Currency-hedged ETFs are exchange-traded funds created to minimize the risks of fluctuating exchange rates in ETFs that have foreign holdings.
Many investment companies offer two versions of the same ETF with one version including a currency hedge. The latter ETF has the same holdings as the former, but it also includes derivatives purchased to protect–or hedge–against currency risk. The protections come at a cost, however, and hedged ETFs may have higher fees than non-hedged ETFs.
Since currency values fluctuate, exchange rates can affect the total return on an asset. While ETFs provide investors with a significant diversification, they don’t offer any protection against the investment risk created by foreign exchange rates. So purchasing an ETF focused on overseas markets creates an additional layer of volatility within the investment.
Currency shifts can boost or diminish returns on international investments — but they almost always make them more uncertain. If the local currency loses value against the ETF’s currency (in this case the dollar), that can offset returns for the dollar-based investor, even if the assets that make up the security’s returns go up in their own currency.
Since many ETF investors are not interested in forex trading, they can minimize their currency risk by purchasing a currency-hedged ETF, which can smooth out volatility related to foreign exchange rates.
Currency-hedged ETFs may have a slightly higher expense ratio than non-hedged ETFs, due to the cost of the futures contracts as well as potential expenses associated with the tools and people who develop the hedged currency strategy.
While a strong dollar may be good when you’re buying assets in a foreign currency, it can hurt returns on assets denominated in a foreign currency. Over the past decade, the strong dollar has meant that hedged portfolios tend to outperform those that weren’t hedged.
Here’s an example: If the dollar-to-foreign-currency conversion rate is 1 to 2, as in one dollar buys you two units of the foreign currency, and you buy 100 shares of a stock at 5 foreign currency units per share, it will cost you $250, or 500 foreign currency units. Now, let’s say those shares double, so that 100 shares are worth 1,000 foreign currency units instead of 500 and your investment is now worth $500, compared to the $250 you spent initially.
But if the dollar strengthened so that the conversion rate went from 2 foreign currency units per dollar to 4 foreign currency units per dollar, those 100 shares are still worth 1,000 foreign currency units but for a US investor, their $250 investment would have shown no gain. While this is an extreme currency fluctuation, it illustrates the reason that some investors might purchase currency-hedged ETFs.
How Does Currency Hedging Work?
Investors use two methods to hedge against currency risk: static hedging and dynamic hedging.
Static Hedging
Static hedging is the most basic kind of hedging. An ETF that uses static hedging has one strategy that it executes, regardless of market conditions. An ETF using this strategy would buy contracts in the future market that lock in a currency’s value relative to the dollar or set parameters around it.
The contract is an agreement to buy a currency at a future price, which has the same effect of cancelling out currency gains or losses if they move from the currency’s current value against the dollar.
Dynamic Hedging
Dynamic hedging may incorporate multiple strategies or change strategies as market conditions change. Dynamic hedging is not always in effect, instead the hedge is “put on” based on the judgment of the ETF manager. Sometimes this judgment reflects an algorithm or series of rules that looks at market conditions for determining when to buy and sell financial instruments that hedge currency exposure.
For example, an ETF might have a rules-based system that looks at the trend of a currency’s value against the dollar, the interest rates in both countries, and the overall value of that currency (namely if it’s more expensive than the dollar). Those data points and, specifically, how they change over time, would determine whether and how much to hedge the ETF at any given time
The Takeaway
Currency-hedged ETFs are one way to get exposure to foreign markets and protection against the currency risks that come with that type of investment, but they may cost more than non-hedged ETFs. It’s important for investors to understand how they work, as they start to build their own investment strategy and learn how to pick ETFs to include (if any) in their portfolio.
If you’re ready to start putting that strategy into action, a great place to start is the SoFi Invest investing platform, which offers personalized investment advice, a range of ETFs, and automated investing.
Start investing today.
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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.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.
Both cryptocurrency and tokens are blockchain-based digital assets—but they are not the same thing. Yet as the public becomes increasingly aware of blockchain technology and more people invest in cryptocurrency, confusion swirls around the difference between the two assets.
What Are Crypto Tokens?
Cryptographic tokens are programmable assets that can be developed and recorded on existing blockchains, as a special-access smart contract.
Tokens operate within a pre-existing blockchain to allow for the creation and execution of unique smart contracts that often deliver ownership of assets outside of the blockchain network. Tokens can represent units of value—including real-world items like electricity, money, points, coins, digital assets, and more—and can be sent and received.
Those tokens, written into the smart contract of the underlying blockchain of the cryptocurrency, are only accessible by the person with the private key for the token. They allow people to create new assets, whose ownership and scarcity can be verified using blockchain technology.
Crypto Tokens vs. Coins: What is the Difference?
Coins—for example, Bitcoin and Litecoin—are built on their own blockchain and are a store of value, intended as a form of currency. Generally, any blockchain-based cryptocurrency that is not Bitcoin is referred to as an altcoin.
Tokens are built on an existing blockchain and while they aren’t currency they can represent other fungible and non-fungible items of value, like points, coins, or even a piece of artwork. One example of a token is the Basic Attention Token, or BAT.
Because crypto coins are more straightforward—they’re a form of currency—they’re often easier to understand than crypto tokens. Below, we’ll go over what crypto tokens are and how they work.
How Do Crypto Tokens Work?
Blockchain uses a decentralized, or distributed, ledger, which resides on a vast array of independent computers to track transactions. Each node organizes new data into blocks, and chains them together in an “append only” mode. That append-only structure means no one on any node can alter or delete the data from earlier blocks. They can only add to the chain, which is one of the core security features of blockchain.
Cryptocurrency tokens offer the append-only secure record of cryptocurrency, connected with a special-access contract, which can connect to all manner of assets. The special-access contract with the tokens can give users the rights to assets such as cash, crypto coins, rewards points, or even digital media such as music, art, a video clip, or a movie. The tokens create the possibility of owning a blockchain-verified private smart contract connected to that asset.
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Different Types of Crypto Tokens
Currently, there are four main categories of tokens: payment tokens, utility tokens, security tokens, and non-fungible tokens. Below we’ll dive deeper into each one.
Payment Tokens
Most of the best known and most widely used forms of cryptocurrency are payment tokens. These crypto tokens are used to buy and sell, just like the U.S. Dollar or the Euro—except they’re not backed by a specific government.
Payment tokens exist within the blockchain of crypto networks like Bitcoin, Monero, and Ethereum, and represent units of value that can be exchanged for other currencies. There are also third-party custodians or exchanges that convert payment tokens into legal tender currencies such as the dollar.
Increasingly though, people have begun using these tokens to buy goods and services, though the overall number of merchants who accept them is still relatively small.
Utility Tokens
Utility tokens give their owners access to a product or service that either exists or is in development. They’re most commonly used as a fundraising vehicle for ICOs (Initial Coin Offerings), as a placeholder for the crypto coins the purchasers will receive when the new coins eventually go live on the blockchain.
The name for these tokens comes from the fact that they can be used to obtain either a good or service offered by the issuer. Their existence on an existing blockchain means that the owners can be verified, and also that they can be easily exchanged. During the 2017 cryptocurrency boom, when hundreds of crypto firms were planning new ICOs, they issued ERC-20 utility tokens on the Ethereum blockchain as a placeholder for prospective investors in their soon-to-launch coins.
Security Tokens
Security tokens offer rights and obligations to securities like stocks and bonds. Most often, a security token represents a share in the company that issued it. They can represent legal ownership of an asset, or a portion of an asset, like real estate, stocks, ETFs, and so on.
As such, they’re more heavily regulated than other tokens. Companies might issue security tokens instead of traditional shares of stock to raise money cheaply, or because the tokens offer instant settlement and easier cross-border trading.
Non-fungible Tokens
Also known as NFTs, these tokens have made the news lately because of the eye-popping sales prices of single NFTs connected with works of art, individual tweets, and sports memorabilia. They exist on pre-existing crypto networks, with ETH being one of the most popular.
These tokens have private contracts that can be clearly distinguished from any other token in existence. Because of that feature, they are used by athletes, artists, musicians and other creators as a way to connect with collectors, who see them as digital one-of-a-kind assets.
NFTs have opened up new markets for digital art and memorabilia, because while the purchaser can still duplicate the underlying media, they can’t copy, sell or pirate it. Some people have also issued NFTs that confer ownership of unique non-digital assets, such as real estate.
The Takeaway
Blockchain offers a unique way to buy and sell just about everything, as well as new ways to verify ownership of assets. Crypto coins function as the currency on these platforms, and crypto tokens serve a variety of uses—representing a wide range of units of value, with the ability to be securely sent and received.
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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.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
2Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.
The “network effect” is one of the most powerful ideas in technology and business. The idea is that the more users there are in a network, the more valuable the network becomes.
Network effects are a big deal for both businesses and investors. For companies that have critical masses of users and have established lock-in, it can mean profits that grow and grow and grow. It also means that investors may be willing to have a company they fund lose money for a while if they have a shot at becoming the number one business in a field with network effects.
We can see networks in all sorts of businesses, but especially ones based around the internet, which connects individuals to one another. There are network effects in the internet, in social networks, and in digital products like cryptocurrencies.
What Is a Network Effect?
The basic idea behind network effects comes from a relatively old form of technology: the telephone. Imagine you’re the first person with a landline telephone installed. You can pick it up and listen to a dial tone, but without anyone else with a telephone, it’s merely a sculpture plugged into your wall. If you had to pay for it, the phone is perhaps of negative value, unless you really like how it looks.
But there’s value for the second person getting a phone installed—after all, they can call you up and you can call them. As more phones get installed, the value of the phone network increases. When there are strong network effects, the value of new users rises for existing users as more and more users are added to the network.
How Does the Network Effect Work?
Network effects are crucial for basically any internet-related business, including the web itself. One of the most influential attempts to quantify network effects comes from Robert Metcalfe, the co-inventor of Ethernet. He maintained that the value of a network grew as the square of its number of users.
Following this line of thinking, the value of the network to the customers or users would grow exponentially while the cost of adding new users grows linearly. For businesses that can establish network effects, then, it may make sense to invest very very heavily in user growth, even if it means losing money in the short run.
What are Businesses with Network Effects?
There are a number of modern-day industries that benefit from network effects.
Communications Networks
Network effects apply to parts of communications infrastructure that are not exactly businesses per se. For example, the World Wide Web, which is a platform for all sorts of nonprofit and for-profit activity and is not controlled by any one company, is characterized by network effects.
Marketplaces
Online marketplace eBay is a useful look at how network effects work in marketplace businesses, where a service tries to connect buyers and sellers. One reason eBay was so successful in its early years was that it achieved “lock-in” (the point where it doesn’t make sense to go to other services) for individuals wanting to auction items online. It did this in part by making the service free for sellers in its early days, attracting new users eager to make money off their items.
Social Networks
Perhaps the most prominent example of businesses characterized by network effects are social networks. Facebook, YouTube, Twitter, and other social networks improve for users as more users, usually people they know or are interested in, use them. Once everyone you know is on a social network, it may become harder to avoid and easier to simply succumb to signing up.
Cryptocurrency
If the previous examples of network effects were internet infrastructure or internet businesses, cryptocurrency may be a combination of both. Some cryptocurrencies are incredibly valuable and have built up an ecosystem of service around them.
As more people consider Bitcoin to have value, it creates an incentive for miners to secure the network—the network effect at work. In the case of Ethereum, as more apps are deployed, each one becomes a building block. This drives increased usage, and ultimately more demand for Ethereum.
In both cases network effects are a sign that the cryptocurrency could have staying power: If it does something useful for its holders, it may do something useful for people who buy in.
Granted, many other cryptocurrencies have flamed out. One big question going forward is the extent to which crypto can be characterized as having network effects — driving greater organic usage, rather than people primarily viewing cryptocurrency as an investment.
The Takeaway
A network effect is an idea that as a product or service gets more users, it will inherently attract more users — thus creating a pattern of success. The network effect can be seen most clearly in communication technology, including digital products and services like social media. For investors, it can be smart to keep an eye on the network effect in businesses you’re invested in, or are considering.
For investors just starting out, or established investors looking to expand their holdings, the SoFi Invest® online trading app offers an active investing solution that allows you to choose your investments as well as an automated investing solution that invests your money for you based on your goals and risk.
Find out how to get started with SoFi Invest.
Photo credit: iStock/Eva-Katalin
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.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
You’ve probably been in one of these conversations, before. Someone who’s older, maybe a teacher or a family member, encourages you to start investing as soon as possible. It’s well-meaning advice.
On an academic level, you know that the younger you get started, the more you can allow the magic of compounding investment returns to work in your favor. You’re also committed to prioritizing your own financial health, and you feel inspired to work towards your own personal financial freedom.
Every new investor has to start somewhere, and there’s no better time than this year.
So, you’ve got the right idea, but you don’t have a playbook. No one taught you how to invest. You’ve heard of Roth IRAs and mutual funds, but how do you know that you’re doing the right thing?
Further, there are a lot of people with divergent opinions on the best way to invest. It’s hard to know where to go and who to listen to.
Much of learning to invest means learning to navigate the options and the conflicting advice and then distilling that down into a portfolio that makes the most sense for you and your goals.
Here are some suggestions for how to start investing in five easy steps.
1. Understanding the Options
While the universe of investment options sometimes feels limitless, it’s not. With knowledge of the core building blocks of investing, you’ll be better able to navigate the available options with ease.
Investors have a variety of options available to them, including: stocks, bonds, cash or money market funds, real estate, private equity, investment partnerships, and natural resources, like gold. These are assets, essentially, things that have economic value and can store wealth. Beginner investors may focus largely on stocks and maybe bonds.
Stocks
A stock represents a share of ownership in a company. Shareholders can make money in two ways: through the value of shares appreciating, and through dividend payouts. Although this is an oversimplification, the success of a stock will generally be correlated to the success of the underlying business. This is highly unpredictable, which leads to the volatile nature of stock prices overall.
Bonds
Bonds, on the other hand, are investments in the debt of a company or government. In this case, the bondholder is the lender, collecting a rate of interest on that debt. The terms of the contract are agreed upon at the outset. Therefore, they are typically less volatile as stocks, although they can lose value.
An investment portfolio generally includes a variety of assets, including both stocks and bonds, for diversification. The purpose of diversification is to minimize risk, especially over the long-term.
Exchange-Traded Funds (ETFs)
What about mutual funds and exchange-traded funds (ETFs)? Funds are pools of investments. It may be helpful to think of a fund as a basket that holds a bunch of investments, such as stocks, bonds, or real estate holdings. For example, an S&P 500 index mutual fund or ETF holds the 500 leading stocks in the US. Therefore, an investment in this fund is really an investment in the US stock market.
Funds are a popular and easy option for investors looking to get broad exposure to whichever market it is that you’d like to invest within. Depending on the fund, this could also be an affordable way to invest. It is a common misconception that you need to invest in individual stocks to be a good stock market investor.
2. Creating a Goals-Based Investment Plan
The decision on which asset class to be invested in, and in what proportions, is an important one. It is called asset allocation. Although it is tempting to dive right into trying to pick out the “best” stocks, it may be appropriate to first take a step back and ask whether stocks are appropriate given your goals.
The next logical question is this: How does one determine asset allocation? Start by determining what the goal or intended use of the money is. To determine your personal investment mix, conduct an examination of your financial goals, risk tolerance, and investment time horizon.
At its core, the asset allocation decision is one regarding your comfort level with the tradeoff between risk versus reward. In investing, risk and reward are intrinsically connected. In order to have the potential for more reward, you have to take more risk. Be leery of investment options that tout “all reward and no risk.” Unfortunately, such an investment may be too good to be true because risk is an inherent part of investing.
A couple of questions worth asking yourself are: What is my goal with this money? When do I need the money? Last, what kind of risk am I willing to take with this money? Then, take these answers and match them up with one or a handful of the available investment options.
It’s may be easier to wrap your noodle around when we consider two different examples of two investors:
Our first investor is saving up for a down payment on a home. They plan to use that money within one year. For them, the risk of losing any money in a potentially volatile investment outweighs the possibility of earning investment returns. Instead of investing, they decide to keep this money in cash, in a savings account.
Next, our second investor. They’re new to investing, with plans to begin investing in a retirement account. They want to focus on growth over the long-term. Because they have a long time horizon for their investments, they have the time to ride through any short-term volatility, so they are more comfortable with the risks of the stock market. They may build out a portfolio that is primarily invested in the stock market, and for diversification purposes, they may decide to include some exposure to bonds as well.
As you can probably tell, there’s no one “right” asset allocation for any one individual, nor is there a universal formula for determining asset allocation. Investors who are learning how to start investing may want to take some time thinking about what allocation makes the most sense for them.
3. Opening an Account
Here’s another common misconception about investing. A Roth IRA and a 401(k) are not investments. These are accounts, just as a brokerage account, that hold investments. Retirement accounts, such as a Roth IRA or 401k, simply have special tax treatment.
Which account you decide on depends on a few factors. First, what are you investing for?
If you are investing for the long-term, then a retirement account may be most appropriate. Retirement accounts can either be opened individually or through your employer. If your employer offers a plan, this could be a good place to start. (And yes, picking funds or a strategy within a 401(k) or 403(b) counts as investing.)
If you are self-employed or do not have a plan through work, you may want to open an individual retirement account. Some options include a traditional or Roth IRA, Solo or Individual 401(k), and SEP IRA.
Because these accounts come with some tax benefits, they also have their own special rules, like when you can withdraw money and limits on how much money can be contributed each year. To determine which type of account that makes the most sense for your personal situation, you may want to speak with a tax professional.
If you would prefer to invest with more flexibility, you may want to open a brokerage or other general-purpose investment account. Though those accounts do not have the tax benefits of a retirement account, they also don’t have restrictions on when the money can be accessed and no penalties for withdrawals before retirement age.
No matter which account type you choose, remember: this is just an account. After opening the account, it will be funded with cash, likely by hooking up an existing checking or savings account. Once the account is funded with cash, that money can be used to buy investments.
If you are opening your own investing account (as opposed to using your workplace retirement plan), you will have to choose a brokerage account or online investing platform. When choosing your account, it helps to pay attention to the fees charged by the platform. Investing costs can dig into your potential returns. SoFi knows that new investors don’t want to pay a bunch in fees just to get in the game. There are no commissions on the SoFi Invest® platform.
4. Deciding How Much to Invest
This may sound oversimplified, but start with whatever you’re comfortable with, knowing that this money will be subjected to some amount of risk. Generally, this should be money that you won’t need in the near-term. That said, one of the greatest features of investing in the modern era is that you can get started with any amount.
There are a few ways to look at this. The first is to consider where you’re at in your own financial journey. It is often recommended that people first work on saving up an emergency fund and paying off credit cards and high-interest debt. And if COVID-19 has taught us anything, it’s that having a firm financial foundation is incredibly important. If you have yet to build up a sufficient safety net or maintain expensive debt on your personal balance sheet, this could be a good place to focus.
It’s easy to get hung up on the “invest versus pay off debt” decision. Here’s a simple place to start: compare interest rates. On debt, it’s the interest rate that you’re paying. On investing, it’s on the interest that you could potentially earn. So for example, if you’re deciding between aggressively paying off a private student loan with a 12% rate of interest or investing at what you expect could be a 7% rate of return, perhaps this makes your decision for you.
That said, it’s not as if you have to be completely debt-free in order to start building wealth. Instead, take some personal inventory. If you feel like you’re missing out on achieving investment and compound returns, then perhaps you’ll want to make investing a priority. If you feel like you’re being weighed down by debt, then maybe you’ll want to give expedited debt pay-off your energy.
If you have arrived at a place of debt repayment that feels manageable, you may want to consider investing as a piece of your overall budget. (Ever hear someone say, “pay yourself first?” This is what they are referring to.) One popular budget, called the 50/30/20 budget, recommends allocating 20% of income towards saving and investing. If you’d like to reach a place of financial freedom sooner than this, then you may want to consider saving more, as a percentage of your overall income.
5. Selecting Investments
Now the fun part of learning how to invest; choosing the actual investments in a portfolio.
Hopefully, you’ve given some thought to which asset class you’d like to invest in. For example, stocks. Then, there are lots of different options to invest within the stock market: You could pick out individual stocks, or stock-based funds, whether mutual funds or ETFs.
With funds, it is possible to invest in categories of the stock market that are very broad, such as the entire global or US stock market, or that are narrower, such as technology stocks. Building simple portfolios of just two or three broad, diversified funds has been a popular method for investors. This is called “passive” or “set it and forget it” investing.
It is also possible to build a diversified portfolio with narrower funds or even individual stocks, but this may require substantial research and curation.
When purchasing funds, investigate whether they are actively managed or indexed. An index fund, as it sounds, mimics some index that measures the performance of the market. For example, a “total US stock market index fund” may be built against the Russell 3000 index, which measures the performance of all stocks in the US. The point is to return whatever the returns of the broader US stock market. Because there is no active manager, the management fee embedded within index funds tends to be lower than the fees on actively managed funds.
Investors opting to buy individual stocks, may want to consider businesses that they believe will produce some sort of future stream of income, either by an increase in the share value or through the dividend payment. Consider reviewing the following: a stock’s price-to-earnings ratio, industry competition, strength of balance sheet, the company research and development, and product pipeline. These factors can help investors determine the value of an investment.
New investors may want to consider buying stocks or ETFs on a platform that offers zero-cost trading, like active investing with SoFi Invest. Fees can eat away at the potential performance of an investment and act as a barrier to entry. Luckily, there are lots of low-cost options for new investors just getting started.
The last option is to use an automated investing service that buys funds for you. This may be an especially compelling option for new investors who want some help building out their first portfolio in a thoughtful, diversified, and goals-driven way. SoFi Invest also offers an automated investing platform.
Be proud of yourself for starting the journey. Invest in a strategy that makes sense for you, starting with any dollar amount.
SoFi Invest is an easy, fast, and no-fee way to get your money working harder for you.
Digital currency is currency that is only used in digital form without any physical form to back it up, such as coins or bills. It’s also referred to as electronic currency, digital money, electronic money, and e-money, among other names. The cryptocurrency Bitcoin is the most well-known and widely used digital currency.
Digital money has existed as long as the internet has, but it has taken many years for it to be widely used and trusted. Part of the reason that digital currency has gained traction in recent years is because of the blockchain technology first used by Bitcoin, which allows for more security and transparency.
Prior to the creation of cryptocurrencies, PayPal brought the idea of quick and easy person-to-person transactions to the masses. The money used by banks and central governments is also digital money, since it often gets transferred electronically rather than physically. However, banks are required by law to hold a certain amount of money in physical cash.
While the terms “money” and “currency” are often used interchangeably, they are not the same thing. Money is a more intangible concept of value and numbers, whereas currency is what is physically (or digitally) exchanged. For example, a check or savings account is money, and coins or paper bills are currency.
How Does Digital Currency Work?
Digital currency can be used in the same way as physical currency to pay for goods and services.
Although money has been transacted digitally for many years via online bank accounts, wire transfers, and credit cards, digital currency is a newer market tool that is changing the way the world transacts. With digital currency, every action—from its creation and storage to sending and receiving it—is done electronically through phones, credit cards, and online exchanges.
Digital currency has been growing in popularity in recent years, in part thanks to its increased transparency and quick transactions. Additionally, without the need for intermediaries, transactions are generally faster and lower cost than going through a bank. As more and more companies and countries are adopting it, this increasingly widespread use has contributed to the spread of globalization, since it’s easier to send money and trade internationally than ever before.
Pros and Cons of Digital Currency
These are some of the pros and cons to using digital currency.
• Still some risk of fraud, data theft, scams, and criminal use
• May be volatile
• Lack of regulations can cause issues
Types of Digital Currency
There is more than one type of digital currency. While cryptocurrency may be the first thing that comes to mind, there are also central bank digital currencies. Below we’ll outline how each works, and how they differ from each other.
Cryptocurrencies as Digital Currency
Cryptocurrencies are a type of digital currency that is secured by cryptography, which adds an extra layer of security and anonymity to transactions—and tackles the problem of “double spend” (the possibility of spending the same unit of digital currency twice). Cryptocurrencies aren’t controlled or created by a central authority, are held in digital wallets, and are sent from peer to peer on decentralized exchanges, using a blockchain ledger that keeps track of all transactions. Examples of popular cryptocurrency types include Bitcoin, Ethereum, Litecoin, and Ripple.
One reason cryptocurrencies were created was as a response to the way current fiat currencies operate. Rather than being created and issued by a company or government, cryptocurrencies are mined using decentralized computational methods and algorithms. Certain cryptocurrencies, such as Bitcoin, have a predetermined amount of ‘coins’ that will ever be available in the market.
Cryptocurrencies aren’t tethered to a physical asset or otherwise backed by anything, so their value is based solely on supply and demand. This has historically made them fairly volatile as their use and demand changes, but they may not remain volatile as they become more widely used.
It’s worth noting that cryptocurrency is subject to different types of crypto regulations than central-bank-backed digital currency.
Central Bank Digital Currencies
Some digital currency is issued by a central bank and has the same regulations as physical currencies. These are called Central Bank Digital Currencies, or CBDC. These are not widely used yet, but more and more governments are working towards issuing digital forms of their fiat currencies.
Central banks have been motivated to update their technology and practices to outpace the growth of cryptocurrencies in the market. Countries and regions such as China and Europe are racing to lead the way into this new era of digital currencies, partly to avoid the rise of unregulated cryptocurrencies. China is already in the process of testing the digital yuan and other countries will be doing similar tests soon.
CBDCs may use the same blockchain technology as cryptocurrencies or they may rely on different, centralized technologies. One benefit of CBDCs is that they may be more stable than cryptocurrencies, because they are backed by central banks. Additionally, if a digital currency is issued by a central authority, they may choose to create more of it over time.
The Bank for International Settlements (BIS) has a list of 14 characteristics that define CBDCs in order to ensure their financial stability and their interoperability with existing fiat currencies. Some of these characteristics include:
• They can be used between different types of banking systems
• They will be legal and supported by central banks
• Their value and conversion rates will be the same as physical money
• The cost of creation and distribution will be low
• They will be resilient and safe, protecting against technology issues and cyberattacks
Investing in Digital Currency
Investing in digital currency like crypto is considered quite risky — in part because prices can fluctuate so wildly. For example, Bitcoin was valued at more than $14,000 per coin in 2017 before dropping to less than $3,500 per coin by the beginning of 2019.
On the flip side, some investors find it appealing to invest in digital assets and crypto because it is also one way to diversify a portfolio that might be largely made up of stocks and bonds. Cryptocurrency is one of many alternative investments that investors sometimes look to in diversifying. In fact, 2021 saw the launch of the first North American crypto exchange traded fund (ETF), in Canada.
The steps to investing in digital currency are relatively simple:
1. Make an account with a digital currency exchange. This is a platform that allows you to buy, sell, and exchange crypto, and gives you the unique addresses you need to make transactions. To open the account, you’ll create a username and password, and also verify personal data like your residential address or social security number.
2. Get a digital wallet. This is a way to securely store your crypto, and is key if you want to trade crypto and also use it to pay for goods and services. There are many free wallets available on the market, some of which are designed for specific platforms, like Windows desktop, iOS, or Android mobile. Note: Some bitcoin brokerages, like Coinbase , operate as both an exchange and a wallet.
3. Link your wallet to an external bank account. This is the account you’ll use to buy digital currency, or to withdraw it in the form of your home currency. You’ll typically need to provide your routing and account numbers, though some wallets can connect to your bank account (or PayPal account, or another source of funds) directly with your digital login credentials.
4. Transfer funds into your new account and start investing. Now you can use your digital currency for purchases or trades. (One thing to note: your wallet may take a portion of your purchase as a transaction fee.)
Digital Currency and Taxes
Anyone who’s interested in investing in digital currency should familiarize themselves with how to pay taxes on crypto. The IRS considers digital currency to be property, rather than monetary income. So in the same way that an individual who purchased or sold a property (like a vacation home) would keep track of the transaction, an individual who bought crypto like a stock or other asset will need to keep track of their crypto transactions—and report the value of their holdings (translated to U.S. dollars) on their tax filings.
There is one exception to the IRS’s cryptocurrency-as-property rule : If you receive crypto as a gift, you mine it, or you are paid in crypto for goods or services you’ve sold, that is in fact treated as income by the IRS, and taxed accordingly.
Typically, crypto exchanges keep track of an investor’s transaction history (in the same way a brokerage might with stocks). But it never hurts to keep your own records, as well.
The Takeaway
Digital currencies are becoming more popular and prevalent in the market, both due to the rise of cryptocurrencies and the shift towards government issued central bank currencies. These currencies reflect the way people are enacting transactions — virtually, rather than in person — and are also considered at the forefront of security and privacy technology.
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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
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