InvestLL Archives

Dec

2024

What Are Margin Rates?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

A margin rate is the interest rate that applies when investors trade on margin. Margin rates can vary from one brokerage to the next, and there are different factors that affect the rates brokerages charge. Many brokerages use a tiered rate schedule based on the amount of the margin loan.

Trading on margin can increase an investor’s purchasing power and potentially, their returns. Margin trading simply means investing with money borrowed from a brokerage in order to buy more shares than you might otherwise be able. While trading on margin may benefit investors by providing them with additional capital, it can also be riskier than regular online stock trading. Before opening a margin account, it helps to understand the basic margin rate definition.

Key Points

• Margin rates represent the interest charged on borrowed funds used for trading securities and can vary between different brokerages based on several factors.

• A margin account allows investors to purchase securities with borrowed money, enabling them to increase their buying power but also introducing additional risks.

• Factors influencing margin rates include the broker call rate, demand for margin loans, inflation, and the account balance maintained by the investor.

• Margin rates accrue daily and are charged monthly, meaning that the longer an investor holds a margin loan, the more interest they will pay.

• Understanding margin rates and their implications is crucial for investors, as these rates directly impact the profitability of margin trading strategies.

Understanding Margin Rates

A margin rate is an interest rate or premium that applies to margin trading accounts with a brokerage.

It helps to start with an overview of how margin accounts work to understand margin rates. Margin accounts allow investors to purchase securities using borrowed money. Investors may use margin to trade options, individual stocks, or other securities. Under Federal Reserve Board Regulation T, brokerage firms must cap the amount investors can borrow up to 50% of the securities’ purchase price. This is called the initial margin.

Investors must also meet maintenance margin requirements in their margin account. Specifically, an investor’s equity can’t fall below 25% of the current market value of the securities held in the account.

If an investor fails to meet maintenance margin guidelines, they may be subject to a margin call. A margin call is when the brokerage requires the investor to deposit more money into their margin account in order to make additional trades.

Brokerage firms charge margin rates, the same way a bank might charge interest on a mortgage or a business loan. Interest is a form of risk management, in the event that a borrower defaults.

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

How Margin Rates Work

Margin rates represent the cost of borrowing for an investor for an outstanding margin loan. Each brokerage can set the margin rate differently, it typically reflects the current broker call rate or call money rate. This is the rate that the bank charges the broker for the money used to fund investors’ margin loans.

Brokerages can establish a base rate, then add or subtract percentage points from that margin rate based on the margin balance. The higher the balance in a margin account, the lower the likely margin rate. So the more you borrow from the brokerage, the less you’ll pay in interest for it, as a percentage of the balance.

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Factors That Affect Margin Rate

There are a variety of factors that can determine what a brokerage charges for margin rates.

Broker Call Rate

This is the rate that brokerages pay to borrow the money used to fund margin loans. The higher this rate is, the higher the base margin rate may be.

Supply and Demand

Increased demand for margin loans could result in brokerages charging higher margin rates, both to manage risk on those loans and to reap higher profits.

Inflation and Monetary Policy

Margin rates reflect broader interest rates. If banks begin charging brokers higher interest rates, they’ll pass those on to investors.

Account Balance

Maintaining a higher balance on margin could result in a lower margin rate if the brokerage discounts rates for clients who invest more.

How Can Margin Rates Affect You?

Margin rates can determine your total net profit when trading securities on margin.

Assume, for example, that you open a margin account. You want to purchase $10,000 worth of securities of which $5,000 is borrowed money. You take out a margin loan to purchase the stocks. Those same stocks increase in value, so your $10,000 investment ($5,000 of your own money + $5,000 margin) is now worth $15,000.

You sell the stocks and repay the $5,000 you initially borrowed. You also pay $500 in interest to the brokerage for the margin loan. Once you subtract your initial $5,000 investment, the total net profit to you is $4,500.

Now, how do margin rates affect you if your investment doesn’t pan out? Going back to the previous example, say those stocks drop in value to $6,000 rather than increasing. You sell them for that amount, then pay back the $5,000 you borrowed on margin. You also have to pay $500 in interest. If you subtract those amounts from your initial $5,000 investment, you’re now left with only $500.

Understanding margin rates — and the risks involved in margin trading — can help you decide if it’s an investment strategy worth pursuing, based on your risk tolerance and goals.

When Is Margin Rate Charged?

Margin rates are accrued daily and charged on a monthly basis. So as soon as you purchase securities on margin, the margin rate applies and begins accruing. The total amount of margin interest paid depends on how much you borrow from the brokerage, the margin rate and how long it takes you to pay the loan back.

Generally speaking, traders use margins for short-term trading purposes. Though there’s no set end date for margin loans, the longer you take to pay them off, the more interest you’ll pay in total.

How Is Margin Rate Calculated?

Unlike other loans, margin loans typically do not have a set end date. Interest charges accrue monthly. To find the annual interest rate on a margin loan, you’d multiply the margin rate by the principal amount. To find the daily rate, you’d divide that amount by 360 days.

So assume that you have a $100,000 margin loan with a 6.825% margin rate, which is a common margin rate figure at top brokerages. Your yearly interest charges would add up to $6,825. If you divide that by 360, your daily interest charge breaks down to $18.96. If you were to pay your margin loan off in 10 days, you’d pay a total of $189.60 in interest.

Determining how much you’ll pay for a margin loan is relatively easy if you know the margin rates that apply and have an idea of how long it’ll take you to pay it back. At the very least, you can figure out the daily interest charge and use that as a guide for calculating your total profits on a margin trade.

💡 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).

The Takeaway

Margin rates refer to the interest rate traders or investors pay on their margin balance – the amount of money they’ve borrowed from a broker to execute traders and buy investments. Margin rates help determine how much traders will pay to use margin, and can help inform investing decisions.

Margin trading is a more advanced investing strategy that requires some consideration of risk and an understanding of market trends. If you’re just getting started with online stock trading and investing, then you may want to get a feel for how stocks work first before opening a margin account.

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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

Are margin rates yearly? Daily?

Margin rates are accrued on a daily basis, and charged by brokerages on a monthly basis. So, every day that a trader has a margin balance, they’re accruing interest in conjunction with their margin rate.

What does margin rate tell you?

The margin rate tells investors how much they’ll pay to borrow money from their brokerage if they trade on margin – or, in other words, it informs them of how much it costs to use margin.

About the author

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.

You may also be interested in:

Margin Trading: What It Is and How It Works

Margin Account: What It Is and How It Works

What You Need to Know About Margin Balance

Photo credit: iStock/Drazen

SoFi Invest®

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

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Dec

2024

What Is the IPO Process?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Before a private company can make its shares available to the public for investment, it must go through the initial public offering (IPO) process. The IPO process is time-consuming, expensive, and it can take months or even years for a privately held company to reach the stage where it can be listed and traded on a public exchange.

An IPO marks the first time individuals other than angel investors or venture capitalists can make investments in a company. Once the initial public offering process is complete, traders can buy or sell shares in the company through a public exchange like the New York Stock Exchange or Nasdaq.

There are different reasons a company may choose to do an IPO, but it’s often used as a means of raising capital. The initial public offer process can also help raise visibility around a particular company’s brand, helping to fuel growth. It means that ownership of the company is transitioning from founders and a few early investors to a much larger group of individuals and organizations.

From an investor standpoint, getting in on the ground floor of a new initial public offering might be appealing if the company you think has the potential to take off. If you’re interested in how to buy IPO stock, this primer explains how the IPO process works step by step.

Key Points

• An initial public offering (IPO) is the process a private company goes through to make its shares available to the public for investment.

• Companies may choose to do an IPO to raise capital and increase visibility around their brand.

• Prior to an IPO, a company must select an underwriter to conduct due diligence and sign necessary contracts.

• The SEC must review and approve all documents before the company can launch its IPO.

• After the launch, the underwriter may take direct action to stabilize the share price during the 25-day “quiet period”.

A Quick Refresher on IPOs

Again, IPO stands for initial public offering. If a company launches an IPO, it means that it’s only had private investors, such as angel investors, up to that point but it’s now ready to let other investors purchase shares. Under federal securities laws, this can’t happen until the company is properly registered with the Securities and Exchange Commission (SEC).

An IPO can help companies raise capital as an alternative to other methods, such as crowdfunding, which also involves raising funds from a pool of investors. But unlike an IPO, it doesn’t involve the buying or selling of shares in a company.

💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.

How Does the IPO Process Work?

At a glance, the initial public offering process seems relatively simple: A private company makes its shares available to the public for the first time, hence why it’s often referred to as “going public.”

But the initial public offering process is more detailed and complex than that. There are specific steps that have to take place to ensure that an IPO is completed in accordance with SEC regulations. The company, either on its own or while working with analysts and investors, must value the company and set an initial public offer.

After completing due diligence, the company can move forward with an IPO announcement and choose an IPO launch date. Investors can then review the IPO prospectus to determine whether they want to invest or not.

The entire IPO process can take six months to a year or even longer to complete. Aside from being time-consuming, it can also be costly, so companies must have some degree of certainty that the IPO will succeed before undertaking it.

7 Steps of the IPO Process

The IPO process takes time, and it’s important for all parties involved that the appropriate steps be followed. If something is missed or overlooked, that could put the success of a company’s initial public offering in jeopardy. Here are the steps they must go through:

1. Choosing an Underwriter

Before starting any of the other IPO process steps, a company first has to connect with a reputable IPO underwriter or group of underwriters. Again, these are investment banks that are registered with the SEC to offer underwriting services.

When choosing an underwriter, companies can consider a variety of factors, including:

• Reputation

• IPO track record

• Research quality

• Industry expertise

• Distribution (i.e. what type of investors the bank will be able to distribute the initial public offering to)

Companies may also weigh any prior relationship they have with a particular investment bank or banks when deciding which one(s) to use for underwriting.

2. Due Diligence

During the due diligence phase, the IPO underwriting team will conduct background research into the company and its upper management. This ensures that there are no surprises prior to or during the IPO launch that could affect share pricing.

At this step in the IPO process, the underwriter and the company will sign necessary contracts specifying the scope of services provided. The contract can take several structures:

• Firm Commitment: In this type of arrangement, the underwriter agrees to purchase the IPO and resell shares to the public. This guarantees that the company receives an agreed-upon amount of money.

• Best Efforts: With this type of agreement, the underwriter assents to selling shares to the best of its ability, though there’s no guarantee that all shares will sell.

• All or None: In an all or none or agreement, all shares of the IPO must be sold or the offering is canceled.

In some cases, a group or syndicate of underwriters can come together to oversee the IPO process and manage risk. Each bank in the syndicate can sign a contract with the company to sell part of the IPO.

The underwriters will also initiate the registration process with the SEC and complete supporting documents for the IPO. These might include:

• Engagement Letter: An engagement letter typically includes a clause stating what expenses the company will reimburse to the underwriter as well as the spread that’s used to pay the underwriter’s fees, typically 7% of proceeds.

• Letter of Intent: This letter outlines the underwriter’s commitment or obligations to the issuing company, the company’s statement of commitment to cooperate with the underwriter and an agreement to provide the underwriter with a 15% over allotment option.

• Underwriting Agreement: The underwriting agreement binds the underwriter to purchase shares from the issuing company at a specified price.

• Red Herring Document: A red herring document contains some of the same information about the IPO that’s included in the IPO prospectus, excluding the price and number of shares being offered.

• S-1 Registration Statement: This is the document that’s submitted to the SEC to register the IPO and it must include relevant information about the company that must be included in the prospectus, as well as additional details that are not made available to the public.

3. SEC Review and Road Show

At this stage of the initial public offering process, the SEC will review all of the documents submitted for the registration. Meanwhile, the company and its underwriting team will prepare for the road show.

This road show is effectively a marketing strategy in which the underwriters attempt to gauge interest in the IPO from institutional investors. This can help underwriters to set the IPO price and determine what number of shares to offer.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

4. IPO Pricing

Once the SEC has approved the IPO, the next critical step is choosing an initial share price. In terms of how an IPO price is set, this can depend on a number of factors, including:

• Company valuation

• Anticipated demand for shares among investors

• Road show outcomes

• Market conditions

• How much capital the company hopes to raise

• The company’s reputation

Pricing is important because it can determine the success or failure of an IPO. Price an initial public offer too high and it may scare off investors; price it too low and the company may not reach its target goal for capital raised once shares go on the market.

5. Launch

Once an IPO has the SEC’s approval and the number and price of shares has been set, all that’s left to do is launch. The company or underwriters typically announce ahead of time when an IPO is set to list so interested investors can ready themselves to buy shares on that date.

6. Stabilization

Stabilization refers to the underwriter taking direct action to stabilize share prices once the IPO launches. This is something underwriters can do during the 25-day window after an initial public offering hits the market, otherwise known as the quiet period.

In essence, the underwriter can execute trades during this period in an effort to influence pricing in favor of the company. Any SEC restrictions against price manipulation are temporarily suspended during this time.

SEC rules do, however, still apply to investors who owned shares before the company went public. Specifically, they’re required to observe the IPO lock-up period rule. This rule prevents them from selling any shares they own in the company for a set time period after the IPO, typically 90 to 180 days. This keeps those investors from dumping their shares prematurely which could affect share prices.

7. Transition to Market Competition

After the initial 25-day period following an IPO launch, the underwriters take their hands off the wheel. Rather than relying on the prospectus to determine valuations, shareholders turn their attention to market movements instead. The underwriter can continue acting in an advisory role but at this point, they can no longer do anything to influence pricing.

What Parties Participate in the IPO Process?

It takes a team to successfully launch an IPO, and each member has a distinct role in the initial public offer process. The company is the star player around which the team revolves around, with senior management typically taking the lead.

But an IPO also requires assistance from other professionals. Understanding who is involved and what they do can help with navigating the steps of the IPO process.

Investment Banks

One role of an investment banker, also called underwriters, is to effectively oversee and manage the initial public offer process. The underwriting team is responsible for performing some of the most important IPO steps, including:

• Preparing IPO documentation

• Conducting necessary due diligence

• Preparing marketing materials for distribution to investors

• Overseeing the sale of company stock through the IPO

The investment banks serving as underwriters can also help with determining the appropriate valuation of a business as part of the IPO process.

Securities and Exchange Commission (SEC)

Companies must register with the SEC before launching an initial public offering. The SEC must review and accept all documentation the company submits in reference to the IPO prior to shares being sold to the public.

Attorneys and Accountants

Attorneys and accountants work alongside underwriters during the initial public offer process to prepare the required documentation. Legal counsel may draft documents and manage the SEC filing, while accountants may prepare the financial statements that accompany the SEC registration paperwork.

Stock Exchange

Going public with an IPO means choosing an exchange through which traders can buy and sell stock. In the United States, this typically means the New York Stock Exchange (NYSE) or the Nasdaq.

Recommended: What Are the Different Stock Exchanges?

Investors

These include both those who put money into the company prior to its going public, such as venture capitalists, and those who anticipate trading shares once the IPO launches.

Both institutional investors, such as hedge funds or mutual funds, and individual retail investors who are interested in owning shares, may participate in an IPO.

Buying IPO shares may seem desirable, and there has been a lot of hype in the media about IPO stock. But it’s important to remember that IPO stocks are typically high risk, and investors can also lose money. That’s why many brokerages require that investors meet certain standards in order to be qualified to trade IPO shares.

The Takeaway

The process of taking a company public can be exciting, but it’s also a rigorous transition that requires a fledgling company to meet a series of criteria and pass through several stages before actually making its debut on a public exchange.

This process helps to ensure that the company has sound fundamentals, and is ready for public shareholder investment. Investing in IPOs has gotten a reputation as a way to make money quickly; it’s also a way investors can rapidly lose their investment, as IPOs are traditionally volatile. In addition, not all investors may qualify to trade IPO shares; check with your brokerage.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

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.

About the author

Rebecca Lake

Explore the IPO Series:

What Is an Initial Public Offering (IPO)?

What Are IPO Proceeds?

IPO vs Acquisition: Advantages and Disadvantages

How Are IPO Prices Set?

What Is an IPO Underwriter and What Do They Do?

What Is an IPO Roadshow?

How Many Companies IPO Per Year? 2023 Trends

What Is a Quiet Period?

What Is IPO Subscription Status?

Navigating the IPO Lock-up Period

What Is IPO Due Diligence?

How to Find Upcoming IPO Stocks Before Listing Day

What Is an IPO Pop?

What to Do With Company Stock If Your Company Goes Public

IPO Book-Building Process Explained

Hot Issues (IPOs): What You Need to Know

What Is Pre-IPO Placement?

Do IPOs Offer Dividends?

Testing the Waters: What It Means in an IPO

Shorting an IPO: When Can You Do It?

Guide to the Dual-Track Process for IPOs

What Is Gross Spread?

IPO Oversubscription: Definition & Examples

A Guide to Tech IPOs

History of IPOs That Failed

Photo credit: iStock/TimArbaev

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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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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Dec

2024

History of IPOs That Failed

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

An initial public offering or IPO represents a company’s first foray into the world of publicly traded stock. While an IPO can be highly anticipated by the company, prospective investors, and the market, success isn’t guaranteed.

In some cases, an IPO flops, which can raise questions about the company’s long-term viability. While a failed IPO isn’t a guarantee that a company won’t succeed, it can make establishing a firm footing in the marketplace more challenging.

What Happens During the IPO Process?

An initial public offering, or IPO, is the first time that shares of a company are offered for sale to the public. Once an IPO occurs, company stock is listed on a stock exchange and is available for pretty much anyone to buy. That said, shares can be limited, and individual investors may face certain restrictions or availability issues when it comes to trading IPO shares.

Before the IPO, the company is considered to be private. Private companies may still have shareholders, but it’s often a relatively small circle that may include founders, early employees, or even private investors such as venture capitalists.

To have an IPO, a company must file a prospectus with the SEC. The company will use the prospectus to solicit investors, and it includes key information like the terms of the securities offered and the business’s overall financial condition.

💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.

Behind the Scenes of an IPO

Behind the scenes, companies typically hire investment bankers and lawyers to help them with the IPO process. The investment bankers act as underwriters, or buyers of the shares from the company before transferring them to the public market. The underwriters at the investment bank help the company determine the offering price, the number of shares that will be offered, and other relevant details.

The company will also apply to list their stock on one of the different stock exchanges, like the New York Stock Exchange or Nasdaq Stock Exchange.

What Does It Mean When an IPO Fails?

When an IPO flops, it usually means that the stock’s price dips below the initial opening price set on the first day of trading.

Trading may pick up again the next day, resulting in a jump in the share price, or it may continue to flatline — or, in a worst-case scenario, it might hit rock bottom. There are different reasons why this can happen but it is disappointing to company executives as well as investors who were banking on the IPO being a winner. Despite all the hype around IPOs in recent years, there are no guarantees.

An IPO failure can also refer to a planned IPO that gets scuttled at the last minute due to problems with the company or a lack of interest from the investor community.

Knowing about failed IPOs can be useful for investors, who may benefit from a cautionary tale or too before investing in the next “big thing.”

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

10 of the Biggest IPO Failures in History

Throughout IPO history, there are some IPOs that failed more spectacularly than others. The following list is in chronological order.

1. TheGlobe.com

TheGlobe’s IPO flop in 1998 is one of the worst of the dotcom-bubble era and in IPO history overall. The company’s stock jumped an astonishing 600% on the first day of trading, raising $27.9 million in its IPO. But less than two years later, the NYSE delisted the stock after it fell below $1 per share.

2. Pets.com

Pets.com’s IPO makes the list of worst IPOs in history largely because of how quickly the company’s downfall happened. After raising $82.5 million in its February 2000 IPO, the company filed for bankruptcy a mere nine months later.

3. Vonage

Vonage’s IPO in May 2006 was so bad that the company was eventually sued over it, and three U.S. investment banks received fines from the Financial Industry Regulatory Authority (FINRA) in connection with the IPO. After falling short of the initial $17 price point, share prices continued to tumble, eventually bottoming out in the peak of the Great Recession at under $0.50 per share.

4. Omeros

Biotech company Omeros was one of the worst IPO flops of 2009. The company saw its stock price decline 36% in the worst two weeks of trading alone. Over the years, the company’s share price has see-sawed, most recently dropping below $10 per share in October 2021 and hovering there through the beginning of 2022.

5. Etsy

Etsy ended up being one of the worst IPOs of 2015. After its stock price nearly doubled from $16 to $27 on the first day of trading, the trend began to move in the other direction with prices eventually falling below $10 per share. The stock has since rebounded, but Etsy is notable for being one of the worst-performing IPOs in recent history.

6. Uber

Uber’s IPO in May of 2019 was deemed a Wall Street flop after the company failed to meet its expected valuation of $120 billion upon its debut. While the ride-sharing company aimed for a $45 per share price at opening, it opened at $42 instead before closing down at $41 per share on the first day of trading.

7. SmileDirectClub

SmileDirectClub’s first day of trading in September 2019 ended up being one of the worst IPOs in decades. The stock was initially priced at $23 per share, opened at $20.55 per share, and continued to fall throughout the trading day, eventually ending down 27.5%.

8. Root

Root Inc., an auto insurance startup, looked promising enough when its IPO raised $724.4 million in 2020. Since then, the insuretech stock’s share price is down nearly 90% since its initial offering and the company’s valuation has been cut in half.

9. Casper Sleep Inc.

Casper Sleep’s 2020 IPO got off to a shaky start, with shares trading at $12 to start. The company revised its IPO price down from an initial target range of $17 to $19 per share. The IPO put the company’s valuation at around $470 million, well below the $1.1 billion valuation it had previously garnered through private fundraising.

10. Robinhood

Robinhood’s initial public offering in July of 2021 was deemed one of the worst IPOs ever for a company of its size, with shares falling as much as 10% within minutes of the opening of trading. The company ended its first day of trading at a $29 billion valuation, well short of the $35 billion valuation that had been expected.

How Many IPOs Fail?

Pinning down the IPO success rate can be difficult, as there’s a distinction between companies that flop at opening and stay down and those that eventually go on to be highly profitable. As such, investing in IPOs entails a certain amount of risk for investors because it’s so different from analyzing a stock that already has a history of being traded.

According to a Nasdaq analysis of companies that have gone public since the 1980s, the IPO success rate is about 20%. This means that 80% of companies that go public end up being unprofitable when they make their debut on a stock exchange.

The study also found that the majority of IPOs produce negative returns over the long-term. Specifically, two-thirds of new companies underperform the market within three years of their IPO date.

Those figures may seem discouraging but that doesn’t prevent companies from pursuing initial public offerings. In fact, 2021 was a record-breaking year for IPOs, with more than 2,000 companies raising $594 billion globally with public offerings. It’s impossible to know how many of those companies will succeed, but there are certain factors that can influence whether an IPO flops or not.

Why Do IPOs Fail?

IPO success — or failure — tends to be measured in terms of how well results align with expectations. There can be a significant departure from IPO valuations and the trading prices of a stock at listing.

Whether price variation is above or below the initial valuation can determine the success of an IPO. IPOs can also be evaluated based on the actual capital raised versus what the company anticipates raising by going public.

As to what causes some IPOs to fail while others succeed, planning or lack of it typically plays a part. Central to the IPO process is researching the market to determine how much interest and enthusiasm there is among investors for the company’s offering. IPO underwriters also research the company itself to determine how well-received the offering is likely to be.

If an IPO fails, it can often be chalked up to one or all of the following:

• The IPO’s valuation is wrong and the stock is priced too high to attract interest among investors

• The company is attempting to go public at the wrong time

• There’s an underlying issue with the company’s fundamentals or governance

In the case of WeWork, there were questions about the initial $47 billion valuation and whether it might be too high. There were also concerns about the company’s leadership, which contributed to the IPO being shelved.

But even companies with a promising IPO can later fail. And conversely, a seemingly failed IPO can turn into a success story later on, as evidenced by Facebook’s initial flop and eventual rise to become a trillion-dollar company in 2021.

The Takeaway

IPO investing holds the potential for rewards, but as the flops listed here show there are also serious risks involved with trading IPO stocks. If an IPO fails, it can often be chalked up to the IPO’s valuation being off the mark; an underlying problem with company fundamentals or leadership – or maybe the initial public offering occurs at a bad time, for one reason or another.

Whatever the situation, it’s important for individual investors to research upcoming IPOs to determine whether they make sense as part of an overall investing strategy.

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

FAQ

What makes an IPO successful?

Successful IPOs are often associated with companies that have strong fundamentals and have managed to create significant interest among investors. These companies have IPO valuations that closely align with investor expectations and they’re entering the market at an optimal time.

What happens when an IPO fails?

If an IPO fails, that doesn’t necessarily signal the end of the company. The company may adjust its business model or expectations in order to find a path toward profitability. In a worst-case scenario, however, the company could end up closing down or filing bankruptcy.

Why does an IPO fail?

There are a number of reasons why an IPO may fail but it often comes down to lack of planning or unrealistic expectations on the part of the company executives or their underwriting team. An overvalued IPO, for example, or a company that has shaky financials, could end up underwhelming investors once trading opens.

About the author

Rebecca Lake

Explore the IPO Series:

What Is an Initial Public Offering (IPO)?

What Is the IPO Process?

What Are IPO Proceeds?

IPO vs Acquisition: Advantages and Disadvantages

How Are IPO Prices Set?

What Is an IPO Underwriter and What Do They Do?

What Is an IPO Roadshow?

How Many Companies IPO Per Year? 2023 Trends

What Is a Quiet Period?

What Is IPO Subscription Status?

Navigating the IPO Lock-up Period

What Is IPO Due Diligence?

How to Find Upcoming IPO Stocks Before Listing Day

What Is an IPO Pop?

What to Do With Company Stock If Your Company Goes Public

IPO Book-Building Process Explained

Hot Issues (IPOs): What You Need to Know

What Is Pre-IPO Placement?

Do IPOs Offer Dividends?

Testing the Waters: What It Means in an IPO

Shorting an IPO: When Can You Do It?

Guide to the Dual-Track Process for IPOs

What Is Gross Spread?

IPO Oversubscription: Definition & Examples

A Guide to Tech IPOs

Photo credit: iStock/kate_sept2004

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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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.

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.

SOIN0623079

Dec

2024

Guide to the Sectors of the S&P 500 and Their Weights

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

The S&P sectors represent the different categories that the index uses to sort the companies it follows. There are 11 sectors that make up the S&P 500, and they include health care, technology, energy, real estate, and more.

Understanding how the S&P sectors work and break down further can help both institutional and retail investors manage risk through different economic cycles by allocating their portfolio across multiple sectors. For example, cyclical stocks and cyclical sectors tend to fare well when the economy booms. During a recession, however, defensive stocks may outperform them. However, it’s also possible for all 11 sectors to trend in the same direction.

Key Points

• The S&P 500 is divided into 11 sectors, including technology, healthcare, and financials, which help categorize the largest U.S. companies.

• Technology is the largest sector, reflecting significant growth and market influence from major companies like Apple and Microsoft.

• Utilities is the smallest sector, comprising just over 2% of the index, highlighting its smaller market impact compared to other areas.

• Sector weighting in the S&P 500 is dynamic, changing with the economic influence and size of constituent companies.

• Understanding these sectors aids investors in diversifying portfolios and strategizing investments based on economic conditions and market trends.

What Is the S&P 500

“S&P” refers to Standard & Poor, and the S&P 500 index tracks the movements of 500 large-cap U.S. companies. A number of mutual funds and exchange-traded funds (ETFs) use this index as a benchmark.

Many investors use the S&P 500 as a stand-in for the entire market when it comes to investing, particularly index investing. But again, the S&P 500 can be broken down into specific sectors in which companies of particular types are concentrated — allowing investors to get more granular, if they wish, with their investment strategies.

💡 Quick Tip: For investors who want a diversified portfolio without having to manage it themselves, automated investing could be a solution (although robo advisors typically have more limited options and higher costs). The algorithmic design helps minimize human errors, to keep your investments allocated correctly.

Examining the 11 Sectors of the S&P

The Global Industry Classification System (GICS) has 11 stock market sectors in its taxonomy. It further breaks down these 11 sectors into 24 industry groups, 74 industries, and 163 sub-industries. Here’s a look at the S&P Sector list, by size:

Technology
Health Care
Financials
Real Estate
Energy
Materials
Consumer Discretionary
Industrials
Utilities
Consumer Staples
Communications

1. Technology

Technology is the largest sector of the S&P 500. This sector includes companies involved in the development, manufacturing, or distribution of tech-related products and services. For example, companies in the technology sector may produce computer software programs or electronics hardware, or research and develop new technologies.

Tech stock investments are typically cyclical, in that they usually perform better during economic expansions. The technology sector includes a number of growth stocks, which are companies that reinvest most or all of their profits in expansion versus paying dividends. Examples of some popular tech stocks include:

• Facebook (META)

• Apple (AAPL)

• Microsoft (MSFT)

• Alphabet (GOOG)

• IBM (IBM)

2. Financials

The financials sector covers a variety of industries, including banking and investing. Banks, credit unions, mortgage companies, wealth management firms, credit card companies and insurance companies are all part of the financial sector.

Financial services companies are usually categorized as cyclical. For example, a credit card issuer’s profit margins may shrink during a recession if unemployment rises and people spend less or can not keep up with credit card payments. But this can be subjective, as mortgage companies may benefit during recessionary periods if lower interest rates spur home-buying activity.

Some of the biggest names in the financial sector include:

• Visa (V)

• JPMorgan Chase (JPM)

• Bank of America (BAC)

• PayPal Holdings (PYPL)

• Mastercard (MA)

3. Health Care

The next largest of the S&P sectors is health care. This sector includes pharmaceutical companies, companies that produce or distribute medical equipment, and supplies and companies that conduct health care-related research.

The health care sector also includes alternative health companies, including companies that use cannabis as a part of their medical research and product development.

Recommended: Cannabis Investing 101

More traditional examples of healthcare sector companies include:

• CVS (CVS)

• Johnson & Johnson (JNJ)

• UnitedHealth Group (UNH)

• Thermo Fisher Scientific (TMO)

• Regeneron (REGN)

Health care stocks are typically non-cyclical, as demand for these products and services usually doesn’t hinge on economic movements.

4. Consumer Discretionary

The consumer discretionary sector is a largely cyclical sector that includes companies in the hospitality and entertainment sectors, as well as retailers.

Examples of stocks that fit into the consumer discretionary sector are:

• Starbucks (SBUX)

• AMC (AMC)

• Best Buy (BBY)

• Home Depot (HD)

• Nike (NKE)

Generally, these companies represent things consumers may spend more money on in a thriving economy and cut back on during a downturn. That’s why they’re considered cyclical in nature.

5. Communications Services

This sector spans companies that provide communications services of some kind. That can include landline phone services, cellular phone services, or internet services. Communications also includes companies responsible for producing movies and television shows.

The communications sector can be hard to pin down in terms of whether it’s cyclical or defensive. In a down economy, for example, people may continue to spend money on phone and internet services but cut back on streaming services. So there’s an argument to be made that the communication sector is a little of both.

Companies that belong to this sector include:

• Comcast (CMCSA)

• AT&T (T)

• Dish Network (DISH)

• Discovery Communications (WBD)

• Activision Blizzard (ATVI)

6. Industrials

The industrial sector covers a broad range of industries, including those in the manufacturing and transportation sectors. For example:

• Honeywell (HON)

• 3M (MMM)

• Stanley Black & Decker (SWK)

• Delta Airlines (DAL)

• Boeing (BA)

Industrials are often considered to be cyclical stocks, again because of how they react to changes in supply and demand. The airline industry, for example, saw a steep decline in 2020 as air travel was curtailed due to the coronavirus pandemic.

7. Consumer Staples

Consumer staples stocks represent things consumers regularly spend money on. That includes groceries, household products and personal hygiene products. The consumer staples sector is also a defensive sector because even when the economy hits a rough spot, consumers will continue spending money on these things.

From an investment perspective, consumer staples stocks may not yield the same return profile as other sectors. But they may provide some stability in a portfolio when the market gets shaky.

Companies that are recognized as some of the top consumer staples stocks include:

• General Mills (GIS)

• Coca-Cola (KO)

• Procter & Gamble (PG)

• Conagra Brands (CAG)

• Costco Wholesale (COST)

8. Energy

The energy sector includes companies that participate in the production and/or distribution of energy. That includes the oil and gas industry as well as companies connected to the development or distribution of renewable energy sources.

Energy stock investments can be more sensitive to economic movements and supply-demand trends compared to other sectors.

Some of the biggest energy sector companies include:

• Exxon Mobil (XOM)

• Royal Dutch Shell (SHEL)

• Chevron (CVX)

• Conocophillips (COP)

• Halliburton (HAL)

9. Real Estate

This sector includes real estate investment trusts (REITs) as well as realtors, developers and property management companies. REITs invest in income-producing properties and may pay out as much as 90% of profits out to investors as dividends.

Investing in real estate can be a defensive move as this sector is largely uncorrelated with stocks. So if stock prices fall, for example, investors may not see a correlating drop in real estate investments as property generally tends to appreciate over time.

Examples of real estate companies in the S&P 500 include:

• Digital Realty (DLR)

• American Tower (AMT)

• Prologis (PLD)

• Simon Property Group (SPG)

• Boston Properties (BXP)

10. Materials

The materials sector includes companies connected to the sourcing, processing or distribution of raw materials. That includes things like lumber, concrete, glass, and other building materials.

Materials is one of the cyclical S&P sectors, as it can be driven largely by supply and demand. During a housing boom, for example, the materials sector may benefit from increased demand for lumber, plywood and other construction materials.

Material stocks in the S&P 500 include:

• Dupont (DD)

• Celanese (CE)

• Sherwin Williams (SHW)

• Air Products & Chemicals (APD)

• Eastman Chemical (EMN)

11. Utilities

Utilities represent one of the core defensive S&P sectors. This sector includes companies that provide gas, electricity, water, and other utilities to households, businesses, farms, and other entities.

Since these are essentials that people typically can’t do without, they’re generally less sensitive to major shifts in the economic cycle. They also often pay dividends to their investors.

Examples of utilities stocks include:

• AES (AES)

• UGI (UGI)

• CenterPoint Energy (CNP)

• Duke Energy (DUK)

• Dominion Energy (D)

Recommended: How to Invest in Utilities

How Are the Sectors of the S&P 500 Weighted?

Given that the S&P 500 is composed mostly of the largest companies, its weighting is relative to the size of those companies and their respective industries. As such, that’s why technology, health care, and financials are relatively large compared to other sectors.

It’s also important to understand that things change over time — in terms of company and industry size and influence on the overall economy. Accordingly, the index itself changes, and weighting of specific sectors and companies changes as well.

Which Is the Largest S&P 500 Sector?

As discussed, technology, or information and technology, is currently the largest sector in the S&P 500. That’s in large part due to the tech sector’s growth over the past couple of decades, and certain companies within the sector becoming larger with massive market caps — companies such as Apple, Microsoft, Alphabet, Meta, Netflix, and others.

Which Is the Smallest S&P 500 Sector?

As of March 2024, utilities is the smallest S&P 500 sector, comprising a little more than 2% of the overall index. But the materials and real estate sectors are not much bigger.

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

What Can You Do As an Investor With This Information?

Investors can tap their knowledge of the S&P 500 sectors to help inform their investing strategy and plan. As discussed, while some sectors tend to be a bit more volatile, investors may look at specific and strategic allocations in other sectors to help “smooth” things out during times of volatility in the market.

Further, sector investing can help investors diversify their portfolios, or find additional opportunities to invest.

The Takeaway

Knowing what the S&P sectors are and which types of industries or sub-industries they represent can help investors achieve diversification through different types of investments. While some financial experts liken the sectors to a pie, with several individual slices, it may be more helpful to think of them as a buffet from which investors can pick and choose.

You can either purchase stocks within or across sectors, or look for funds that can provide that diversification for you. It’ll all depend on your overall financial plan and investment strategy. If you need help honing that in, it may be beneficial to speak with a financial professional.

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

What are the S&P 500 sector weights?

As of March 2024, information technology is the largest sector in the S&P 500, comprising nearly 30% of the overall index. It’s followed by financials at 13%, health care at 12.5%, and consumer discretionary at 10.6%.

What is the sector breakdown of the S&P 500?

The eleven sectors of the S&P 500 are information technology, financials, health care, consumer discretionary, communication services, industrials, consumer staples, energy, real estate, materials, and utilities.

What is the smallest sector of the S&P 500?

As of March 2024, utilities is the smallest sector of the S&P 500, comprising 2.1% of the overall index.

Photo credit: iStock/izusek

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.

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

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

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.

SOIN0324001

Dec

2024

Guide to Taxes and Mutual Funds

By Samuel Becker | Growing Wealth, invest, Investing | Comments Off

Mutual fund investors pay taxes on the income or capital gains they see from their investments. But the specific tax treatment of mutual fund investments depends on several variables, which can breed confusion. For a long time, mutual funds have been a popular investment vehicle for millions of investors, largely because they offer an easy way to purchase no-fuss, diversified assets with relative ease. This out-of-the-box diversification and risk mitigation is something that individual stocks can’t match.

Read on to learn how taxes on mutual funds work, what investors should expect or anticipate when dealing with mutual funds and the IRS, and some strategies for tax-efficient investing.

Key Points

• Mutual fund investors must pay taxes on income or capital gains distributed by the fund, including dividends, interest, and realized capital gains.

• The tax treatment of mutual fund investments varies depending on the type of fund and the income or capital gains it generates.

• Shareholders may owe taxes on mutual fund holdings even without selling shares, due to realized gains from distributions.

• The amount of tax paid depends on the type of fund, income or capital gains, and the investor’s tax situation.

• Strategies to minimize taxes include investing in tax-efficient funds, using tax-deferred accounts, and employing a buy-and-hold strategy to avoid short-term capital gains taxes.

Quick Mutual Fund Overview

A mutual fund is a pooled investment vehicle that allows individuals to invest in a professionally managed portfolio of stocks, bonds, and other securities. Mutual funds are managed by professional portfolio managers who use the pooled capital to buy and sell securities according to the fund’s stated investment objective. When investors buy into a mutual fund while online investing, they’re purchasing a spectrum of assets all at once.

Mutual funds can be actively managed, where the portfolio manager actively buys and sells securities in the fund, or passively managed, where the fund tracks an index. Mutual funds are a popular way for individuals to diversify their portfolios and access professional investment management.

Recommended: How to Buy Mutual Funds Online

Do You Pay Taxes on Mutual Funds?

Mutual fund investors generally need to pay taxes on any income or capital gains the mutual fund distributes, including dividends, interest, and realized capital gains from the sale of securities within the fund.

It’s worth noting that mutual funds can be structured in different ways, and the tax treatment of mutual fund investments can vary depending on the specific type of mutual fund. For example, some mutual funds are classified as tax-exempt or tax-deferred, which means that they are not subject to certain taxes or that taxes on the income or gains from the fund are deferred until later.

When a mutual fund distributes income or capital gains to its investors, it must provide them with a Form 1099-DIV, which reports the distribution amount and any associated taxes. Investors are then responsible for reporting this income on their tax returns and paying any taxes that are due.

How Are Mutual Funds Taxed?

Mutual funds are taxed based on the income and capital gains they generate and distribute to their investors. This income and capital gains can come from various sources, such as dividends on stocks held by the fund, interest on bonds held by the fund, and profits from the sale of securities within the fund.

The tax treatment of mutual fund investments can vary depending on the type of fund and the type of income or capital gains it generates. Here are some general rules to keep in mind:

Paying Tax on “Realized Gains” from a Mutual Fund

It may come as a surprise that shareholders may owe taxes on their mutual fund holdings even if they don’t sell shares of the fund. That’s because shareholders still generate income from those holdings, which are often called “realized” gains.

Mutual funds are often actively managed, meaning that a portfolio manager regularly makes decisions about what the fund contains by buying and selling investments — a process that can net profits. Those profits, or gains, are then passed back to shareholders as distributions (or as dividends) or reinvested in the fund.

When shareholders are awarded distributions from funds, they see a “realized” gain from their investment. For that reason, shareholders may end up owing tax on investments that they have not sold or may have lost value over the year.

Paying Capital Gains on Mutual Funds

Most investors likely know that when they sell shares of a mutual fund, they’ll need to pay taxes on the earnings. Specifically, they’ll pay capital gains tax on the profit from selling an investment. The capital gains tax rate will vary depending on how long an investor holds the investment (short-term versus long-term).

Because funds contain investments that may be sold during the year, thereby netting capital gains, investors may be responsible for capital gains taxes on their mutual fund distributions. As each fund is different, so are the taxes associated with their distributions. So reading through the fund’s prospectus and any other available documentation can help investors figure out what, if anything, they owe.

How Much Tax Do You Pay on Mutual Funds?

The amount of tax you may need to pay on mutual fund investments depends on the type of fund, the type of income or capital gains the fund generates, and your individual tax situation.

Here are some general rules to keep in mind:

• Dividends: Dividends paid by mutual funds are taxed at different rates, depending on whether the payouts are ordinary or qualified dividends. Qualified dividends are taxed at a lower rate than ordinary dividends; they’re taxed at the long-term capital gains rate, which ranges from 0% to 20%. In contrast, ordinary dividends are taxed at an investor’s ordinary income tax rate.

• Interest: The tax on the interest income from mutual funds depends on whether the payout comes from tax-exempt bonds, federal debt, or regular fixed-income securities. Depending on the type of asset, the interest may be taxed at ordinary income tax rates or exempt from certain taxes.

• Capital gains: When a mutual fund sells securities for a profit, it may realize a capital gain, which is subject to tax. The tax rate on capital gains depends on how long the securities were held and your tax bracket. Short-term capital gains (on securities held for one year or less) are taxed at the same rate as ordinary income. In comparison, long-term capital gains (on securities held for more than one year) are generally taxed at the lower capital gains tax rate.

How to Minimize Taxes on Mutual Funds

Here are a handful of ways to potentially lower taxable income associated with mutual funds:

Know the Details Before You Invest

Do your homework! The holdings in each fund and how they’re managed will ultimately play a significant role in the tax liabilities associated with each fund. Before investing in a specific mutual fund, it’s worth digging through the prospectus and other documents to understand what to expect.

For example, an investor can typically find out ahead of time if a mutual fund makes capital gains distributions or how often a fund pays out dividends. Those types of income-generating events will need to be declared to the IRS come tax time.

Some investors may look for tax-efficient funds specifically designed to help mutual fund investors avoid taxes.

Use a Tax-deferred Account

Some brokerage or investment accounts — including retirement accounts like IRAs and 401(k) plans — are tax-deferred. That means they grow tax-free until the money they contain is withdrawn. In the short term, using these types of accounts to invest in mutual funds can help investors avoid any immediate tax liabilities that those mutual funds impose.

Recommended: Are Mutual Funds Good for Retirement?

Hang Onto Your Funds to Try and Avoid Short-term Capital Gains

If the goal is to minimize an investor’s tax liability, avoiding short-term capital gains tax is important. That’s because short-term capital gains taxes are steeper than the long-term variety. An easy way to ensure that an investor is rarely or never on the hook for those short-term rates is to subscribe to a buy-and-hold investment strategy.

This can be applied as an overall investing strategy in addition to one tailor-made for avoiding additional tax liabilities on mutual fund holdings.

Talk to a Financial Professional

Of course, not every investor has the same resources, including time, available to them. That’s why some investors may choose to consult a financial advisor specializing in these services. They usually charge a fee, but some may offer free consultations. For some investors, the cost savings associated with solid financial advice can outweigh the initial costs of securing that advice.

How Do You Report Mutual Funds on Your Taxes?

If you own mutual funds, you will generally need to report any income or capital gains you receive from the fund on your tax return.

Mutual funds are required to provide their investors with a Form 1099-DIV, which reports the amount of any dividends, interest, and capital gains distributions the fund paid out during the year. Make sure to keep this form for your records and use it to help complete your tax return.

You will then need to report any dividends, interest, and capital gains distributions you received from your mutual fund on your tax return, specifically on IRS Form 1040 or Schedule D (Form 1040).

The Takeaway

Mutual fund taxes are generally unavoidable, but with a little planning, you may be able to minimize the amount you get taxed. Employing some of the above strategies can help you minimize your mutual taxes. For example, those investing for long-term financial goals, like retirement, can use tax-deferred accounts as their primary investing vehicles. And by using those accounts to invest in mutual funds and other assets, they can help offset their short-term tax liabilities.

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

Do you pay taxes when you sell mutual funds?

Yes, you may be required to pay taxes when you sell mutual funds. The specific taxes you may be required to pay will depend on several factors, including the type of mutual funds you are selling, how long you have held the funds, and the type of gains you have earned from the sale.

Are mutual funds taxed twice?

Mutual funds are not taxed twice. However, some investors may mistakenly pay taxes twice on some distributions. For example, if a mutual fund reinvests dividends into the fund, an investor still needs to pay taxes on those dividends. Later, when the investor sells shares of the mutual fund for a gain, they’ll have to pay capital gains taxes on those earnings.

SoFi Invest®

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

SOIN-Q424-019

Understanding Margin Rates

How Margin Rates Work

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 12%* and start margin trading.

Factors That Affect Margin Rate

Broker Call Rate

Supply and Demand

Inflation and Monetary Policy

Account Balance

How Can Margin Rates Affect You?

When Is Margin Rate Charged?

How Is Margin Rate Calculated?

The Takeaway

FAQ

Are margin rates yearly? Daily?

What does margin rate tell you?

You may also be interested in:

A Quick Refresher on IPOs

How Does the IPO Process Work?

7 Steps of the IPO Process

1. Choosing an Underwriter

2. Due Diligence

3. SEC Review and Road Show

4. IPO Pricing

5. Launch

6. Stabilization

7. Transition to Market Competition

What Parties Participate in the IPO Process?

Investment Banks

Securities and Exchange Commission (SEC)

Attorneys and Accountants

Stock Exchange

Investors

The Takeaway

Explore the IPO Series:

What Happens During the IPO Process?

Behind the Scenes of an IPO

What Does It Mean When an IPO Fails?

10 of the Biggest IPO Failures in History

1. TheGlobe.com

2. Pets.com

3. Vonage

4. Omeros

5. Etsy

6. Uber

7. SmileDirectClub

8. Root

9. Casper Sleep Inc.

10. Robinhood

How Many IPOs Fail?

Why Do IPOs Fail?

The Takeaway

FAQ

What makes an IPO successful?

What happens when an IPO fails?

Why does an IPO fail?

Explore the IPO Series:

What Is the S&P 500

Examining the 11 Sectors of the S&P

1. Technology

2. Financials

3. Health Care

4. Consumer Discretionary

5. Communications Services

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

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6. Industrials

7. Consumer Staples

8. Energy

9. Real Estate

10. Materials

11. Utilities

How Are the Sectors of the S&P 500 Weighted?

Which Is the Largest S&P 500 Sector?

Which Is the Smallest S&P 500 Sector?

What Can You Do As an Investor With This Information?

The Takeaway

FAQ

What are the S&P 500 sector weights?

What is the sector breakdown of the S&P 500?