Pros & Cons of Sector Investing

Pros & Cons of Sector Investing

Sector investing simply refers to targeted investing in a particular market sector or industry. Finance, real estate, utilities, and retail are a few examples of common sectors.

Many institutional investors use a sector investing strategy, but it’s one that individual investors can use as well, either by selecting individual stocks according to a theme or to describe different exchange-traded funds (ETFs) or mutual funds that focus their investments on a single sector.

Common Investing Sectors

Investors who want exposure to the following sectors can either invest directly in companies or assets, or invest in ETFs or mutual funds composed of securities within that sector.

Health Care

This section focuses on companies that contribute to health care needs and related endeavors.These may include hospitals and related real estate, health insurance companies, pharmaceutical companies, companies that make medical devices, and more.

Precious Metals

The precious metals sector is historically seen as a safe haven asset that investors flock to in times of crisis. Even outside of a crisis, companies involved in the exploration of new metal deposits and mining of those deposits can sometimes provide significant returns.

Investors may be keen to find ways to invest in gold, but other examples include mining companies, direct investments in commodities, or in funds ETFs that purchase them.

Real Estate

This sector includes real estate developers and property owners, as well as mortgage-backed securities.

Real estate investors may also choose to put money into real estate investment trusts (REITs), which use investor money to acquire income-producing properties like data centers, office builds, shopping malls, or apartment buildings. One attractive feature of REITs is that they pay out a large portion of their income in the form of dividends to investors.

Utilities

Utility investing focuses on companies that provide utilities like phone and internet service, electricity, or natural gas. Utilities are considered to be a defensive or safe haven sector, since they tend to do well during a recession because people almost always need the services they provide.

Tech

Technology companies have become an increasingly large part of the economy as more organizations continue to undergo digital transformation. Investments in the tech sector might include streaming video providers, computer companies, or social media companies.

Consumer Staples

This sector focuses on the companies that make or sell items that people need to buy, such as supermarkets, food producers, and convenience stores.

Consumer Discretionary

This sector includes companies that make or sell goods that people like to purchase but don’t need, such as e-commerce companies, home improvement, apparel, or sporting goods retailers. This sector tends to perform well during times of economic expansion and to lag during a recession.

Energy

This sector focuses on companies that produce or supply energy. That may include oil drillers, coal miners, and pipeline operators. Some energy investors might focus only on stocks in the renewable energy space, such as wind farms or solar panel producers.

Recommended: Investing in Low Carbon Stocks: What to Know

Pros of Sector Investing

Some of the benefits involved in sector investing include diversification and the ability to invest with market cycles.

Diversification

Investing in multiple sectors of the economy is one method of attaining diversification within a portfolio, which involves investing in many different types of stocks. If some sectors produce outsize gains, they can help offset lower returns in other sectors.

Rotation Strategy

One of the more common sector investing strategies is sector rotation, meaning that investors change their allocation to certain sectors depending on the economic cycle. For example, they might invest more heavily in the utility sector during a recession, when utilities tend to outperform, and move those funds into consumer discretionary goods during a recovery.

Cons of Sector Investing

While sector investing may prove beneficial, it also has its potential drawbacks. Some of the same features that make this strategy profitable or appealing can also make it risky.

Potential Volatility

Things that impact one sector as a whole tend to affect most or all companies within that sector. As a result, a single relevant event or news headline could have dramatic consequences for those heavily invested. This could result in large moves upward or downward.

For example, imagine being heavily invested in the oil and natural gas sector. Suddenly, the demand for energy plummets because of restrictions on travel, decreased consumer spending, and overall lack of demand for petroleum products. This would likely have a dramatic effect on nearly all companies in the oil and gas sector, leading to potentially large losses for investors with a large exposure to this sector.

On the other hand, if markets became optimistic that a future event would restore demand, or something happened to decrease supply, then volatility could swing the other way pushing up the value of investments.

Recommended: How Investors Can Manage Stock Volatility

Concentration risk

Concentration risk is a form of investment risk in which investors over-allocate a portion of their portfolio to a single sector and lose the downside protection that may come with a properly diversified portfolio, which spreads investments across different types of assets to minimize risk.

It is notoriously difficult for individual investors to sustainably engage in stock market timing, in which they can precisely determine the most optimal time to buy and sell a specific investment.

Sector ETF Investing

Investing in sector-focused ETFs is one of the easiest and most common ways to invest in sectors. Sector-specific exchange-traded funds hold dozens or hundreds of stocks within a specific sector, allowing investors to get exposure to the entire sector without having to make investments in individual companies.

Choosing an ETF takes less time and research than choosing many individual stocks. While ETFs may not experience the same level of gains as individual stocks, they also have less volatility.

The Takeaway

Sector investing involves making investments in specific parts, segments, or sectors of the economy. There can be pros and cons to doing so, and investors should consider all factors or even speak with a financial professional before making a decision.

To determine the best investing strategy for you, you’ll need to consider your long-term goals, your risk tolerance, financial objectives, and the amount of time and effort you want to spend choosing investments.

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

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


Photo credit: iStock/diego_cervo

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
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 [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Claw Promotion: Customer must fund their Active Invest account with at least $10 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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How to Avoid FOMO Trading

How to Avoid FOMO Trading

FOMO, or, “fear of missing out” when trading, applies to the anxiety of potentially passing up a profitable investment that an investor may experience. “FOMO” is a term commonly used to describe other anxiety-inducing situations as well. For investors who visualize a scenario where a stock rises sharply in value but goes unpurchased, the fear of missing out may cause them to make investing decisions that aren’t fully thought-through or in line with their investing strategy.

Making emotional, knee-jerk decisions when investing can derail your overall strategy, too. That’s why it can be important to try and avoid it the best you can.

What Is FOMO Trading?

FOMO trading happens when an investor allows their fear of missing out to drive their investing decisions — to the exclusion of other insights and instincts. This can trigger errors, creating problems in an otherwise well-managed investment portfolio.

For example, an impatient trader may rush to buy a hot stock even if it doesn’t fit into their investment strategy, or if the stock risks could jeopardize the portfolio’s stability.

Yet, buying any investment without proper research, risk assessment, or a planned exit strategy if the stock goes down, is the opposite of effective stock market investing.

Understanding Behavioral Finance

Sociologists use the term “behavioral finance” to describe the overall need to abandon rational thought and follow a herd to mitigate any FOMO anxieties. With behavioral finance, emotional and sociological influences replace scrutiny and logical thinking, which can significantly alter investment outcomes.

The fact that so many stock market rumors are stoked on social media, and that there are so many investors who rely on social media for investment ideas, only adds more pressure to give in to your anxieties, and buy a stock or other investment that may not necessarily fit in with your investing strategy.

Ways to Avoid FOMO Trading

How can an investor fight off FOMO tendencies and remain a stable and steadfast investor? It’s not easy given the pressure to trade frequently these days, but these tips may help.

Invest With a Plan in Mind

Investors who trade according to a well-thought out plan or investing strategy — and not with a FOMO mindset — are likely to be more prepared for better investment outcomes. By doing research, learning how to value a stock, and establishing your own tolerance for risk, you may be less likely to make rash or emotional decisions regarding your investments.

Stay Calm in Highly Volatile Markets

Many impulse trades come at a time when markets move fast. When investing in a volatile market, it’s especially important to trade with strategy in mind, rather than with your feelings.

Be Sensible About Trading

A single stock market trade rarely makes or breaks an investment portfolio. If you do hear about a can’t-miss stock and are anxious to pull the trigger and buy that stock, it can help to keep it in perspective: there’s always another market opportunity down the road. In other words, keep the big picture in mind.

Avoid Investing Money You Can’t Afford to Lose

The old adage of “never play with money you can’t afford to lose” is very much in play with FOMO investing. It’s never wise to chase a stock with large amounts of money your portfolio can’t afford to be without. In nearly all cases, if an investment’s risk is too high, and the potential impact to your portfolio is too acute, then it may be best to wait things out.

Don’t Mistake Social Media Advice For a Sound Investment Strategy

Social media captures a great deal of attention from market investors. But these platforms may be loaded with touts, short-sellers, penny stock promoters, and other investment shills who have their best interest in mind — not yours. As a rule, social media touts always talk up their gains but rarely mention their losses. Remember that maxim when you’re under the temptation of a FOMO trade.

The Takeaway

FOMO trading is a type of behavioral finance — in which an investor lets emotions like the fear of missing out replace logical, strategic thinking. FOMO trading often happens on a whim without much thought, which can significantly impact investment outcomes.That’s why it’s important to have a cogent strategy in place, and to keep your goals in mind when making investing decisions.

While it can be difficult to completely remove your emotions from your investing activities, keeping your strategy top of mind can help direct your decision-making process. Again: It’s not easy, but with some practice and experience in the markets, learning to skip investing trends might become a bit easier.

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

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


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Claw Promotion: Customer must fund their Active Invest account with at least $10 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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Margin Calls: Defined and Explained

A margin call is when an investor is required to add cash or sell investments to maintain a certain level of equity in a margin account if the value of the account decreases too much.

Margin trading — when an investor borrows money from a brokerage firm to enhance trades — is a risky endeavor. Placing bets with borrowed funds can boost gains but can also supercharge losses. Brokers require traders to keep a minimum balance in their margin accounts for this reason.

If the margin account dips below a certain threshold, this is when the brokerage firm will issue a margin call. A margin call is one of several risks associated with margin trading.

Margin calls are designed to protect both the brokerage and the client from bigger losses. Here’s a closer look at how margin calls work, as well as how to avoid or cover a margin call

What Is a Margin Call?

A margin call is when a brokerage firm demands that an investor add cash or equity into their margin account because it has dipped below the required amount. The margin call usually follows a loss in the value of investments bought with borrowed money from a brokerage, known as margin debt.

A house call, sometimes called a maintenance call, is a type of margin call. A brokerage firm will issue the house call when the market value of assets in a trader’s margin account falls below the required maintenance margin — the minimum amount of equity a trader must hold in their margin account.

If the investor fails to honor the margin call, meaning they do not add cash or equity into their account, the brokerage can sell the investor’s assets without notice to cover the shortfall in the account. This entails a high level of responsibility and potential risk, which is why margin trading is primarily for experienced investors, not for investing beginners.

How Do Margin Calls Work?

When the equity in an investor’s margin account falls below the maintenance margin, a brokerage firm will issue a margin call. Maintenance margins requirements differ from broker to broker.

Additionally, regulatory bodies like the Federal Reserve and FINRA have rules for account minimums that all firms and investors must follow to limit risk and leverage.

Regulation T

The Federal Reserve Board’s Regulation T states that the initial margin level should be at least 50% of the market value of all securities in the margin account. The minimum equity amount must be valued at 50% or more of the margin account’s total value. For example, a $10,000 trade would require an investor to use $5,000 of their own cash for the transaction.

💡 Recommended: Regulation T (Reg T): All You Need to Know

FINRA

The Financial Industry Regulatory Authority (FINRA) requires that investors have a maintenance margin level of at least 25% of the market value of all securities in the account after they purchase on margin. For example, in a $10,000 trade, the investor must maintain $2,500 in their margin account. If the investment value dips below $2,500, the investor would be subject to a margin call.

Example of Margin Call

Here is how a margin trade works. Suppose an investor wants to buy 200 shares of a stock at $50 each for an investment that totals $10,000. He or she puts up $5,000 while the brokerage firm lends the remaining $5,000.

FINRA rules and the broker require that the investor hold 25% of the total stock value in his or her account at all times — this is the maintenance requirement. So the investor would need to maintain $2,500 in his or her brokerage account. The investor currently achieves this since there’s $5,000 from the initial investment.

If the stock’s shares fall to $30 each, the value of the investment drops to $6,000. The broker would then take $4,000 from the investor’s account, leaving just $1,000. That would be below the $1,500 required, or 25% of the total $6,000 value in the account.

That would trigger a margin call of $500, or the difference between the $1,000 left in the account and the $1,500 required to maintain the margin account. Normally, a broker will allow two to five days for the investors to cover the margin call. In addition, the investor would also owe interest on the original loan amount of $5,000.

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 8.50%* and start margin trading.


*For full margin details, see terms.

Margin Call Formula

Here’s how to calculate a margin call:

Margin call amount = (Value of investments multiplied by the percentage margin requirement) minus (Amount of investor equity left in margin account)

Here’s the formula using the hypothetical investor example above:

$500 = ($6000 x 0.25%) – ($1,000)

Investors can also calculate the share price at which he or she would be required to post additional funds.

Margin call price = Initial purchase price times (1-borrowed percentage/1-margin requirement percentage)

Again, here’s the formula using the hypothetical case above:

$33.33 / share = $50 x (1-0.50/1-0.25)

2 Steps to Cover a Margin Call

When investors receive a margin call, there are only two options:

1.    They can deposit cash into the margin account so that the level of funds is back above the maintenance margin requirement. Investors can also deposit securities that aren’t margined.

2.    Investors can also sell the securities that are margined in order to meet requirements.

In a worst case scenario, the broker can sell off securities to cover the debt.

How Long Do I Have to Cover a Margin Call?

Brokerage firms are not required to give investors a set amount of time. As mentioned in the example above, a brokerage firm normally gives customers two to five days to meet a margin call. However, the time given to provide additional funds can differ from broker to broker.

In addition, during volatile times in the market, which is also when margin calls are more likely to occur, a broker has the right to sell securities in a customer’s trading account shortly after issuing the margin call. Investors won’t have the right to weigh in on the price at which those securities are sold. This means investors may have to settle their accounts by the next trading day.

Tips on Avoiding Margin Calls

The best way to avoid a margin call is to avoid trading on margin or having a margin account. Trading on margin should be reserved for investors with the time and sophistication to monitor their portfolios properly and take on the risk of substantial losses. Investors who trade on margin can do a few things to avoid a margin call.

•   Understand margin trading: Investors can understand how margin trading works and know their broker’s maintenance margin requirements.

•   Track the market: Investors can monitor the volatility of the stock, bond, or whatever security they are investing in to ensure their margin account doesn’t dip below the maintenance margin.

•   Keep extra cash on hand: Investors can set aside money to fulfill the potential margin call and calculate the lowest security price at which their broker might issue a call.

•   Utilize limit orders: Investors can use order types that may help protect them from a margin call, such as a limit order.

The Takeaway

While margin trading allows investors to amplify their purchases in markets, margin calls could result in substantial losses, with the investor paying more than he or she initially invested. Margin calls occur when the level of cash in an investor’s trading account falls below a fixed level required by the brokerage firm.

Investors can then deposit cash or securities to bring the margin account back up to the required value, or they can sell securities in order to raise the cash they need.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling margin a SoFi margin account . With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, 8.50%*

FAQ

How can you satisfy your margin call in margin trading?

A trader can satisfy a margin call by depositing cash or securities in their account or selling some securities in the margin account to pay down part of the margin loan.

How are fed and house calls different?

A fed call, or a federal call, occurs when an investor’s margin account does not have enough equity to meet the 50% equity retirement outlined in Regulation T. In contrast, a house call happens when an investor’s margin equity dips below the maintenance margin.

How much time do you have to satisfy a margin call?

It depends on the broker. In some circumstances, a broker will demand that a trader satisfy the margin call immediately. The broker will allow two to five days to meet the margin call at other times.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
*Borrow at 8.50%. 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.
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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Actively Managed Funds vs Index Funds: Differences and Similarities

Actively managed funds and index funds are similar in that they’re both a type of pooled investment fund, and they both come in a variety of styles (e.g. large cap, small cap, green bonds, and so on). The main difference between them is that actively managed funds rely on a team of live portfolio managers vs. index funds, which simply track or mirror a relevant index using an algorithm.

The difference in management style between active and so-called “passive” index funds leads to a series of other differences, including cost and transparency around securities in the fund.

The debate concerning the merits of actively managed funds vs. index funds is a longstanding one. Both types of funds have the potential to yield advantages to investors. But they each have drawbacks that should be weighed in the balance.

What Are Index Funds?

Index funds are a type of mutual fund or exchange-traded fund (ETF) that mirror the performance of a specific stock market index.

A stock market index measures a particular sector of the market. In the case of the S&P 500 Index, for example, what’s being measured is the performance of the 500 largest U.S. companies.

While it’s not possible to invest in an index directly, index funds and ETFs offer a work-around because when you invest in an index fund, you’re purchasing a fund that holds securities which are representative of its representative index.

If you’re buying a fund that tracks the Nasdaq-100 Composite Index, for example, the fund would include stocks from the 100 largest and most actively-traded non-financial domestic and international securities listed on the Nasdaq. The securities are not hand-picked by a portfolio manager, and an index fund doesn’t seek to outperform the benchmark — but rather to match it.

Index funds can be cap-weighted, meaning they track an index that relies on market capitalization to decide which securities to include. Market capitalization is a company’s value as determined by its share price multiplied by the number of shares outstanding.

For example, some index funds only track large-cap companies that have a market capitalization of more than $10 billion. Others focus on small-cap companies that have a market capitalization of $250 million to $2 billion.

Index funds and index investing follow a passive investment strategy. That means that the fund tracks the performance of a particular benchmark, rather than trying to beat the market by using the skills of a live portfolio manager.

What Are Actively Managed Funds?

Actively managed ETFs and mutual funds also represent a collection or basket of securities. The difference between these types of funds and index funds is that instead of being passively managed and tracking a specific index, a fund manager plays a hands-on role in determining which securities to include, in an attempt to beat the market.

Because of that, fund turnover — the movement of assets in and out of the fund — may be more frequent compared to an index fund. This has certain tax and cost implications for investors.

Index Funds vs Actively Managed Funds

Index funds do have some similarities to actively managed funds, but the chief difference between them — i.e. the use of passive management vs. active management — yields some important other differences.

Similarities

As noted above, both types of funds are pooled investment funds. You might have passively or actively managed mutual funds as well as exchange-traded funds.

Both types of funds can be invested in a wide range of different equities, bonds, and other securities. For example, you might have a small-cap ETF that’s passively managed (perhaps it tracks the Russell 2000 small-cap index) or an ETF that’s actively managed and also invested in small-cap companies.

Differences

The chief differences between actively managed funds show up in terms of cost and tax implications, and performance.

Actively managed funds are generally more expensive than index funds, because the fund employs a team of active managers who hand-pick securities and trade them.

Active funds also have a different investment objective: to beat the market. Index funds merely seek to mirror the performance of its benchmark index.

So a large-cap actively managed fund might seek to outperform the S&P 500, whereas a large-cap index fund that tracks the S&P 500 would aim to deliver the same results as the index itself.

Index Funds

Active Funds

Types of securities All securities (stocks, bonds, etc.) All securities (stocks, bonds, etc.)
Investment objective To mirror its benchmark To outperform its benchmark
Management style Passive (securities in the fund match the index) Active (fund managers select securities in the fund on the basis of performance)
Cost Average expense ratio is about 0.03 to 0.05% Average expense ratio is about 0.50% to 0.75%
Tax efficiency Less turnover, more tax efficient Higher turnover, less tax efficient

Pros and Cons of Index Funds

There’s a lot to like about index funds but with any investment, it’s important to consider the potential downsides. Reading through an index fund’s prospectus can offer more insight into how the particular fund works, in terms of what it invests in, its risk profile, and the costs you’ll pay to own it. This can help you better gauge whether a particular index fund aligns with your investment strategy.

When weighing index funds as a whole, here are some important points to keep in mind.

Index Fund Pros

•   Simplified diversification. Diversification may help manage risk inside a portfolio. Index funds can make diversifying easier through exposure to multiple securities that represent a specific index.

•   Cost. Because they are passively managed, index funds typically charge fewer fees and carry expense ratios that are well below the industry average of 0.57%. Fewer fees allow you to keep more of your investment returns.

•   Tax efficient. Index funds tend to turn over assets less frequently than actively managed funds, which means fewer capital gains tax events — another way index funds can save investors money.

•   Consistent returns. The idea behind an index fund is that it will closely track its benchmark to mirror performance. Index funds can offer stable returns over time when they perform in tandem with their respective indices.

Index Fund Cons

•   Underperformance. Index fund returns can differ from one fund to the next and factors such as fees, expense ratios, and market conditions can affect how well a fund performs. It’s possible that rather than matching its benchmark, an index fund may deliver returns below expectations.

•   Cost. Between index funds vs. managed funds, index funds tend to have lower costs — but that’s not always the case. It’s possible to invest in index funds that prove more expensive than actively managed funds.

•   Tracking error. Tracking error occurs when an index fund’s performance doesn’t match the performance of its benchmark. This can happen if the fund’s makeup doesn’t accurately reflect the makeup of securities tracked by the index.

•   Limit on returns. Index funds aren’t designed to beat the market. Investing in these funds, without considering active investing strategies, could limit your return potential over time and cause you to miss out on bigger investment gains.

Why Invest in Index Funds?

Index funds and index investing may work better for a buy-and-hold investor who’s focused on investing for the long-term. Buy-and hold-strategies often go hand in hand with value investing strategies, in which the emphasis lies on finding companies that are undervalued by the market.

Utilizing index funds could simplify investing over the long term, and it may suit people who want to minimize risk-taking in their portfolios. But it’s important to consider the trade-offs involved with choosing index funds vs. actively managed funds.

Pros and Cons of Actively Managed Funds

With active funds, fund managers use their knowledge and expertise to determine which securities to buy or sell inside the fund in order to reach the fund’s investment goals.

As with index investing, using actively managed funds to invest can have its high and low points. Here are some key things to know about investing with actively managed funds.

Actively Managed Funds Pros

•   Professional expertise. Actively managed funds allow investors to benefit from a fund manager’s know-how and experience in the market. This may be reassuring to an investor who’s still learning the ropes of how trading works, or who has faith in a particular fund manager.

•   Higher returns. Actively managed funds seek to outperform the market. If the fund realizes its objectives, returns could possibly exceed those offered by index funds. Historically, though, the majority of active funds don’t outperform the market.

Actively Managed Funds Cons

•   Underperformance. As with index funds, it’s possible that an actively managed fund’s returns won’t meet investor expectations. This can happen if the fund manager makes a miscalculation when choosing securities or unforeseen events, such as a major economic downturn, deliver a blow to the market.

•   High management fees. The costs associated with having a fund manager make decisions are typically higher than with passively managed index funds.

•   Risk. Active trading can be riskier than index investing, since performance relies on the fund manager to make buying and sellings decisions.

•   Taxes. Since asset turnover is higher for actively managed funds, more capital gains tax events are likely. Even though an actively managed fund may generate higher returns, those have to be weighed against the possibility of increased tax liability.

Why Invest in Actively Managed Funds

Actively managed funds may offer more downside than upside to investors. Unlike index funds, actively managed funds may not be suited for a long-term, buy-and-hold strategy. But for investors who have the time or inclination to take their chances for a greater potential yield, they might be an attractive part of a portfolio.

Are Index Funds Better than Managed Funds?

Both actively managed funds and index funds aim to help investors achieve their goals, but in different ways and with potentially different results. Whether index funds or managed funds are better hinges largely on the individual investor and what they need or expect their investments to do for them.

When considering index funds and actively managed funds, ask yourself what’s more important: Steady returns or a chance to beat the market? While actively managed funds can outperform market indices, results aren’t guaranteed and in some cases, active funds can lag behind their benchmarks.

Index funds, on the other hand, may offer a greater sense of stability over time and potentially more insulation against market volatility. While all investments carry the risk of loss, over time there may be a smaller chance of losing money in an index fund. But there are no guarantees.

Lower investment costs can also be attractive when estimating net returns, but again it’s important to compare fund costs against fund performance individually, to ensure that you’re comfortable with the number.

The Takeaway

Whether you prefer index funds vs. managed funds might depend on your age, time horizon for investing, risk tolerance, and goals. If you lean toward a hands-off, goals-based investing approach that carries lower costs, index investing could suit you well.

On the other hand, if you’re more interested in beating the market, and if you believe active management is more likely to deliver outperformance, then you may consider the benefits of active investing.

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

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


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Claw Promotion: Customer must fund their Active Invest account with at least $10 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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What Factors Affect Your Credit Score?

What Factors Affect Your Credit Score?

Your credit score is one of the most influential measures that determine whether you’ll be approved for loans and credit cards. A number of factors go into calculating a credit score, including your history of on-time payments and how much debt you owe as well as what types of credit you have and how long your credit history is.

Knowing what affects your credit score is the first step to ensuring your score stays high so you can qualify for financing opportunities when they arise. We’ll address all your questions about what affects your credit score, as well as how to keep track of it.

Recommended: What Credit Score Is Needed to Buy a Car?

Why a Good Credit Score Is Important

In a nutshell, having a good credit score provides opportunities for you financially and can help you spend less overall on financing. If you want to buy a car, a good credit score can help you secure an auto loan at a low rate. Similarly, having good credit is key to opening a credit card.

Having a bad credit score — generally anything under 500 on the scale of poor to exceptional credit — can limit your financial opportunities. If you have bad credit, you may not qualify for loans that you apply for, or if you do, you may have higher interest rates. You also may not get approved for a credit card, unless it’s a secured card, which requires a deposit and has a low credit limit. A bad credit score could even hamper your job search, particularly if the job involves handling money.

The bottom line is that having bad credit hinders your ability to grow financially, so it’s important to do what you can to maintain a good credit score.

Recommended: 8 Reasons Why Good Credit Is So Important

Check your score with SoFi Insights

Track your credit score for free. Sign up and get $10.*


Recommended: What Is The Difference Between Transunion and Equifax?

5 Factors That Influence Your Credit Score

The first step toward building your credit score is understanding what factors help to determine it. In general, these are the five credit score factors that shape your score:

Factor #1: Credit Utilization

When it comes to what affects your credit score, one of the most important factors is how much credit you have available versus how much debt you currently have. It’s called your credit utilization, and you can calculate this number by dividing your outstanding debts by your total credit available.

Let’s say you have three credit cards with a total credit limit of $30,000. You owe $3,000 in total. So your credit utilization would be:

3,000 / 30,000 = 0.10

Your credit utilization of 10% (you’re using 10% of your total available credit) is great, as lenders generally want to see a utilization rate below 30% to approve a loan application.

Factor #2: Payment History

You might not feel like an occasional late payment on a credit card is a big deal, but it can impact your credit score negatively. In fact, payment history accounts for 35% of your FICO score (the scoring system for the credit bureau Experian).

The easiest way to raise your credit score? Pay your bills on time. Many loans and credit cards will allow you to set up autopay, which is a foolproof way to make sure you never miss a payment.

Factor #3: Credit History Length

You’re not born with a credit history; it has to be built over time. Many college students start the journey by opening their first credit card account. This is a great place to start, though remember that good habits like paying on time and keeping your credit utilization rate down will help build good credit.

And lest you think if you want a new credit card you need to close an old one, you don’t. The longer you have relationships with credit companies, the better your credit.

Factor #4: Types of Credit

While this factor isn’t nearly as important as the others, the types of credit you have can impact your credit score. Having a nice mix of credit — such as credit cards, a home mortgage, and an auto loan — can contribute positively to your credit scores, though it isn’t required.

Recommended: Should I Sell My House Now or Wait?

Factor #5: Recent Applications

Whenever you apply for credit, whether that’s a car loan or a credit card, there is what’s called a “hard inquiry” on your credit report. If you make several applications within a few days or weeks of one another, it may be seen as derogatory on your report, and your credit score might dip a bit.

Consider your credit needs carefully and try to look for lenders that let you see if you prequalify, since that is considered a “soft inquiry” and won’t impact your credit the same way.

Remember, There Are 3 Main Credit Scores to Consider

While the factors above are what generally affect your credit score, you actually have three different credit scores, each of which may be calculated slightly differently. These three credit scores come from the following three personal credit bureaus that track your financial activity:

•   TransUnion

•   Experian

•   Equifax

Each bureau has its own credit scoring system that it uses to determine your score. Some loans and credit card companies report to one or two bureaus — or even all three — so it’s important to know that your activity may show up slightly differently depending on the reporting agency.

How to Track Your Credit Score

Now that you understand what affects your credit score, it’s your responsibility to stay on top of your score so you know when it changes. Each credit scoring bureau updates scores on a different schedule, but you can expect updates roughly every 30 to 45 days.

There are several places you can check your credit score. Some banks and credit card issuers offer the service free to customers. Additionally, you are entitled to one free credit report a year from
AnnualCreditReport.com
, which provides your credit reports and scores from each of the three credit bureaus.

Tracking your score is important even if you don’t plan to take out a loan or open a credit card any time soon. Make sure to regularly review your report to ensure there are no discrepancies, such as a late payment you know you didn’t make, or an open account you closed. If you see anything that is incorrect, contact the credit bureau immediately to get it resolved.

Recommended: Does Net Worth Include Home Equity?

The Takeaway

Once you understand what affects your credit score, you have the power to improve your score by taking steps such as reducing your credit utilization and paying your bills on time. As you build your credit, you will qualify for better loan offers and interest rates on credit cards, which can empower you to purchase what you need without high expense.

Take control of your finances with the SoFi Insights money tracker app, which allows you to track your spending, set goals, and monitor your credit, all in one place.

See how SoFi’s Insights can help you easily keep track of your credit score and what affects it.


Photo credit: iStock/oatawa

*Terms and conditions apply. (Must click on the link to be eligible.) This offer is only available to new SoFi users without existing SoFi accounts. It is non-transferable. One offer per person. To receive the Rewards points offer, you must successfully complete setting up Credit Score Monitoring. Rewards points may only be redeemed into SoFi accounts such as cash in SoFi Checking and Savings or loan balances, Stock Bits, fractional shares and cryptocurrency subject to program terms that may be found here: SoFi Member Rewards Terms and Conditions. SoFi reserves the right to modify or discontinue this offer at any time without notice.
Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
SoFi’s Insights tool offers users the ability to connect both in-house accounts and external accounts using Plaid, Inc’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score provided to you is a Vantage Score® based on TransUnion™ (the “Processing Agent”) data.
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.
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.
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