InvestLL Archives | Page 31 of 78

Sep

2023

What Is Yield to Call? Formula & Examples

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

An investor calculating yield to call is getting an idea of how much their overall bond returns will be. Specifically, yield to call refers to the total returns garnered by holding onto a bond until its call date. That doesn’t apply to all bonds, naturally, but can be very important for many investors to understand.

For investors who utilize bonds — callable bonds, in particular — as a part of their investment strategy, having a deep understanding of yield to call can be critical.

What Is Yield to Call?

As mentioned, yield to call (often abbreviated as “YTC”) refers to the overall return earned by an investor who buys an investment bond and holds it until its call date. Yield to call only concerns what are called callable bonds, which are a type of bond option.

With callable bonds, issuers have the option of repaying investors the value of the bond before it matures, potentially allowing them to save on interest payments. Callable bonds come with a call date and a call price, and the call date always comes before the bond itself matures.

A little more background: in a YTC scenario, ”yield” refers to the total amount of income earned over a period of time. In this case, the yield is the total interest a bond purchaser has accrued since purchasing the bond.

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

Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.

*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.

How Yield to Call Works

If an investor buys a callable bond, they’ll see interest payments from the bond issuer up until the bond reaches maturity. The callable bond also has a call date, and the investor can choose to hold onto the bond until that date. If the investor does so, then YTC amounts to the total return the investor has received up until that date.

Yield to call is similar to yield to maturity, which is the overall interest accrued by an investor who holds a bond until it matures. But there are some differences, especially when it comes to how YTC is calculated.

💡 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.

Yield to Call Formula

The raw yield to call calculation formula looks like this:

Yield to Call Formula:

Yield to call = (coupon interest payment + ( The call price – current market value ) ÷ time in years until call date ) ÷ (( call price + market value ) ÷ 2)

An investor should have all of the variables on-hand to do the calculation. Before we run through an example, though, here’s a breakdown of those variables:

• Yield to call: The variable we are trying to solve for!

• Coupon interest payment: How much the bondholder receives in interest payments annually.

• Call price: The predetermined call price of the callable bond in question.

• Current market value: The bond’s current value.

• Time until call date: The number of years until the bond’s first call date arrives

The yield-to-call calculation will tell an investor the returns they’ll receive up until their bond’s call date. A bond’s value is roughly equal to the present value of its future earnings or cash flows — or, the return, at the present moment, that the bond should provide in the future.

How to Calculate Yield to Call

It can be helpful to see how yield to call looks in a hypothetical example to further understand it.

Yield to Call Example

For this example, we’ll say that the current face value of the bond is $950, it has an annual coupon interest payment of $50, and it can be called at $1,000 in four years.

Here’s how the raw formula transforms when we input those variables:

Yield to call = ($50 + ( $1,000 – $950 ) ÷ 4 ) ÷ (( $1,000 + $950 ) ÷ 2)

YTC = $25 ÷ $975

YTC = 0.0256 = 2.56%

Interpreting Yield to Call Results

Once we know that our hypothetical, callable bond has a yield to call of 2.56%, what does that mean, exactly? Well, if you remember back to the beginning, yield to call measures the yield of a bond if the investor holds it until its call date.

The percentage, 2.56%, is the effective return an investor can expect on their bond, assuming it is called before it matures. It’s important to remember, too, that callable bonds can be called by the issuer at any time after the call date. So, just because there is an expected return, that doesn’t necessarily mean that’s what they’ll see.

Yield to call calculations make a couple of big assumptions. First, it’s assumed that the investor will not sell the bond before the call date. And second, the calculation assumes that the bond will actually be called on the call date. Because of these assumptions, calculations can produce a number that may not always be 100% accurate.

Yield to Call Comparisons

Two calculations that are similar to YTC are “yield to maturity,” and “yield to worst.” All three calculations are related and offer different methods for measuring the value that a bond will deliver to an investor.

A different type of yield calculation would be needed if you wanted to try and measure the overall interest you’d earn if you held a bond to maturity. That’s different from measuring the overall interest you’d earn by simply holding the bond until its call date.

Yield to Call vs Yield to Maturity

YTC calculates expected returns to a bond’s call date; yield to maturity calculates expected returns to the bond’s maturity date. Yield to maturity gives investors a look at the total rate of return a bond will earn over its entire life, not merely until its call date (if it has one).

Yield to Call vs Yield to Worst

Yield to worst, or “YTW,” measures the absolute lowest possible yield that a bond can deliver to an investor. Assuming that a bond has multiple call dates, the yield to worst is the lowest expected return for each of those call dates versus the yield to maturity. Essentially, it gives a “worst case” return expectation for bondholders who hold a bond to either its call date or for its entire life.

If a bond has no call date, then the YTW is equal to the yield to maturity — because there are no other possible alternatives.

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

The Takeaway

Learning what yield to call is and how to calculate it, can be yet another valuable addition to your investing tool chest. For bond investors, YTC can be helpful in trying to figure out what types of returns you can expect, especially if you’re investing or trading callable bonds.

It may be that you never actually do these calculations, but having a cursory background in what the term yield to call means, and what it tells you, is still helpful information to keep in your back pocket.

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

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

FAQ

What is the advantage of yield to call?

Yield to call helps investors get a better idea of what they can expect in terms of returns from their bond holdings. That can help inform their overall investment strategy.

How do you calculate yield to call in Excel?

Calculating yield to call can be done the old fashioned way, with a pen and paper, or in a spreadsheet software, of which there are several. An internet search should yield results as to how to calculate YTC within any one of those programs.

Is yield to call always lower than yield to maturity?

Generally, an investor would see higher returns if they hold a bond to its full maturity, rather than sell it earlier. For that reason, yield to call is generally lower than yield to maturity.

Photo credit: iStock/MicroStockHub

Sep

2023

What Is Scalp Trading?

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Scalp trading, or scalping, is a style of short-term trading used with stocks, cryptocurrencies, and other assets. The goal of this trading style is to make profits off of small changes in asset prices. Generally this means buying a stock, waiting for it to increase in value by a small amount, then selling it.

The theory behind it is that many small gains can add up to a significant profit over time. Scalp trading is one of the most popular day trading strategies. Scalping requires a lot of focus, quick decision-making, the right trading tools, and a strategy — and even then, it’s no sure thing. Since traders make many small gains, one big loss could wipe out all their profits.

How Scalping Works in Trading

The goal of scalping is to make many small profits during a trading session. This is the opposite of a buy-and-hold or long term trading strategy, where one hopes to see their portfolio grow over time. Scalpers might make anywhere from 10 to more than 100 trades in a single day, taking a small profit on as many of them as possible. And they might only stay in each position for a few minutes.

With each trade they assess the risk-to-reward ratio with a goal of profiting on more than 50% of their trades. Each win may be small, but the profits can add up over time if they outnumber the losses. Often, scalpers make use of stop losses and leverage when making trades.

Scalp trading reduces risk exposure, since traders only have their money in the market for a short amount of time. It can also be an easier day trading strategy than some others because the goal is to capitalize on small price movements. Small moves happen constantly in the market, and it’s easier to make a profit of a few cents or dollars than a larger amount.

However, any type of day trading involves a significant amount of risk. Scalping is challenging and can result in large losses. This is just one reason why some traders use scalping along with other trading methods.

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

Scalp Trading Strategies

There are many different scalp trading strategies, some of which can be used together.

Systematic Planning

Technical analysis helps scalp traders spot trading opportunities and plan exits ahead of time. Traders use one-minute charts, Level II quotes, moving averages, exchange order books, and other tools while scalping. Since positions may be entered and exited within seconds or minutes, five- or 10-minute charts aren’t very useful.

On the Fly

Although fundamental analysis doesn’t play a large role in scalping, it can help to identify stocks that are currently in the news or of interest based on a current event, which may lead to more price movement and trading opportunities. Higher volatility is generally a good sign for scalpers.

Shorting Stocks

Some scalpers also short stocks and sell when they decrease in value. This can be done with the same asset repeatedly, or with different assets throughout a trading session.

Bid/Ask Profiting

Some scalpers prefer to earn profits off of the bid/ask spread rather than actual stock price movements. This takes a significant amount of experience and is a particular trading skill that takes time to learn. It entails looking for trades with a wide spread, meaning a large difference between the broker’s ask price and the price at which a trader buys the asset.

Range Trading

With this strategy, the trader waits for an asset to enter a specific price range before they start trading. Generally, the range is between a support and a resistance level.

Market Making

Market making is when traders post a bid and an offer on a stock at the same time. This only works with stocks that trade a large volume but have low volatility, and the profits are small.

How to Scalp Trade

While there is no one way to engage in scalp trading, these are the general guidelines that scalpers follow to make decisions:

• Create a watchlist each day based on fundamental analysis and news

• Trade stocks with enough liquidity that there will be price movement and more options for exit points

• Quickly sell a stock isn’t increasing in value

• Make a daily profit goal

• Set goals for each stock trade and stick to them

• Buy stocks at breakouts

• Keep trades short for more chance at a profitable exit

• Adjust exit points as stocks move.

Pros and Cons of Scalp Trading

Scalp trading is a particular day trading strategy which works well for some people, there are many risks associated with day trading.

Pros of Scalp Trading

• Small gains can add up to significant returns

• It reduces risk exposure to market due to short trade times

• It may be easier than some other day-trading strategies

• It can be easier to make profitable trades when the goal is to profit off of small movements rather than large price movements

• There are many trading opportunities, no matter what the market conditions are.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Cons of Scalping

• Even one large loss can cancel out any gains made during a trading session

• It requires a lot of focus to watch the charts for several hours and execute trades, and can be tedious

• It requires knowledge and experience with technical analysis

• Transaction and commission fees can add up quickly if making multiple trades per day—and potentially cancel out profits. It’s key to use a broker that doesn’t charge commissions or one that offers discounts to high volume traders.

• If traders experience a few losses it can be distressing, and it’s easy to let emotions get in the way of good trading habits. Scalping may be one of the most stressful trading strategies.

• Scalpers often use margin trading and leverage to increase their positions, which can be very risky.

The Takeaway

Scalp trading, or scalping, is a style of short-term trading used with stocks or other securities. Scalping is best suited for more experienced traders, since it requires an understanding of technical analysis, fast trades, and an understanding of how to set up and execute trades in specific ways.

But scalp trading is just one of many different strategies when it comes to trading stocks and other assets. While trading can seem complex, there are simple ways to get started building a portfolio.

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.

SOIN0623009

Sep

2023

Understanding Low-Float Stocks

By Ashley Kilroy | Growing Wealth, invest, Investing | Comments Off

Table of Contents

Stock Float: Quick Recap
What Are Low-Float Stocks?
Floating Stock Example Calculation
Understanding Shares Outstanding
Benefits of Trading Low-Float Stocks
Importance of Low-Float Stocks
6 Reasons for Low-Floating Shares
Evaluating Low-Float Stocks
How to Trade Low-Float Stocks
FAQ

Low-float stocks are companies with a relatively small number of shares available for public trading. It doesn’t mean the company has very few shares in total.

A company’s float, or floating shares, are those available after subtracting closely held and restricted shares from all outstanding shares. In some cases, a company has a lower float, meaning there are relatively few shares for the public to trade.

low-float stocks are considered more volatile and have higher spreads. But a company’s float can change owing to various conditions.

Stock Float: Quick Recap

The float of a stock measures the number of shares of a particular stock. It indicates the number of shares of stock available for trading. The measure doesn’t include closely held shares, those owned by controlling investors, employees, or company owners.

Calculating floating stock requires looking at a company’s balance sheet and taking the total number of shares of a company and subtracting any restricted and closely held shares.

Stock indexes, such as the S&P 500, often use floating stock as the basis for figuring out the market cap (the total value of outstanding shares in dollars) of a company.

Recommended: Investing 101 Guide

What Are Low-Float Stocks?

A company’s float is the total number of shares outstanding, minus closely held and restricted shares.

Some larger corporations have very high floats in the billions, and investors typically consider a float of 10 to 20 million shares as a low-float. But there are companies with floats of less than one million, and you can find even lower-float stock trading on over-the-counter exchanges (OTC).

Companies with a low-float frequently have a large portion of their equity held by controlling investors such as directors and employees, which leaves only a small percentage of the stock available for public trading. That limited supply can cause dramatic price swings if demand changes quickly.

Because low-float stocks have fewer shares available, investors may have difficulty finding a buyer or seller for them. This may make the stocks more volatile, which appeals to day traders. The bid/ask spread of low-float stocks tends to be high as well.

Floating Stock Example Calculation

If a trader looks at a company’s balance sheet, they can see how many outstanding shares the company has under the heading “Capital Stock.”

Looking at fictional Company A, the company’s balance sheet shows outstanding shares and floating stock shares:

• 50 million shares outstanding

• 45 million float shares

This is a high-float stock, with 90% of the stock available for trade. By contrast, Company B has:

• 2 million shares outstanding

• 475,000 float shares

This is a 23.75% float, and could serve as a signal for day traders to look at other factors to determine whether they want to invest in the stock.

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

Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.

*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.

Understanding Shares Outstanding

Another stock market term that helps explain low-float stocks is shares outstanding. Shares outstanding refers to the total number of shares issued by a company, including those that can’t be traded.

The float is the number of shares that’s the percentage of the shares outstanding available for public trade. This is known as the float percentage. Companies might have numerous shares outstanding, but only a small percentage of floating stock.

The amount of floating stock a company has typically changes over time, as companies might sell more stock to raise money, or company stakeholders might sell their holdings. If a stock goes through a stock split or reverse split, this will also increase or decrease floating shares.

Benefits of Trading Low-Float Stocks

Essentially, low-float stocks primarily benefit day traders who are interested in earning large profits in a short time.

By their nature, low-float stocks are volatile. There are relatively few low-float stocks in the marketplace, and their prices tend to go up and down easily and quickly. Moreover, every trade of a low-float stock issue can have a larger impact on the value of the stock than it would on a security with a higher float.

For example, when good news hits a security with a limited supply, it doesn’t take much for it to have a huge impact on the share price. A low-float stock can see big gains when demand skyrockets. Conversely, if bad news comes to the same security, its price can nosedive rapidly.

The dramatic volatility in investing in low-float companies, can lead to a greater level of risk. But an experienced and highly skilled day trader might be delighted to take on this volatility challenge in exchange for potential continuous gains in a short trading session.

Importance of Low-Float Stocks

If you’re interested in investing in a particular company, it’s important to understand its stock float. You don’t want to overlook this detail while performing your due diligence on an issuing company.

The size of a stock float can change over time, which would affect the stock’s liquidity and volatility. Stock buybacks, secondary share offerings, insider buying or selling shares, and stock splits (or reverse splits) can cause the number of shares outstanding to change, and thus the float.

6 Reasons for Low-Floating Shares

Low-float stocks tend to have higher spreads and higher volatility than a comparable higher-float stock. You may find it hard to enter or exit positions in stocks that have a low float. What are some specific instances that could account for low-floating shares?

1. Special Purpose Acquisition Companies (SPACs)

Certain shares may be trading at a low float because the company that’s issuing the stock is part of a special purpose acquisition company (SPAC). A SPAC is a corporation formed for the sole purpose of raising investment capital through an initial public offering (IPO).

Typically, experienced business executives in the same industry as the SPAC’s target acquisition become the founders of a SPAC. A SPAC could take as long as a number of years to complete. And, even when the new company does go public, there may be fewer shares available for public purchase because they’re held by founders of the SPAC or other officers and insiders close to the deal.

2. The Company Is Family Operated

Another reason for low-float shares could be that the company is family owned. In these cases, a family likely would own a significant share of the company’s shares and would influence important decisions, like electing a chairman and CEO. In particular, if a family-operated company is small to midsize, there may be few shares left for the public to buy.

In fact, family-owned or operated businesses are all around us — including well-known names like BMW, Samsung, and Wal-Mart Stores. About 35% of all companies in the S&P 500 index are family controlled, and 118 of the top family-owned companies in the world are based in the U.S., according to the 2023 Global Family Business Index.

3. Stock Buybacks

If a company buys back some of its shares, that may affect its float by reducing the number of shares available for trading; there’s even a name for it: float shrink.

Regular share buybacks, along with dividend payments, are two ways that a company may reward shareholders. Another reason for a share buyback could be for a company to gain better control of its strategic initiatives without needing to consult its shareholders.

4. Company Has Donated Shares to Its Charitable Foundation

If a company founder has donated a large percentage of its shares to an associated charitable foundation, this could result in a lower float, if the foundation has held onto the shares which are then excluded from the overall float count.

5. Initial Public Offerings (IPOs)

In another scenario, a company might be involved in an initial public offering (IPO), in which its shares are considered privately held until the IPO is complete. Once the new shares are made publicly available for trade, a stock could be considered low float because a high percentage of shares are still restricted for a period of time.

6. Stock-Based Compensation

Some companies have initiatives that reward their employees with company stock; either as part of an incentive program or combined with their regular pay. A company also could have an equity compensation program in place as a way of rewarding employees, executives, and directors of a company with equity in the business.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

Evaluating Low-Float Stocks

Not every low-float stock represents a good buy, but it is a popular strategy for day traders. To evaluate a low-float stock, day traders often look at several other factors.

High Relative Volume

The relative volume shows a stock’s current volume in comparison to earlier periods in a company’s history. This is important to investors because it can affect a stock’s liquidity. If a stock has low liquidity, traders can potentially get stuck with shares they can’t sell.

They may also find themselves unable to take advantage of news catalysts with a significant buy or sell the move. If a stock’s price changes, but there isn’t a lot of trading volume, it may not be a good pick.

News Catalysts

Positive or negative news about a company frequently makes a low-float stock increase or decrease in a short amount of time.

Day traders keep a close eye on the stock market and corporate news to see which stocks likely would make moves. A news event can cause a low-float stock to move anywhere from 50% to 200% in a single day, as they are in low supply.

Float Percentage

This is the percentage of the total shares of stock available for trading. Each trader has their preferences, but most look for a percentage between 10% and 25%.

How to Trade Low-Float Stocks

When trading a low-float stock, a trader might buy and sell the same stock multiple times in a single day. Then, move on to a different low-float stock the next day in an extreme form of market timing.

Many traders will plan out their profit targets and support and resistance ahead of time and stop losses to reduce risk. As with any trade, traders can look at technical indicators like candlestick charts and moving averages to see whether a stock looks bullish or bearish.

A good strategy pays attention to technical analysis and rather than simply buying or selling based on rumors or news.

Finding low-float Stocks

Finding and evaluating stocks to trade requires some knowledge and experience. Several platforms offer the ability to trade low-float stocks. Some of these platforms allow traders to filter by criteria such as volume and float to find the best opportunities. Traders can look for stocks with a float of less than 50 million and a relatively high volume.

Penny stocks less than $5 are very popular with day traders. Traders can also look to watchlists for ideas about which low-float stocks to trade.

• Reuters’ Free Scanner: Free to register. Users can find low-float stocks by scanning with the filter “float.”

• Trade Ideas: This site has multiple low-float stocks lists for the U.S. market. It highlights stocks that are moving so that traders can capitalize on opportunities.

• Stock Screeners: There are many other stock-screening tools you can use to find low-float stocks — such as Benzinga Pro, which lets you “search and filter stocks by any attribute.”

Some Risks to Know

Every investment comes with risks, but low-float stocks present some particular challenges. Day trading is inherently very risky and can result in significant losses (as well as gains). So, other types of investments are often a better fit for those with a low appetite for risk.

Low-float stocks can have high volatility; their price can change within seconds or minutes. If an investor isn’t careful, knowledgeable, or always on top of it, this volatility could wipe out a large portion of their portfolio. Low-float stocks could also present substantial profit opportunities; traders might see gains of 50% to 200% in a single day.

Looking at both the news and technical indicators is crucial for trading success. Trading low-float stocks requires a daily look at market news, as the stocks that look like a promising trade one day may not be ideal the next.

The Takeaway

The term “low-float,” as it pertains to stocks, refers to the amount of shares available to trade in the public market after the appropriate number of shares are allocated to founders, officers of the company, and other inside investors.

It’s important for investors to be aware of the amount of a company’s low-floating stock, as it can reflect the stock’s liquidity. If a stock has relatively few available issues, it might be harder for traders to sell it.

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

FAQ

Is a low-float stock good?

When a company’s stock is considered low float, there are fewer shares available for public trading. That can increase volatility for some investors, while others (like day traders) may be able to leverage changes in the share price.

How important is a stock’s float?

Understanding why a company may have a higher or lower float is an important factor for investors to take into consideration, because it can reveal (or be tied to) other aspects of the company’s management or status.

Are low-float stocks good for day trading?

Low-float stocks can garner huge profits for day traders when a particular industry, sector, or company is in high demand. But when demand shifts, low-float stocks can be risky.

What’s the difference between high- and low-float stocks?

You can find a company’s float by taking the total number of shares outstanding and subtracting the number of shares that are closely held or restricted. If the remainder is a high percentage of the outstanding shares, that’s considered a high-float stock — which can indicate the stock has a certain amount of liquidity.

If the remainder is a small percentage of the outstanding shares, that indicates a low-float stock, which generally has a higher spread, lower liquidity, and may be more volatile.

Photo credit: iStock/damircudic

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.

SOIN0523017

Sep

2023

Guide to Morningstar Ratings

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

Morningstar is a highly regarded financial services firm whose mission revolves around providing investors with the research and tools, including Morningstar ratings, they need to make informed decisions in their portfolios.

Those tools, used by individual investors as well as institutional investors and financial advisors, include Morningstar fund ratings, which can help investors gauge how well various mutual funds and exchange-traded funds (ETFs) have performed over time.

What are Morningstar Ratings?

In simple terms, the Morningstar ratings system is a tool investors can use to compare financial securities such as mutual funds and ETFs. And if you’re wondering whether Morningstar ratings are legitimate, the answer is yes. Even FINRA, the Financial Industry Regulatory Authority, uses Morningstar ratings.

Morningstar reviews of mutual funds and ETFs reflect different metrics, depending on which ratings system is being applied. The main Morningstar ratings investors may turn to learn more about a particular investment are the Star Ratings and Analyst Ratings. (Morningstar also has a separate ratings system for individual stocks.)

These ratings can be helpful to investors for a variety of reasons — whether they’re trying to diversify their portfolio, or some research into socially responsible investing, and trying to find securities that fit their strategy.

How Morningstar Ratings Work

As Morningstar itself describes, the ratings system uses a methodology based on specific categories and risk-adjusted return measures. The company will only rate a fund that’s been around for more than three years. Morningstar also updates its ratings on a monthly basis.

You can use these ratings to select from the funds available in your 401(k), or to decide which funds to add to an IRA or a taxable brokerage account.

Recommended: Investing in Growth Funds

The “Star Rating” Explained

The Morningstar Star Rating system, more simply referred to as star rating, is a quantitative ranking of mutual funds and ETFs. Introduced in 1985, the star rating looks backward at a fund’s past performance, then assigns a rating from one to five stars based on that performance.

As mentioned, Morningstar reviews ETFs and mutual funds with a record of more than three years, so newer funds do not receive a star rating until they’re reached this milestone. The rating methodology utilizes an enhanced Morningstar risk-adjusted return measure. Specifically, the star ratings system looks at each fund’s three-, five-, and 10-year risk-adjusted returns.

Star ratings can serve as a report card of sorts for comparing different funds, based on how they’ve performed historically. The Morningstar ratings are not forward-looking, as past performance is not a foolproof indicator of future behavior. But investors can use the ratings system as a starting off point for conducting fund research when deciding where to invest.

If you’re looking for a tool to help you compare mutual funds or exchange-traded funds at a glance based on past performance, the star rating system can help.

The “Analyst Rating” Explained

The Morningstar Analyst Rating takes a different approach to ranking funds and ETFs. Instead of looking backward, the qualitative analyst rating looks forward to assess a fund’s ability to outperform similar funds or a market benchmark. Rather than using stars, funds receive a rating of Gold, Silver, Bronze, Neutral or Negative, based on the analyst’s outlook for performance.

The firm does not update analyst ratings as frequently as star ratings. Morningstar reviews for analyst ratings are reevaluated at least every 14 months. The firm typically assigns analyst ratings to funds with the most interest from investors or the most assets.

When ranking funds, analysts look at three specific metrics:

• People

• Process

• Parent

Performance is also taken into account within the People and Process pillars. In order to earn a Gold, Silver or Bronze rating, an analyst must determine that an active fund can beat its underlying benchmark when adjusted for risk.

Generally speaking, these Morningstar reviews go into more detail, in terms of the analysis, ranking, and comparison of funds. If you’re an active trader or a buy-and-hold investor you might use the Morningstar analyst ratings to get a feel for what a particular mutual fund might do next, which can be helpful when an investor is, for example, trying to pick an ETF.

How Morningstar Measures Volatility

Morningstar uses a few key volatility measurements as it aims to minimize risk and maximize returns through strategic diversification. Chief among those measurements are standard deviation, mean, and the Sharpe ratio.
It’s a somewhat complicated process, but using these three measurements in tandem helps Morningstar get a handle on volatility and make appropriate ratings decisions.

💡 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.

Example of a Morningstar Rating

Morningstar star ratings are free to access for investors on the company’s website, and it’s relatively easy to find plenty of examples of Morningstar ratings on the platform. For instance, to find a star rating for a particular fund or ETF you’d simply search for it using its name or ticker symbol. You can also view Morningstar ratings and picks for funds by category, such as small-cap funds or U.S. index funds.

Here’s an example of a Morningstar rating for the Calvert International Responsible Idx I fund (CDHIX). This fund, which is in the foreign large-blend category and is an index fund, has a four-star rating from Morningstar. You can see at a glance that the fund has an expense ratio of 0.29%, a minimum investment of $100,000 and just over $867 million in assets, as of August 2023.

Are Morningstar Ratings Accurate?

Morningstar fund ratings are designed to be a guide to use as you invest, rather than the absolute word on how well a fund is likely to perform. That’s to say that there’s always going to be risk involved when investing, so don’t expect any rating to be a sure-thing.

So, how well do Morningstar ratings perform over time and are they an accurate guide for investing?

According to Morningstar’s own analysis of its ratings system, the star ratings can be a useful jumping-off point for investors. That analysis resulted in three key findings:

• Funds with higher star ratings tend to have lower expense ratios and be cheaper for investors to own

• Higher rated funds tend to be less volatile and experience less dramatic downward swings when the market is in flux

• Funds that received higher star ratings tended to produce higher returns for investors compared to funds with lower ratings

The analysis didn’t look specifically at how star ratings and fund performance aligned through different bull and bear markets. But the ultimate conclusion Morningstar drew is that the Star Ratings tend to steer investors toward cheaper funds that are easier to own and stand a better chance of outperforming the market.

Use Expense Ratios

According to Morningstar, fees are one of the best predictors of future performance, at least for Star Ratings. For funds and ETFs, that means it’s important to consider the expense ratio, which represents the cost of owning a fund annually, calculated as a percentage of fund assets.

Actively managed funds typically carry higher expense ratios, as they require a fund manager to play an important role in selecting fund assets. Passively managed funds and ETFs, on the other hand, often have lower expense ratios.

So which one is better? The answer is that it all comes down to performance and returns over time. A fund with a higher expense ratio is not guaranteed to produce a level of returns that justify higher fees. Likewise, a fund that has a lower expense ratio doesn’t necessarily mean that it’s a poor investment just because it’s cheaper to own. Morningstar’s research found that the average one-star fund cost significantly more than the average five-star fund.

As you do your own research in comparing funds and ETFs, consider both performance and cost. This can help you find the right balance when weighing returns against fees.

How Should Investors Use Morningstar Ratings?

How much do Morningstar ratings matter in the grand scheme of things? The answer is, it depends on what you need from investment research tools.

Morningstar reviews of mutual funds and ETFs can be helpful for comparing investments, especially if you’re just getting started with the markets. Morningstar is a respected and trusted institution and both the Star and Analyst Ratings are calculated using a systematic approach. The reviews aren’t just thrown together or based on a best guess.

They’re designed to be a guide and not a substitute for professional financial advice. So, for instance, you may use them to compare two index funds that track the same or a similar benchmark. Or you may use them to compare two ETFs that are representative of the same market sector.

Risks of Morningstar Ratings

Morningstar Ratings are not an absolute predictor of how a mutual fund or ETF will perform in the next five minutes, five days, or five years. After all, there’s no way to perfectly predict how any investment will perform as the market changes day to day or even minute-to-minute.

One risk to avoid with Morningstar ratings is relying on them solely as your only research tool and not doing your own independent research. Again, that means checking expense ratios as well as looking at the underlying assets of a particular fund and its investment strategy (i.e. active vs. passive) to determine how well it aligns with your goals and risk tolerance.

Looking only at Morningstar reviews without doing your own due diligence could cause you to invest in funds that aren’t the best fit for your portfolio. Or you may overestimate how well a fund will perform, only to be disappointed later. For those reasons, it’s important to look under the hood, so to speak, to ensure that you fully understand what you’re investing in before buying in.

Morningstar Ratings for Funds

As discussed, Morningstar’s rating system mostly focuses on funds, including index funds, mutual funds, and ETFs. The company also has a ratings system for individual stocks, but its bread and butter is its focus on funds. And, as a quick refresher, it uses a data-driven, quantitative methodology for determining those rankings.

Also, as it bears repeating, a good Morningstar rating does not mean that an investment is risk-free.

Other Investment Risk Rating Providers

Morningstar is just one of many companies that offers investment ratings. An internet search will likely yield many results. But it’s a list that includes many familiar names, such as Bloomberg, Nasdaq Market Data Feeds, S&P Global Market Intelligence, MarketWatch, Thomson Reuters, and others.

💡 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).

Trading Stocks With SoFi

Having research tools can help you make educated decisions about where and how to invest. Morningstar Ratings are one tool you can use. When you’re ready to invest and apply the knowledge you’ve acquired, the next step is opening an online brokerage account. But keep in mind that there are many ratings services on the market, and that Morningstar’s ratings are far from the only research tool out there.

It’s also important for investors to keep in mind that all investments involve risk, whether they’re highly-rated or not. Be sure to do your due diligence before investing, but know there’s always a chance that things could turn sour on you.

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

FAQ

How reliable are Morningstar ratings?

Morningstar ratings are generally considered to be high-quality in the financial industry, but that doesn’t mean that its ratings are always spot-on. All investing involves risk, and even a high rating doesn’t guarantee that an investment will pan out.

Is a Morningstar rating of “5” good?

Morningstar uses a scale of one to five “stars” to rate investments, with five stars being the highest, or best-quality investment. So, yes, a five-star rating is generally considered good, although not risk-free.

Sep

2023

What Are Real Estate Options? Advantages for Buyers

Understanding the Basics of Real Estate Options

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

Another way to invest in real estate is through buying or selling real estate options. With an options contract, a buyer is granted the right to purchase a property for a specific price by a specific date, but they are not obligated to buy it.

In order to purchase this option, the buyer of the contract pays the seller a premium.

This is a flexible and typically less expensive way to enter the real estate market that may also help reduce risks involved in single property investment.

What Are Real Estate Options?

Real estate options are contracts between a potential buyer and seller. They grant the buyer the exclusive right to purchase a particular property within terms set in the contract. But the buyer doesn’t have to purchase the property.

However, if the buyer decides to exercise the option and purchase the property, the seller is obligated to sell the property at the agreed-upon price. Once the agreement is entered into, the property owner can’t sell to anyone else within the time period set in the option.

An options contract for a purchase is also known as a call option, whereas an option to sell would be called a put option.

Recommended: Call vs Put Options: Main Differences

How Do Options in Real Estate Work?

Generally, real estate options set a particular purchase price and are valid for anywhere from six months to one year. The buyer doesn’t have to purchase the property, but if they want to, the seller is obligated to sell to them even if the market price has gone up.

The buyer pays what is known as a “premium” in options terminology to enter into the contract. If they decide not to buy the property, the property owner (the seller) keeps that premium.

Real estate options are most often used in commercial real estate, but they can be used by retail investors as well. They aren’t sold on exchanges, and each contract is specific for the property it represents. Usually a contract is only for a single property, not multiple properties.

Real estate options are similar to stock options in that they set a specific price, premium, and period of time for a contract related to an underlying asset. Options can be exercised early or at the expiration date. They can also be sold to another investor.

• Most of the benefits involved in real estate options tilt in the buyer’s favor.

• If the property value goes up a few months into the contract, the buyer can exercise the contract and purchase the property, and sell it for a profit.

• If the property value drops, the buyer can simply let the option expire — thus losing only the premium they paid, which is typically a small percentage of the value of the underlying asset or property in this case.

If the buyer decides not to exercise the contract, they can sell it to another buyer at a potentially higher premium (and pocket the difference).

For a seller, there is the potential for them to make a profit if the buyer exercises their option to purchase the property. They may also profit if the buyer doesn’t exercise the option — at which point they can keep the premium amount, and then sell the contract (or the property) to someone else.

💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

Lease Options

In addition to real estate options for purchases, there are also lease options. These are rent-to-own agreements between a buyer and seller. They let someone lease a property with the option to buy it after a certain amount of time, but not the obligation.

Generally with a lease option, some or all of the rental payment goes towards the purchase. Some lease options lock in a particular price, but others just give the buyer the exclusive right to buy at whatever the market price is.

Although lease options can be great for buyers, they are also more expensive than simply renting a property since they involve a premium. For this reason, it’s important for a buyer to carefully consider the contract and their future plans before entering into a lease option agreement.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

2 Advantages of Real Estate Options for Buyers

Options are a common investing strategy for commercial real estate investors. There are several reasons a buyer might enter into a real estate option contract with a seller.

It Can Allow Time for the Buyer to Amass Funds

One might choose a real estate option if they want to secure a piece of land or property at a certain price but they need some time to get funds in order for the purchase.

A Real Estate Option Locks in a Price

If a buyer thinks the price of a property might go up, they can purchase an option to lock in the current market price. However, some real estate options are not completely set in their sale prices. There may be clauses in the contract to determine what the final sale price will actually be.

2 Advantages of Real Estate Options for Investors

Real estate investors can also use options to their advantage.

It’s a Lower-Risk Way to Develop Property

For example, let’s say an investor finds a property they’re interested in developing into housing. The investor needs to create a plan for the property and get other investors involved before they can buy it, so they purchase a real estate option to give them the exclusive right to buy the land.

The investor can make a profit by bringing in investors at a higher rate than the option. They can then buy the land and sell it to the developers they brought in to make a profit.

If they aren’t able to get developers and investors involved before the contract expires then they simply don’t buy the land.

An Investor Can Buy and Sell Real Estate Options

Investors can also make a profit just on buying and selling real estate options contracts rather than the properties themselves. This is a much less capital-intensive way to get involved in real estate investing.

For instance, an investor might find a property they expect will increase in value in the coming months. They purchase a real estate option to buy the land at the current market rate within the next year, pay a premium, and wait.

At any point during the period of the agreement the investor can either act on the contract and buy the property, or they can sell the contract to someone else. Let’s say the value of the property increases three months into the contract. The investor can find another investor who wants to purchase the contract for them for a higher price than the premium the original investor paid.

Whether any investor buys the property or not, the seller of the property keeps the premium.

The Takeaway

Real estate options are a way for investors to get involved in real estate investing without directly buying properties. As with any other kind of options, the investor buys the right to buy or sell at a certain price, but is not obligated to do so.

Qualified investors who are ready to try their hand at options trading, despite the risks involved, might consider checking out SoFi’s options trading platform. The platform’s user-friendly design allows investors to trade through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors.

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

Photo credit: iStock/Melpomenem

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.

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

SOIN0723075