differences between cyclical vs. non-cyclical stocks, as outlined:

Cyclical Stocks

 Non-Cyclical Stocks
May Perform Best During Economic growth Economic contraction
Goods and Services Non-essential Essential
Sensitivity to Economic Cycles Higher Lower
Volatility Higher Lower

A cyclical investing strategy can involve choosing both cyclical and non-cyclical stocks. In terms of how they react to economic changes, they’re virtual opposites.

Cyclical stocks are characterized as being:

•   Strong performers during periods of economic growth

•   Associated with goods or services consumers tend to spend more money on during growth periods

•   Highly sensitive to shifting economic cycles

•   More volatile than non-cyclical stocks

When the economy is doing well a cyclical stock tends to follow suit. Share prices may increase, along with profitability. If a cyclical stock pays dividends, that can result in a higher dividend yield for investors.

Non-cyclical stocks, on the other hand, share these characteristics:

•   Tend to (but don’t always) perform well during periods of economic contraction

•   Associated with goods or services that consumers consider essential

•   Less sensitive to changing economic environments

•   Lower volatility overall

A non-cyclical stock isn’t completely immune from the effects of a slowing economy. But compared to cyclical stocks, they’re typically less of a roller-coaster ride for investors in terms of how they perform during upturns or downturns. A good example of a non-cyclical industry is utilities, since people need to keep the lights on and the water running even during economic downturns.


💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Cyclical Stocks

In the simplest terms, cyclical stocks are stocks that closely follow the movements of the economic cycle. The economy is not static; instead, it moves through various cycles. There are four stages to the economic cycle:

•   Expansion. At this stage, the economy is in growth mode, with new jobs being created and company profits increasing. This phase can last for several years.

•   Peak. In the peak stage of the economic cycle, growth begins to hit a plateau. Inflation may begin to increase at this stage.

•   Contraction. During a period of contraction, the economy shrinks rather than grows. Unemployment rates may increase, though inflation may be on the decline. The length of a contraction period can depend on the circumstances which lead to it.

•   Trough. The trough period is the lowest point in the economic cycle and is a precursor to the beginning of a new phase of expansion.

Understanding the various stages of the economic cycle is key to answering the question of what are cyclical stocks. For example, a cyclical stock may perform well when the economy is booming. But if the economy enters a downturn, that same stock might decline as well.

Examples of Cyclical Industry Stocks

Cyclical stocks most often represent companies that make or provide things that consumers spend money on when they have more discretionary income.

For example, that includes things like:

•   Entertainment companies

•   Travel websites

•   Airlines

•   Retail stores

•   Concert promoters

•   Technology companies

•   Car manufacturers

•   Restaurants

The industries range from travel and tourism to consumer goods. But they share a common thread, in terms of how their stocks tend to perform during economic highs and lows.

Examples of Non-Cyclical Industry Stocks

Non-cyclical industry stocks would be shares of companies that are more insulated from economic downturns than their cyclical counterparts. It may be easier to think of them as companies that are probably going to see sales no matter what is happening in the overall economy. That might include:

•   Food producers and grocers

•   Consumer staples

•   Gasoline and energy companies

Cyclical Stock Sectors

The stock market is divided into 11 sectors, each of which represents a variety of industries and sub-industries. Some are cyclical sectors, while others are non-cyclical. The cyclical sectors include:

Consumer Discretionary

The consumer discretionary sector includes stocks that are related to “non-essential” goods and services. So some of the companies you might find in this sector include those in the hospitality or tourism industries, retailers, media companies and apparel companies. This sector is cyclical because consumers tend to spend less in these areas when the economy contracts.

Financials

The financial sector spans companies that are related to financial services in some way. That includes banking, financial advisory services and insurance. Financials can take a hit during an economic downturn if interest rates fall, since that can reduce profits from loans or lines of credit.

Industrials

The industrial sector covers companies that are involved in the production, manufacture or distribution of goods. Construction companies and auto-makers fall into this category and generally do well during periods of growth when consumers spend more on homes or cars.

Information Technology

The tech stock sector is one of the largest cyclical sectors, covering companies that are involved in everything from the development of new technology to the manufacture and sale of computer hardware and software. This sector can decline during economic slowdowns if consumers cut back spending on electronics or tech.

Materials

The materials sector includes industries and companies that are involved in the sourcing, development or distribution of raw materials. That can include things like lumber and chemicals, as well as investing in precious metals. Stocks in this sector can also be referred to as commodities.

Cyclical Investing Strategies

Investing in cyclical stocks or non-cyclical stocks requires some knowledge about how each one works, depending on what’s happening with the economy. While timing the market is virtually impossible, it’s possible to invest cyclically so that one is potentially making gains while minimizing losses as the economy changes.

For investors interested in cyclical investing, it helps to consider things like:

•   Which cyclical and non-cyclical sectors you want to gain exposure to

•   How individual stocks within those sectors tend to perform when the economy is growing or contracting

•   How long you plan to hold on to individual stocks

•   Your risk tolerance and risk capacity (i.e. the amount of risk you’re comfortable with versus the amount of risk you need to take to realize your target returns)

•   Where the economy is, in terms of expansion, peak, contraction, or trough

For example, swing trading is one strategy an experienced investor might employ to try and capitalize on market movements. With swing trading, you’re investing over shorter time periods to attempt to see gains from swings in stock prices. Short-term trading, however, is considered high risk given the potential for seeing losses, and requires investors to be familiar with risk mitigation strategies. Swing trading relies on technical analysis to help identify trends in stock pricing, though you may also choose to consider a company’s fundamentals if you’re interested in investing for the longer term.

How to Invest in Cyclical Stocks

Investors can invest in cyclical stocks the same way they do any other type of stock: Purchasing them through a brokerage account, or from an exchange.

One way to simplify cyclical investing is to choose one or more cyclical and non-cyclical exchange-traded funds (ETFs). Investing in ETFs can simplify diversification and may help to mitigate some of the risk of owning stocks through various economic cycles.

Recommended: How to Trade ETFs: A Guide for Retail Investors

The Takeaway

Cyclical stocks tend to follow the economic cycle, rising in value when the economy is booming, then dropping when the economy hits a downturn. Non-cyclical stocks, on the other hand, tend to behave the opposite way, and aren’t necessarily as affected by the overall economy.

Investing around economic cycles can be a viable strategy, but it has its potential pitfalls. Investors who do their homework may be able to successfully invest around economic cycles, but it’s important to consider the risks involved.

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).

¹Opening and funding an Active Invest account gives you the opportunity to get up to $3,000 in the stock of your choice.

FAQ

What are indicators of cyclical stocks?

A few examples of indicators of cyclical stocks include the earnings per share data reported by public companies, which can give insight into the health of the economy, along with beta (a measure of volatility of returns) and price-to-earnings ratios.

What is the difference between cyclicality vs seasonality?

While similar, cyclicality and seasonality differ in their frequency. Seasonality refers to events or trends that are observed annually, or every year, whereas cyclicality, or cyclical variations, can occur much less often than that.

How do you mitigate the risk of investing in cyclical stocks?

Investors can use numerous strategies to help mitigate the risk of investing in cyclical stocks, such as sector rotation and dollar-cost averaging.

Photo credit: iStock/Eoneren

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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 emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.

Dollar Cost Averaging (DCA): Dollar cost averaging is an investment strategy that involves regularly investing a fixed amount of money, regardless of market conditions. This approach can help reduce the impact of market volatility and lower the average cost per share over time. However, it does not guarantee a profit or protect against losses in declining markets. Investors should consider their financial goals, risk tolerance, and market conditions when deciding whether to use dollar cost averaging. Past performance is not indicative of future results. You should consult with a financial advisor to determine if this strategy is appropriate for your individual circumstances.

¹Claw Promotion: Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

SOIN-Q325-035

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Aug
08
2025
colorful chart

How to Invest in Emerging Markets

By | Financial Independence, Growing Wealth, invest, Investing, Terminology | Comments Off on How to Invest in Emerging Markets

Emerging markets or emerging market economies (EMEs) are in the process of achieving the building blocks of developed nations: they’re establishing regulatory bodies, creating infrastructure, fostering political stability, and supporting mature financial markets. But many emerging markets still face challenges that developed market countries have overcome, and that contributes to potential instability.

Developed economies have higher standards of living and per-capita income, strong infrastructure, typically stable political systems, and mature capital markets. The U.S., Europe, U.K, and Japan are among the biggest developed nations. India, China, and Brazil are a few of the larger countries that fall into the emerging markets category. Some emerging market economies, like these three, are also key global players — and investors may benefit by understanding the opportunities as well as the potential risks emerging markets present.

Key Points

•   Emerging market economies show rapid growth, rising personal incomes, and increasing GDP, despite lower per-capita income.

•   Political and economic instability, infrastructure, and climate challenges are potential factors to consider.

•   China and India have robust sectors and growing foreign investment potential.

•   Thailand and South Korea offer high growth potential but face potential political instability and other risks.

•   Potential returns and portfolio diversification are advantages, but significant volatility and currency risks exist.

What is an Emerging Market?

In essence, an emerging market refers to an economy that can become a developed, advanced economy soon. And because an emerging market may be a rapidly growing one, it may offer investment potential in certain sectors.

Internationally focused investors tend to see these countries as potential sources of growth because their economies can resemble an established yet still-young startup company. The infrastructure and blueprint for success have been laid out, but things need to evolve before the economy can truly take off and ultimately mature. At the same time, owing to the challenges emerging market economies often face, there are also potential risks when investing in emerging markets.

Investors might bear the brunt of political turmoil, local infrastructure hurdles, a volatile home currency and illiquid capital markets (if certain enterprises are state-run or otherwise privately held, for example).

Emerging Market Examples

What constitutes an emerging market economy is somewhat fluid, and the list can vary depending on the source. Morgan Stanley Capital International (MSCI) classifies 24 countries as emerging; Dow Jones also classifies 24 as emerging. There is some overlap between lists, and some countries may be added or removed as their status changes.

India is one of the world’s biggest emerging economies. Increasingly, though, some investors see India as pushing the bounds of its emerging market status.

China

China is the second-largest economy globally by gross domestic product (GDP). It has a large manufacturing base, plenty of technological innovation, and the largest population of any country in the world.

Yet China still has a few characteristics typical of an emerging market, and with its Communist-led political system, China has embraced many aspects of capitalism in its economy but investors may experience some turbulence related to government laws and policy changes. The Renminbi, China’s official currency, has a history of volatility.

India

India is another big global economy, and it’s considered among the top 10 richest countries in the world, yet India still has a low per-capita income that is typical of an emerging market and poverty is widespread.

At the same time, India was ranked as being among the more advanced emerging markets, thanks to its robust financial system, growing foreign investment, and strong industrials, especially in telecommunication and technology.

Brazil

Brazil is a large country, with more than 200 million people, 26 states, and 5,500 municipalities. In 2024, Brazil’s GDP clocked in at more than 3%, and its economy has grown steadily in recent years, despite hiccups caused by the pandemic.

As the largest country in South America, and one that is continuing to see growth, it’s attracted the attention of some investors. In all, it’s one of a handful of emerging markets, though there are still areas rife with poverty, similar to India.

South Africa

South Africa is the largest economy in Africa, and one of only a handful that has seen a relatively stable macroeconomic environment. It’s a country that has its issues, of course, and some ugly history to contend with — as most countries do. Even so, it’s created a fairly welcoming environment for businesses, and thus, investors.

Mexico

Mexico is another country that ticks all the boxes to qualify as an emerging market, and is a major trading partner with countries like the U.S. Like the aforementioned countries, though, it still has economic weaknesses, and widespread poverty.

Characteristics of an Emerging Market Economy

As noted above, there isn’t a single definition of an emerging market, but there are some markers that distinguish these economies from developed nations.

Fast-Paced Growth

An emerging market economy is often in a state of rapid expansion. There is perhaps no better time to be invested in the growth of a country than when it enters this phase.

At this point, an emerging market has typically laid much of the groundwork necessary for becoming a developed nation. Capital markets and regulatory bodies have been established, personal incomes are rising, innovation is flourishing, and gross domestic product (GDP) is climbing.

Lower Per-Capita Income

The World Bank keeps a record of the gross national income (GNI) of many countries. For the fiscal year of 2025, lower-middle-income economies are defined as having GNI per capita of between $1,146 and $4,515 per year. At the same time, upper-middle-income economies are defined as having GNI per capita between $4,516 and $14,005.

The vast majority of countries that are considered emerging markets fall into the lower-middle and upper-middle-income ranges. For example, India, Pakistan, and the Philippines are lower-middle-income, while China, Brazil, and Mexico are upper-middle-income. Thus, all these countries are referred to as emerging markets despite the considerable differences in their economic progression.

Political and Economic Instability

For most EMEs, volatility is par for the course. Risk and volatility tend to go hand in hand, and both are common among emerging market investments.

Emerging economies can be rife with internal conflicts, political turmoil, and economic upheaval. Some of these countries might see revolutions, political coups, or become targets of sanctions by more powerful developed nations.

Any one of these factors can have an immediate impact on financial markets and the performance of various sectors. Investors need to know the lay of the land when considering which EMEs to invest in.

Infrastructure and Climate

While some EMEs have well-developed infrastructure, many are a mix of sophisticated cities and rural regions that lack technology, services and basic amenities like reliable transportation. This lack of infrastructure can leave emerging markets especially vulnerable to any kind of crisis, whether political or from a natural disaster.

For example, if a country relies on agricultural exports for a significant portion of its trade, a tsunami, hurricane, or earthquake could derail related commerce.

On the other hand, climate challenges may also present investment opportunities that are worth considering.

Currency Crises

The value of a country’s currency is an important factor to keep in mind when considering investing in emerging markets.

Sometimes it can look like stock prices are soaring, but that might not be the case if the currency is declining.

If a stock goes up by 50% in a month, but the national currency declines by 90% during the same period, investors could see a net loss, although they might not recognize it as such until converting gains to their own native currency.

Heavy Reliance on Exports

Emerging market economies tend to rely heavily on exports. That means their economies depend in large part on selling goods and services to other countries.

A developed nation might house all the needs of production within its own shores while also being home to a population with the income necessary to purchase those goods and services. Developing countries, however, must export the bulk of what they create.

Emerging Economies’ Impact on Local Politics vs. Global Economy

Emerging economies play a significant role in the growth of the global economy, accounting for about 50% of the world’s economic growth. Moreover, it’s estimated that by 2050 three countries could represent the biggest economies: the U.S., China, and India, with only one currently being classified as a developed economy.

But, while emerging markets help fuel global growth, some of those with higher growth opportunities also come with turbulent political situations.

As an investor, the political climate of emerging market investments can pose serious risks. Although there is potential for higher returns, especially in EMEs that are in a growth phase, investors should consider the potential downside. For example, Thailand and South Korea are emerging economies with high growth potential, but there is also a lot of political instability in these regions.


💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Pros and Cons of Investing in Emerging Markets

Let’s recap some of the pros and cons associated with EME investments.

Pros

Pros of investing in emerging markets include:

•  High-performance potential: Selecting the right investments in EMEs at the right time may result in returns that might be greater than other investments. Rapidly growing economies could provide opportunity for potential returns. But as noted above, it’s impossible to guarantee the timing of any investment.

•  Global diversification: Investing in EMEs provides a chance to hold assets that go beyond the borders of an investor’s home country. So even if an unforeseen event should happen that contributes to slower domestic growth, it’s possible that investments elsewhere could perform well and provide some balance.

Cons

Cons of investing in emerging markets include:

•  High volatility: As a general rule, investments with higher liquidity and market capitalization tend to be less volatile because it takes significant capital inflows or outflows to move their prices.

EMEs tend to have smaller capital markets combined with ongoing challenges, making them vulnerable to volatility.

•  High risk: With high volatility and uncertainty comes higher risk. What’s more, that risk can’t always be quantified. A situation might be even more unpredictable than it seems if factors coincide (e.g. a drought plus political instability).

All investments carry risk, but EMEs bring with them a host of fresh variables that can twist and turn in unexpected ways.

•  Low accessibility: While liquid capital markets are a characteristic of emerging markets, that liquidity still doesn’t match up to that of developed economies.

It may be necessary to consult with an investment advisor or pursue other means of deploying capital that may be undesirable to some investors.

Why Invest in Emerging Markets?

Emerging markets are generally thought of as high-risk, high-reward investments.

They can provide yet another way to diversify an investment portfolio. Having all of your portfolio invested in the assets of a single country may put you at the mercy of that country’s circumstances. If something goes wrong, like social unrest, a currency crisis, or widespread natural disasters, that might impact your investments.

Being invested in multiple countries may help mitigate the risk of something unexpected happening to any single economy.

The returns from emerging markets could potentially exceed those found elsewhere. If investors can capitalize on the high rate of growth in an emerging market at the right time and avoid any of the potential mishaps, they could stand to profit. Of course timing any market, let alone a more complex and potentially volatile emerging market, may not be a winning strategy.

Strategies for Investing in Emerging Markets

There are a few ways or strategies that investors can utilize to invest in emerging markets, such as buying funds, or buying stocks directly.

Exchange-Traded Funds (ETFs) and Mutual Funds

Investors can look at different exchange-traded funds (ETFs) or mutual funds that comprise assets from emerging markets. Funds may have some degree of built-in diversification, too, within those markets (such as holding different types of assets, or stocks of companies from various industries). This may be a simple way to add exposure to a specific or slate of emerging economies to a portfolio.

Direct Stock Investments

It’s also possible to buy stocks of companies based in various emerging markets. That could entail buying Chinese or Indian stocks, for example, but it’s possible that you may need to buy them over-the-counter (OTC).

Diversification Strategies

If diversification is a chief concern for mitigating risk, then investors may want to look at starting with some emerging market funds that are already diversified to some degree. There are many options out there, and it may also be worth discussing with a financial professional to see what your options are.

The Takeaway

While developed nations like the U.S. and Europe and Japan regularly make headlines as global powerhouses, emerging market countries actually make up a major part of the world’s economy — and possibly, some opportunities for investors. China and India are two of the biggest emerging markets, and not because of their vast populations. They both have maturing financial markets and strong industrial sectors and a great deal of foreign investment. And like other emerging markets, these countries have seen rapid growth in certain sectors (e.g., technology).

Despite their economic stature, though, both countries still face challenges common to many emerging economies, including political turbulence, currency fluctuations and low per-capita income.

It’s factors like these that can contribute to the risks of investing in emerging markets. And yet, emerging markets may also present unique investment opportunities owing to the fact that they are growing rapidly. But investors need to carefully weigh the potential risks.

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).

¹Opening and funding an Active Invest account gives you the opportunity to get up to $3,000 in the stock of your choice.

FAQ

What qualifies as rapid growth to make a market emerging?

Generally, “rapid growth” in reference to an emerging market would take economic growth into account, often measured by GDP. So, if an emerging market is seeing high GDP growth, it may be said to be experiencing rapid growth.

How do emerging markets compare to developed markets from an investing standpoint?

Developed markets are inherently more stable, and investing in those markets may introduce less risk to a portfolio. Emerging markets are generally riskier for a variety of reasons, but could also provide the opportunity to see faster growth, and thus, bigger potential returns. There are no guarantees, however.

Which industries thrive in emerging markets?

It’s possible that industries such as tech, health care, and even renewable energy could thrive in emerging markets, but there are many factors that could stymie their growth, too. Suffice it to say that each market is different, and because an industry thrives in one country doesn’t mean it necessarily would in another.

How can investors gain exposure to emerging markets?

Investors can buy shares of stocks from companies in emerging markets, or even buy shares of funds with significant holdings in those markets.

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.

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

¹Claw Promotion: Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

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

SOIN-Q325-010

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Aug
07
2025
The Risks and Rewards of Naked Options

The Risks and Rewards of Naked Options

By | Financial Independence, Growing Wealth, invest, Investing, Terminology | Comments Off on The Risks and Rewards of Naked Options

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

A naked (or uncovered) option is an option that is issued and sold without the seller owning the underlying asset or reserving the cash needed to meet the obligation of the option if exercised.

While an options writer (or seller) collects a premium upfront for naked options, they also assume the risk of the option being exercised. If exercised, they’re obligated to deliver the underlying securities at the strike price (in the case of a call option) or purchase the underlying securities at the strike price (in the case of a put).

But because a naked writer doesn’t hold the securities or cash to cover the option they wrote, they need to buy the underlying asset on the open market if the option moves into the money and is assigned, making them naked options. Given the extreme risk of naked options, they should only be used by investors with a very high tolerance for risk.

Key Points

•   Naked options involve selling options without owning the underlying asset or reserving cash to cover the trade if the option is exercised.

•   Naked options are extremely high risk due to unlimited potential losses if the market moves against the position.

•   Naked options sellers must have a margin account and meet specific requirements to trade naked options.

•   Naked options strategies include selling calls and puts to try to generate income.

•   Using risk management strategies is essential to try to mitigate the significant risk of loss associated with naked options.

What Is a Naked Option?

When an investor buys an option, they’re buying the right (but not the obligation) to buy or sell a security at a specific price either on or before the option contract’s expiration. An option giving a buyer the right to purchase the underlying asset is known as a “call” option, while an option giving a buyer right to sell the underlying asset is known as a “put” option.

Investors pay a premium to purchase options, while those who sell, or write options, collect the premiums. Some writers hold the stock or the cash equivalent needed to fulfill the contract in case the option is exercised before or on the day it expires. The ones who don’t are sometimes called naked writers, because their options have no cover.

Writing naked options is extremely risky since losses can be substantial and even theoretically infinite in the case of writing naked calls. The maximum gain naked option writers may see, meanwhile, is the premium they receive upfront.

Despite the risks, some writers may consider selling naked options to try to collect the premium when the implied volatility of the underlying asset is low and they believe it’s likely to stay out of the money. In these situations, the goal is often to try to take advantage of stable conditions and reduced assignment risk, even if premiums are smaller, though there is still a high risk of seeing losses.

Some naked writers traders may be willing to risk writing naked options when they believe the anticipated volatility for the underlying asset is higher than it should be. Since volatility drives up options’ prices, they’re betting that they may receive a higher premium while the asset’s market price remains stable. This is an incredibly risky maneuver, however, since they stand to see massive losses if the asset sees bigger price swings and moves into the money.

Recommended: A Guide to Options Trading

The Pros and Cons of Naked Options

Naked options offer writers the potential to profit from premiums received, but they come with a high risk of resulting in substantial losses. Here’s what to consider before using this advanced strategy.

Potential benefits of naked options

Premium income: Option writers collect premiums upfront, which can generate income if the contract expires worthless.

No capital tied up in the underlying asset: Because the writer doesn’t hold the underlying asset, their available capital may be invested elsewhere.

May appeal in low-volatility markets: While options writers often seek higher premiums during periods of elevated volatility, naked options may be attractive to some when implied volatility is low and premiums are relatively stable. This is because the price of the underlying asset may be less likely to see bigger price movements and move into the money. There is always the possibility, however, that the asset’s price could move against them.

Significant risks of naked options

Unlimited loss potential: For naked calls, a rising stock price can create uncapped losses if the writer must buy at market value. Naked puts can also lead to significant losses if the stock price falls sharply, obligating the writer to purchase shares at a strike price that is well above market value.

Margin requirements: Brokerages often require high levels of capital and may issue margin calls if the position moves against the writer.

Limited to experienced investors: Most brokerages restrict this strategy to individuals who meet strict approval criteria due to its complexity and risk.

Recommended: 10 Options Strategies You Should Know

How to Use Naked Options

Because naked call writing comes with almost limitless risks, brokerage firms typically require investors to meet strict margin requirements and have enough experience with options trading to do it. Check the brokerage’s options agreement, which typically outlines the requirements for writing options. The high risks of writing naked options are why many brokerages apply higher maintenance margin requirements for option-writing traders.

Generally, to sell a naked call option, for example, an investor would tell their broker to “sell to open” a call position. This means the investor is initiating the short call position. The trade is considered to be “naked” only if they do not own the underlying asset. An investor would do this if they expected the stock to go down, or at least not go any higher than the volatility priced into the option contract price.

If the investor who writes a naked call is right, and the option stays “out of the money” (meaning the security’s price is below a call option’s strike price), then the investor will pocket a premium. But if they’re wrong, the losses can be theoretically unlimited.

This is why some investors, when they expect a stock to decline, may instead choose to purchase a put option and pay the premium. In that case, the worst-case scenario is that they lose the amount of the premium and no more.

How to Manage Naked Option Risk

Most investors who employ the naked options strategy will also use risk-control strategies given the high risk associated with naked options.

Perhaps the simplest way to hedge the risk of writing the option is to either buy the underlying security, or to buy an offsetting option that would create an option spread, which may help limit potential losses if the trade moves against the writer. This would change the position from being a naked option to a covered option.

Some investors may also use stop-loss orders or set price-based exit points to try to close out a position before assignment, though this requires monitoring and quick execution. These strategies aim to exit the option before it becomes in-the-money and is assigned. Other risk-mitigation strategies can involve derivative instruments and computer models, and may be too time-consuming for most investors.

Another important way that options writers try to manage their risk is by being conservative in setting the strike prices of the options. Consider an investor selling a put option with a $90 strike price when the stock is trading at $100 (for a premium of say $0.50). Setting the strike price further from where the current market is trading may help reduce their risk. That’s because the market would have to move dramatically for those options to be in the money at expiration.

💡 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 Takeaway

With naked options, the investor does not hold a position in the underlying asset. Because this is a risky move, brokerage firms typically restrict it to high-net-worth investors or experienced investors, and they also require a margin account. It’s crucial that investors fully understand the very high risk of seeing substantial losses prior to considering naked options strategies.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.

Explore SoFi’s user-friendly options trading platform.

🛈 SoFi does not offer naked options trading at this time.

FAQ

What is a naked option?

A naked option is a type of options contract where the seller does not hold the underlying asset, nor has sufficient cash reserved to fulfill the contract if exercised. This exposes the seller to potentially unlimited losses. Naked calls and puts are typically permitted only for experienced investors with high risk tolerance and margin approval.

What is an example of an uncovered option?

A common example of an uncovered, or naked, option is a call option sold by an investor who doesn’t own the underlying stock. If the stock price rises significantly and the option is exercised, the seller must buy shares at market price to deliver them, which can result in substantial losses.

Why are naked options risky?

Naked options are risky because the seller has no protection if the market moves against them. Without owning the underlying asset or an offsetting position, losses can be substantial or even technically unlimited in the case of naked call options if the stock price rises sharply.

Can anyone trade naked options?

No, not all investors can trade naked options. Many brokerages restrict this strategy to high-net-worth individuals or experienced traders who meet strict margin and approval requirements, due to the significant risk involved.

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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

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