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Q: What Is a Simple IRA?

The SIMPLE IRA, or Saving Incentive Match Plan for Employees, is a type of tax advantaged retirement savings plans to help self-employed savers and small business owners put money away for their future.

Q: How Does a SIMPLE IRA Work?

In order for an employee to participate, including self-employed individuals, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, or they must expect to make $5,000 in the current calendar year. It is possible for employers to set less restrictive rules for SIMPLE IRA eligibility.

Nov

2023

The Ultimate Guide to SIMPLE IRAs for Employees and Small Businesses

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

If you’re exploring retirement plans, you may be wondering, what is a SIMPLE IRA? A SIMPLE IRA is one type of tax-advantaged retirement savings plans to help self-employed individuals and small business owners put money away for their future.

You may already be familiar with traditional individual retirement accounts (IRAs). A SIMPLE IRA, or Saving Incentive Match Plan for Employees, is one type of IRA.

What Is a SIMPLE IRA?

SIMPLE IRA plans are employer-sponsored retirement accounts for businesses with 100 or fewer employees. They are also retirement accounts for the self-employed. If you’re your own boss and self-employed, you can set one up for yourself.

For small business owners, SIMPLE IRAs are an easy-to-manage, low-cost way to contribute to their own retirement while at the same time helping employees to contribute to their savings as well.

How Does a SIMPLE IRA Work?

Now that you know the answer to the question, what is a SIMPLE IRA?, you are probably wondering how this plan works. A SIMPLE IRA is one of the different types of retirement plans available. In order for an employee to participate, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, or they must expect to make $5,000 in the current calendar year.

It is possible for employers to set less restrictive rules for SIMPLE IRA eligibility. For example, they could lower the amount employees are required to have made in a previous two-year time. However, they cannot make participation rules more restrictive.

Employers can exclude certain types of employees from the plan, including union members who have already bargained for retirement benefits and nonresident aliens who don’t receive their compensation from the employer.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Simple IRA vs. Traditional IRA

When it comes to a SIMPLE IRA vs. Traditional IRA, the two plans are similar. However, there are some key differences between the two. A SIMPLE IRA is for small business owners and their employees. A traditional IRA is for anyone.

The eligibility criteria is different for the two plans. To be eligible for a SIMPLE IRA, an employee must have earned at least $5,000 in compensation over the course of two years prior — or expect to make $5,000 in the current calendar year. With a traditional IRA, an individual must be under age 70 and have earned income in the past year.

And while both types of IRAs are tax deferred, a traditional IRA allows individuals to make tax deductible contributions, while only an employer or sole proprietor can make tax deductible contributions to a SIMPLE IRA.

One of the biggest differences between the two plans is the contribution amount. Individuals can contribute $6,500 in 2023 to a traditional IRA (or $7,500 if they are age 50 or older), while those who have a SIMPLE IRA can contribute $15,500 (plus an extra $3,500 for those age 50 and older) in 2023.

Simple IRA vs. 401(k)

SIMPLE IRAs have some similarity to 401(k)s. Both are employer-sponsored plans that eligible employees can contribute to, contributions made to both are made with pre-tax dollars, and the money in the accounts grows tax-deferred. Both types of plans give the employer the option to make matching contributions to employees’ plans.

One major difference between the two plans is that while self-employed individuals can’t open a 401(k), they can set up a SIMPLE IRA for themselves.

Additionally, individuals can contribute much more to a 401(k) than they can to a SIMPLE IRA. In 2023, those with a 401(k) can contribute $22,500 to the plan, plus an extra $7,500 for those 50 and older. In comparison, individuals can contribute $15,500 to a SIMPLE IRA, plus $3,500 extra for those 50 and up.

SIMPLE IRA Contribution Rules

Employer Contribution and Matching Rules

When an employer sets up a SIMPLE IRA plan, they are required to contribute to it each year. They have two options: They can either make matching contributions of up to 3% of an employee’s compensation, or they can make a nonelective contribution of 2% for each eligible employee, up to an annual limit of $330,000 in 2023.

If the employer chooses the latter option, they must make a contribution to their employees’ accounts, even if those employees don’t contribute themselves. Contributions to employee accounts are tax deductible.

Employee Contributions

Eligible employees can choose to contribute to the plan, as well. In 2023, SIMPLE IRA contribution limits are up to $15,500 in deferrals. Those over the age of 50 can contribute an extra $3,500 in catch-up contributions, which brings their annual maximum contributions up to $19,000. Those contribution levels may change over time, as the government adjusts them to account for inflation.

Contributions reduce employees’ taxable income, which gives them an immediate tax benefit, lowering their income taxes in the year they contribute. Contributions can be invested inside the account and grow tax-deferred until the employee makes withdrawals when they retire.

IRA withdrawal rules are particularly important to pay attention to as they can be a bit complicated. Withdrawals made after age 59 ½ are subject to income tax. If you make withdrawals before then, you may be subject to an additional 10% or 25% penalty. Account holders must make required minimum distributions from their accounts when they reach age 73.

Establishing and Operating a SIMPLE IRA Plan

SIMPLE IRAs are relatively easy to put in place, since they have no filing requirements for employers. Employers cannot offer another retirement plan in addition to offering a SIMPLE IRA.

If you’re interested in opening a SIMPLE IRA, banks and brokerages may have a plan, known as a prototype plan, that’s already been approved by the IRS.

Otherwise you’ll need to fill out one of two forms to set up your plan:

• Form 5304-SIMPLE allows employees to choose the financial institutions that will receive their SIMPLE IRA contributions.

• You can also fill out Form 5305-SIMPLE, which means employees will deposit SIMPLE IRA contributions at a single financial institution chosen by the employer.

Once you have established the SIMPLE IRA, an account must be set up by or for each employee, and employers and employees can start to make contributions.

Notice Requirements for Employees

There are minimal paperwork requirements for a SIMPLE IRA. Once the employer opens and establishes the plan through a financial institution, they need to notify employees about it. This should be done by October 1 of the year the plan is intended to begin. Employees have 60 days to make their elections.

Eligible employees need to be notified about the plan annually. Any changes or new terms to the plan must be disclosed. At the beginning of each annual election period, employers must notify their employees of the following:

• Opportunities to make or change salary reductions.

• The ability to choose a financial institution to receive SIMPLE IRA contribution, if applicable.

• Employer’s decisions to make nonelective or matching contributions.

• A summary description provided by the financial institution that acts as trustee of SIMPLE IRA fund, and notice that employees can transfer their balance without cost of penalty if the employer is using a designated financial institution.

Participant Loans and Withdrawals

No loans are allowed to participants in a SIMPLE IRA. Withdrawals made before age 59 ½ are subject to a possible 10% or 25% penalty.

Rollovers and Transfers to Other Retirement Accounts

For the first two years of participating in a SIMPLE IRA, participants can only do a tax-free rollover to another SIMPLE IRA. After two years, they may be able to roll over their SIMPLE IRA to other non-Roth IRAs or an employer-sponsored plan such as 401(k).

💡 Quick Tip: Want to lower your taxable income? Start saving for retirement with a traditional IRA. The money you save each year is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).

The Advantages and Drawbacks of a SIMPLE IRA Plan

While SIMPLE IRAs offer a lot of benefits, including immediate tax benefits, tax-deferred growth, and employer contributions, there are some drawbacks. For example, SIMPLE IRAs don’t allow employees to save as much as other retirement plans such as 401(k)s and Simplified Employee Pension (SEP) IRAs.

In 2023, employees can contribute up to $22,500 to a 401(k) account, with an extra $7,500 in catch-up contributions for those 50 and older. Individuals with a SEP IRA account can contribute up to 25% of their employee compensation, or $66,000, whichever is less, in 2023.

The good news is, employees with SIMPLE IRAs can make up some of that lost ground. Employers may be wondering about the merits of choosing between a SIMPLE and traditional IRA, but they can actually have both.

Employers and employees can open a traditional or Roth IRA and fund it simultaneously. For 2023, total contributions to IRAs can be up to $6,500, or $7,500 for those ages 50 and older.

Here some pros and cons of starting and funding a SIMPLE IRA at a glance:

Pros of a SIMPLE IRA	Cons of a SIMPLE IRA
Easy to set up, with less paperwork than other retirement accounts, such as 401(k)s.	Lower contribution limits than other plans, such as 401(k)s and SEP IRAs.
Employers have lower upfront and management costs to run the plan.	Withdrawals made before age 59 ½ are subject to a possible 10% or 25% penalty.
Contributions are tax deductible for employers and employees.	There is no Roth option that would allow employees to fund the retirement account with after-tax dollars that would translate to tax-free withdrawals in retirement.
There are no filing requirements with the IRS.

Eligibility and Participation in a SIMPLE IRA

As mentioned previously, there are some rules about who can participate in a SIMPLE IRA. Here’s a quick recap.

Who Can Establish and Participate in a SIMPLE IRA?

Small business owners with fewer than 100 employees and self-employed individuals can set up and participate in a SIMPLE IRA, along with any eligible employees.

Employers can’t offer any other type of employer-sponsored plan if they set up a SIMPLE IRA.

Employees’ Eligibility and Participation Criteria

In order for an employee to be eligible to participate, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, or they must expect to make $5,000 in the current calendar year.

Employees can choose less restrictive requirements if they choose. They may also exclude certain individuals from a SIMPLE IRA, such as those in unions who receive benefits through the union.

Investment Choices and Account Maintenance

The employer chooses investment options for the SIMPLE IRA and maintains the plan. Employees then select the investment options they want.

Investment Choices Under a SIMPLE IRA

Typically, there are more investment choices with a SIMPLE IRA than there with a 401(k). Investment options can include stocks, mutual funds, exchange-traded funds (ETFs), and bonds.

Understanding SIMPLE IRA Distributions

There are particular rules for SIMPLE IRA distributions, and it’s important to be aware of them. This is what you need to know.

Withdrawal Rules and Tax Consequences

As discussed previously, withdrawals made before age 59 ½ are subject to income tax plus a potential 10% or 25% penalty. Withdrawals made after age 59 ½ are subject to income tax only and no penalty. Account holders must make required minimum distributions from their accounts when they reach age 73.

The 2-Year Rule and Early Withdrawal Penalties

There is a two-year rule for withdrawals from a SIMPLE IRA. If you make a withdrawal within the first two years of participating in the plan, the penalty may be increased from 10% to 25%.

The Takeaway

SIMPLE IRAs are one of the easiest ways that self-employed individuals and small business owners can help themselves and their employees save for retirement, whether they’re experienced retirement investors or they’re opening their first IRA.

These accounts can even be used in conjunction with certain other retirement accounts and investment accounts to help individuals save even more.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

Photo credit: iStock/shapecharge

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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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.

SoFi Invest®
SoFi Invest refers to the two investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing 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, including state licensure of SoFi Digital Assets, LLC, 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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

SOIN1023152

Nov

2023

Am I on Track for Retirement?

By Austin Kilham | invest, Life & Career, Preparing for Retirement | No Comments

If everyone got a dollar every time they wondered, “Am I on track for retirement?” and “How much do I need to retire?” we’d all be a lot closer to retiring.

Joking aside, there’s no one answer to the perplexing question of how much you really need to retire. It’s a personal calculation based on numerous factors, including your income, your age, how much you’ve already saved, and when you can tap retirement and Social Security benefits.

That said, it is possible with the help of a few guidelines to get a sense of what size nest egg you’ll need to retire comfortably.

How Much Do I Need to Retire, Really?

The amount of money you need to save for retirement depends largely on your goals, health, and lifestyle. However, one rule of thumb suggests that an individual will likely spend 80% of their current income each year in retirement. So, if you earn $100,000, you’ll need about $80,000 per year when you retire.

This figure is flexible, and can be adjusted based on the amount of Social Security you can claim, and how much your retirement lifestyle might cost. You may need more income if you’re planning to retire and start a small business, or less if you’re planning to downsize or work part time.

You likely want to take into account what your health or medical expenses might be, and whether your retirement nest egg is meant to cover two people or one.

It’s worth spending some time thinking about, and perhaps having some candid conversations with your spouse and family members, about your retirement plan. The amount of money you think you need may be different than the amount you actually will need. It’s important to explore the options, since there are different ways to slice this pie.

The 4% Rule

How much do you need to retire? To understand the amount of total savings you might need if you’re aiming to replace 80% of your income each year, you can use the 4% rule. This guideline recommends you withdraw no more than 4% of your total retirement savings to cover your annual expenses. The theory behind this rule is that by withdrawing a small percentage of your nest egg each year, you can leave the bulk of your portfolio intact and hopefully growing steadily over time.

So if you consider your desired annual income of $80,000, and subtract, say, $20,000 in annual Social Security benefits (learn more about Social Security below), you would need about $60,000 to come from savings or other income.

Then, divide this target income amount by 4% to get the approximate total you’ll need to save. For example, for a target annual income of $60,000, divide $60,000 by 4% (60,000/0.04) you get about $1.2 million.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Target Retirement Savings By Age

Because lifestyle, standard of living, and individual costs can vary so widely, there’s no exact recommendation for how much different age groups should have already saved for retirement. However, once again, there are some useful guidelines.

Age	How Much Should You Have Saved?
30	By age 30, experts recommend you have saved an amount equal to your annual salary. Start by saving 10%-15% of your gross income, beginning in your 20s.
40	Three or four times your annual salary.
50	Six times your annual salary
60	Eight times your annual salary
67	10 times your annual salary. So if you make $75,000, you should have $750,000 saved.

Are You on Track?

You may still be wondering, “Am I on track for retirement?” The rules of thumb above can help you benchmark whether you are on track. However, it’s also important to factor in your personal financial situation, as well as your retirement goals, to get a handle on your individual needs. Depending on your personal circumstances, you may need to save more or less.

Give yourself an honest assessment of your financial present by doing an inventory of your current expenses, income, taxes, and savings. Which expenses do you expect to carry over into retirement? Which won’t?

For example, perhaps you have a mortgage that you’ll pay off before you retire, so you won’t need to include that in your retirement income needs. Do you have enough income to meet your savings goals? How much have you already saved in your retirement, brokerage, and savings accounts? You can subtract the amount you’ve already saved from your total goal.

Recommended: How to Save for Retirement at 30

Understanding the Role of Social Security

Social Security benefits can provide a vital supplement to your retirement income and help you get closer to financial security. However, it’s critical to understand that the amount of your benefit will vary depending on your age.

The earliest you can start receiving Social Security Benefits is age 62, but your benefits will be reduced by as much as 30% if you take them that early — and they will not increase as you age.

If you wait until your full retirement age (FRA) you can begin receiving full benefits. Your full retirement age is based on the year you were born. For example, if you were born in 1960 or later, your full retirement age is 67. You can find a detailed chart of retirement ages at ssa.gov.

But here is the real Social Security bonus: If you can put off claiming your Social Security benefits until age 70, perhaps by working longer or working part time, the size of your benefits will increase considerably. Typically, for each additional year you wait to claim your benefits up to age 70, your benefits will grow by 8%.

💡 Quick Tip: The advantage of opening a Roth IRA and a tax-deferred account like a 401(k) or traditional IRA is that by the time you retire, you’ll have tax-free income from your Roth, and taxable income from the tax-deferred account. This can help with tax planning.

Choosing From the Different Types of Retirement Plans

There are a number of tax-advantaged retirement accounts that can help you meet your retirement savings goals:

401(k) Plans

A 401(k) plan is an employer-sponsored retirement plan. Contributions are made with pre-tax dollars, which lowers your taxable income for an immediate tax break. In 2023, individuals can contribute up to $22,500 each year, with an additional $7,500 for those age 50 and up. Funds are typically taken directly from your paycheck to make savings automatic. Employers will often offer matching contributions, and employees should typically save enough to meet the matching requirements. After all, it’s essentially free money and can boost your retirement savings.

Investments inside 401(k) accounts grow tax-deferred, and withdrawals in retirement are taxed at your normal income tax rate.

Account holders who leave their job or are laid off at age 55 or older can make withdrawals from their 401(k) without paying an early withdrawal penalty. Otherwise individuals must wait until age 59½. Your 401(k) plan is subject to required minimum distributions (RMDs) once you turn 73.

Traditional and Roth IRAs

In addition to saving in a 401(k), you can also consider a traditional or Roth IRA. To help decide which one works for you, consider the differences between the two:

• Traditional IRA. With a traditional IRA, contributions are made with pre-tax funds and grow tax-deferred inside the account. Withdrawals for a traditional IRA are taxed at ordinary income tax rates. Withdrawals can be made at age 59½ without penalty. Early withdrawals, though, are subject to both income tax and a 10% penalty. Traditional IRAs are also subject to RMDs.

• Roth IRA. Roth IRAs, on the other hand, are funded with after-tax contributions, so there is no immediate tax break. However, money inside the account grows tax-free, and withdrawals are also tax-free in retirement. Because you’ve already paid taxes on the principal (the amount of your contributions), those funds can be withdrawn penalty-free at any time — but if you withdraw earnings as well, you could incur a penalty.

While the idea of tax-free retirement income is pretty appealing, Roth accounts come with several rules and restrictions, most notably income limits. Before opening a Roth, be sure you understand the terms. Contribution limits for both traditional and Roth IRAs are $6,500, or $7,500 in 2023 for those age 50 and up.

The Takeaway

Asking yourself, “Am I on track for retirement?”, is such a common question — yet it doesn’t have a one-size-fits-all answer. Determining the amount you’ll need to cover your expenses in retirement requires weighing various personal and financial factors, including how much you’ve saved, and estimating how much you’re likely to need in the years to come.

Fortunately, there are some basic rules of thumb that can help you reach a potential target amount. While these figures aren’t set in stone, they can provide a reasonable ballpark to help you start planning, saving, and investing for your post-work future.

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), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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

FAQ

What are the signs that you are ready to retire?

Signs that you’re ready to retire include having enough money for the retirement lifestyle you want, having diversified portfolio to help manage investment risk, you’ve paid off or significantly reduced your debt, you have a plan to collect Social Security in a way that will help you maximize your benefits, and you feel comfortable that you can afford healthcare costs or any emergencies that come up.

Am I on track to retire comfortably?

To gauge if you are on track with your retirement savings, you can use a couple of general guidelines. The 80% rule says you will need 80% of your income per year when you retire. Another guideline recommends having 10 times your annual salary saved by the time you’re 67.

But you also need to factor in your personal financial situation, as well as your retirement goals to determine if you can retire comfortably. Depending on your circumstances, you may need to save more or less than the guidelines recommend.

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.

SoFi Invest®
SoFi Invest refers to the two investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing 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, including state licensure of SoFi Digital Assets, LLC, 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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOIN1023158

Nov

2023

SIMPLE IRA Contribution Limits for Employers & Employees

By Austin Kilham | invest, Investing, Preparing for Retirement | Comments Off

A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is a way for self-employed individuals and small business employers to set up a retirement plan.

It’s one of a number of tax-advantaged retirement plans that may be available to those who are self-employed, along with solo 401(k)s, and traditional IRAs. These plans share a number of similarities. Like 401(k)s, SIMPLE IRAs are employer-sponsored (if you’re self-employed, you would be the employer in this case), and like other IRAs they give employees some flexibility in choosing their investments.

SIMPLE IRA contribution limits are one of the main differences between accounts: meaning, how much individuals can contribute themselves, and whether there’s an employer contribution component as well.

Here’s a look at the rules for SIMPLE IRAs.

SIMPLE IRA Basics

SIMPLE IRAs are a type of employer-sponsored retirement account. Employers who want to offer one cannot have another retirement plan in place already, and they must typically have 100 employees or less.

Employers are required to contribute to SIMPLE IRA plans, while employees can elect to do so, as a way to save for retirement.

Employees can usually participate in a SIMPLE IRA if they have made $5,000 in any two calendar years before the current year, or if they expect to receive $5,000 in compensation in the current year.

An employee’s income doesn’t affect SIMPLE IRA contribution limits.

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

SIMPLE IRA Contribution Limits, 2022 and 2023

Employee contributions to SIMPLE IRAs are made with pre-tax dollars. They are typically taken directly from an employee’s paycheck, and they can reduce taxable income in the year the contributions are made, often reducing the amount of taxes owed.

Once deposited in the SIMPLE IRA account, contributions can be invested, and those investments can grow tax deferred until it comes time to make withdrawals in retirement. Individuals can start making withdrawals penalty free at age 59 ½. But withdrawals made before then may be subject to a 10% or 25% early withdrawal penalty.

Employee contributions are capped. For 2022, contributions cannot exceed $14,000 for most people. For 2023, it’s $15,500. Employees who are age 50 and over can make additional catch-up contributions of $3,000 for 2022 and $3,500 for 2023, bringing their total contribution limit to $17,000 in 2022 and $19,000 in 2023.

See the chart below for SIMPLE IRA contribution limits for 2022 and 2023.

	2022	2023
Annual contribution limit	$14,000	$15,500
Catch-up contribution for age 50 and older	$3,000	$3,500

Employer vs Employee Contribution Limits

Employers are required to contribute to each one of their employees’ SIMPLE plans each year, and each plan must be treated the same, including an employer’s own.

There are two options available for contributions: Employers may either make matching contributions of up to 3% of employee compensation — or they may make a 2% nonelective contribution for each eligible employee.

If an employer chooses the first option, call it option A, they have to make a dollar-for-dollar match of each employee’s contribution, up to 3% of employee compensation. (If the employer chooses option B, the nonelective contribution, this requirement doesn’t apply.) An employer can offer smaller matches, but they must match at least 1% for no more than two out of every five years.

In option A, if an employee doesn’t make a contribution to their SIMPLE account, the employer does not have to contribute either.

Now let’s consider the second option, option B: Employers can choose to make nonelective contributions of 2% of each individual employee’s compensation. If an employer chooses this option, they must make a contribution whether or not an employee makes one as well.

Contributions are limited. Employers may make a 2% contribution up to $330,000 in employee compensation for 2023, and up to $305,000 in employee compensation for 2022.

(The 3% matching contribution rule for option A is not subject to this same annual compensation limit.)

Whatever contributions employers make to their employees’ plans are tax deductible. And if you’re a sole proprietor you can deduct the employer contributions you make for yourself.

See the chart below for employer contribution limits for 2022 and 2023.

	2022	2023
Matching contribution	Up to 3% of employee contribution	Up to 3% of employee contribution
Nonelective contribution	2% of employee compensation up to $305,000	2% of employee compensation up to $330,000

SIMPLE IRA vs 401(k) Contribution Limits

There are other options for employer-sponsored retirement plans, including the 401(k), which differs from an IRA in some significant ways.

Like SIMPLE IRAs, 401(k) contributions are made with pre-tax dollars, and money in the account grows tax deferred. Withdrawals are taxed at ordinary income tax rates, and individuals can begin making them penalty-free at age 59 ½.

Contribution limits for 401(k)s are much higher than for SIMPLE IRAs. In 2023, individuals can contribute up to $22,500 to their 401(k) plans. Plan participants age 50 and older may make $7,500 in catch-up contributions for a total of $30,000 per year.

Employers may also choose to contribute to their employees’ 401(k) plans through matching contributions or non-elective contributions. Employees often use matching contributions to incentivize their employees to save, and individuals should try to save enough each year to meet their employer’s matching requirements.

Employers may also make nonelective contributions regardless of whether an employee has made contributions of their own. Total employee and employer contributions can equal up to $66,000 in 2023, or 100% of an employee’s compensation, whichever is less. For those age 50 and older, that figure jumps to $73,500.

As a result of these higher contribution limits, 401(k)s can help individuals save quite a bit more than they could with a SIMPLE IRA. See chart below for a side-by-side comparison of 401(k) and SIMPLE IRA contribution limits.

	SIMPLE IRA 2022	SIMPLE IRA 2023	401(k) 2022	401(k) 2023
Annual contribution limit	$14,000	$15,500	$20,500	$22,500
Catch-up contribution	$3,000	$3,500	$6,500	$7,500
Employer Contribution	Up to 3% of employee contribution, or 2% of employee compensation up to $305,000	Up to 3% of employee contribution, or 2% of employee compensation up to $330,000	Matching and nonelective contributions up to $61,000	Matching and nonelective contributions up to $66,000.

SIMPLE IRA vs Traditional IRA Contribution Limits

Individuals who want to save more in tax-deferred retirement accounts than they’re able to in a SIMPLE IRA alone can consider opening an IRA account. Regular IRAs come in two flavors: traditional or Roth.

Traditional IRAs

When considering SIMPLE vs. traditional IRAs, the two actually work similarly. However, contribution limits for traditional accounts are quite a bit lower. For 2023, individuals can contribute $6,500, or $7,500 for those 50 and older.

That said, when paired with a SIMPLE IRA, individuals could be making $22,000 in total contributions, almost as much as with a 401(k).

Roth IRAs

Roth IRAs work a little bit differently.

Contributions to Roths are made with after-tax dollars. Money inside the account grows-tax free and individuals pay no income tax when they make withdrawals after age 59 ½. Early withdrawals may be subject to penalty. Because individuals pay no income tax on withdrawals in retirement, Roth IRAs may be a consideration for those who anticipate being in a higher tax bracket when they retire.

Roth contributions limits are the same as traditional IRAs. Individuals are allowed to have both Roth and traditional accounts at the same time. However, total contributions are cumulative across accounts.

(Want to learn more about IRAs? Check out these frequently asked questions.)

See the chart for a look at SIMPLE IRA vs. traditional and Roth IRA contribution limits.

	SIMPLE IRA 2022	SIMPLE IRA 2023	Traditional and Roth IRA 2023
Annual contribution limit	$14,000	$15,500	$6,500
Catch-up contribution	$3,000	$3,500	$1,000
Employer Contribution	Up to 3% of employee contribution, or 2% of employee compensation up to $305,000 for 2022	Up to 3% of employee contribution, or 2% of employee compensation up to $330,000 for 2023	None

The Takeaway

SIMPLE IRAs are an easy way for employers and employees to save for retirement — especially those who are self-employed (or for companies with under 100 employees). In fact, a SIMPLE IRA gives employers two ways to help employees save for retirement — by a direct matching contribution of up to 3% (assuming the employee is also contributing to their SIMPLE IRA account), or by providing a basic 2% contribution for all employees, regardless of whether the employees themselves are contributing.

While SIMPLE IRAs don’t offer the same high contribution limits that 401(k)s do, individuals who want to save more can compensate by opening a traditional or Roth IRA on their own.

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Photo credit: iStock/FatCamera

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.

SoFi Invest®
SoFi Invest refers to the two investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing 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, including state licensure of SoFi Digital Assets, LLC, 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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOIN1023162

Nov

2023

How to Know When to Sell a Stock

By Inyoung Hwang | Growing Wealth, invest, Investing | Comments Off

Table of Contents

When Is a Good Time to Sell Stocks?
7 Reasons You Might Sell a Stock
4 Reasons You Might Not Want to Sell a Stock
Selling a Stock 101

Knowing the right time to sell a stock can be a complicated decision. There’s the desire to sell at a profit, or to sell in order to prevent a loss — and sometimes there’s a logic to selling at a loss for tax purposes.

There can also be times when selling a stock isn’t necessarily a good idea — like when the market is volatile, and an investor lets the market jitters interfere with their wider investing strategy. In any circumstance, it helps to know your rationale for when to sell a stock.

Key Points

• Knowing when to sell stocks requires considering factors such as a company’s fundamentals, opportunity cost, valuation, personal needs, and tax implications.

• Economic reports and earnings releases can affect stock prices, but there is no specific ideal time to sell.

• Different sell order types, such as market sell, limit sell, stop-loss sell, and stop-limit sell, offer investors varying levels of control and execution.

• Investors selling stock should consider how a sale aligns with their financial goals, risk tolerance, and time horizon.

• Financial advisors and online brokerage platforms provide options for selling stocks, but costs and individual preferences should be considered.

When Is a Good Time to Sell Stocks?

There are a few ways to approach the question of when to sell stocks. Perhaps the most relevant answer is “when you need to.” That will depend on the individual investor, of course. But some investors, looking to generate a profit from their stock holdings, may also want to plan to sell stocks on certain dates, or during certain times of the day.

For example, earnings reports are usually released quarterly, and are often associated with movements in share price. This is often called “earnings season.” While there’s no way to know for sure how an earnings release will affect a stock’s price, more often than not, share prices gain or lose value in the wake of an earnings report.

As for specific times of the day — if you’re a more experienced trader, you may consider selling your shares around the open (9:30 am EST) or close (4 pm EST) of the stock market. Stock prices are most volatile around these times, so you may be able to capitalize on a sudden jump in price.

The point is not that there is a specific time period that’s ideal, or not ideal, when it comes to selling stocks. It’s best to familiarize yourself with the cadence of different economic reports (the jobs report, consumer confidence survey, interest rate changes, etc.), and learn what the impact of those data releases can be.

Once you have a sense of the literal ‘when’ of selling stocks, it’s up to you to judge the right time to make a move based on your rationale for why you want to do so.

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7 Reasons You Might Sell a Stock

There are several reasons that could prompt you to think about selling your stock.

1. When You No Longer Believe in the Company

When you bought shares of a certain company, you presumably did so because you believed that the company was promising and you wanted to invest in its stock, and/or that the share price was reasonable. But if you start to believe that the underlying fundamentals of the business are in decline, it might be time to sell the stock and reinvest those funds in a company with a better outlook.

There are many reasons you may lose faith in a stock’s underlying fundamentals. For example, the company may have declining profit margins or decreasing revenue, increased competition, new leadership taking the company in a different direction, or legal problems.

Part of the task here is differentiating what might be a short-term blip in the stock price due to a bad quarter or even a bad year, and what feels like it could be the start of a more sustained change within the business.

2. Due to Opportunity Cost

Every decision you make comes at the cost of some other decision you can’t make. When you spend your money on one thing, the tradeoff is that you cannot spend that money on something else.

The same goes for investing — for each stock you buy, you are doing so at the cost of not buying some other asset.

No matter the performance of the stock you’re currently holding, it might be worth evaluating to see if there could be a more profitable way to deploy those same dollars. Exchange-traded funds (ETFs) that provide easy access to other asset classes — like bonds or commodities — as well as newer markets like crypto, have also created competition to simply holding plain-vanilla company stocks.

This is easier said than done, however, because we are often emotionally invested in the stocks that we’ve already purchased. It may be a good idea to try and be as objective as possible during the evaluation and re-evaluation processes.

3. Because the Valuation Is High

Often, stocks are evaluated in terms of their price-to-earnings (P/E) ratios. The market price per share is on the top of the equation, and on the bottom of the equation is the earnings per share. This ratio allows investors to make an apples-to-apples comparison of the relative earnings at different companies.

The higher the number, the higher the price as compared to the earnings of that company. A P/E ratio alone might not tell you whether a stock is going to do well or poorly in the future. But when paired with other data, such as historical ratios for that same stock, or the earnings multiples of their competitors or a benchmark market, like the S&P 500 Index, it may be an indicator that the stock is currently overpriced and that it may be time to sell the stock.

A P/E ratio could increase due to one of two reasons: Because the price has increased without a corresponding increase in the expected earnings for that company, or because the earnings expectations have been lowered without a corresponding decrease in the price of the stock. Either of these scenarios tells us that there could be trouble for the stock on the horizon, though nothing’s a sure bet.

4. For Personal Reasons

Though not an analytical reason to sell, it is possible that you may need to sell a stock for personal reasons, such as needing a cash infusion in preparation for the home-buying process or some other purchase. If this is the case, you may want to consider a number of factors in choosing which stock to sell.

You may make the decision based purely on which stocks you feel have the worst forward-looking prospect for growth while keeping those that you feel have a better outlook.

5. Because of Taxes

Employing a tax-efficient investing strategy shouldn’t outweigh making decisions based on investment principles. Still, some people may take the rules of taxation into account when making decisions about which stocks to keep and which stocks to sell.

When purchased outside of a retirement account, gains on the sale of an investment like stock are subject to capital gains tax.

It may be possible to offset some capital gains with capital losses, which are triggered by selling stocks at a loss. If you’re considering this strategy, you may want to consult a tax professional. One strategy that some people use is tax-loss harvesting, where you purposely sell some investments at a loss in order to offset the tax consequences of gains in your portfolio.

6. To Rebalance a Portfolio

If you’re looking to make some tweaks to your investment strategy for one reason or another, you may want to sell some stocks as a part of a strategy to rebalance your portfolio. Investors are often encouraged to rebalance their portfolios often — but not too often — as market and economic conditions can and do change.

This typically involves taking a look at your desired asset allocation, thinking about your risk tolerance (and how it may have changed), and deciding how you may want to change the different asset classes that comprise your portfolio, if at all. Selling stocks would be involved in most rebalancing efforts.

7. Because You Made a Mistake

Finally, you may want to sell stocks if you simply made a mistake. You may have purchased shares of the wrong company, or bought a stock that is simply too risky, and are doing your due diligence and risk management in regards to your portfolio. If that’s the case, you can sell your stocks and reinvest the money elsewhere.

4 Reasons You Might Not Want to Sell a Stock

In addition to weighing possible reasons for selling a stock, there are counter arguments for holding onto your shares: e.g. having a knee-jerk reaction to the recent performance of that stock. There is, of course, a lot to think about when considering risk and investing, but you’ll need to know before buying any stocks that the markets are going to move — a lot.

1. Because a Stock Went Up

As mentioned, stock prices will go up at some point, and you may want to hold onto your stock in the hope that it will continue to grow. But that isn’t necessarily a good reason to try to time the market.

Even the experts cannot always buy at the bottom and sell at the top. There are no crystal balls, as they say. So even if a stock’s price is rising, you may want to have a few other reasons for not selling the stock.

2. Because a Stock Went Down

Conversely, stock prices will, at some point, go down. Again, it may be tempting to try and cut your losses before you accrue even bigger losses — assuming you think that the stock’s value will continue to plummet. But, again, it may be helpful to think longer-term rather than what’s happening today. Prices will, likely, rebound, and you may only lock your losses in by selling.

3. Because of an Economic Forecast

Economic forecasts come and go, and they change — a lot, and often. This is especially the case in the short term. Therefore, price changes may have as much to do with investor sentiment or outside forces (such as political or economic events or announcements) as they do with the health of the underlying company.

4. Because of Short-Term Reasons

There can be a million potential reasons that could spur you to sell your stocks in the short term. But many financial professionals will probably tell you that focusing on the longer term is a better idea, and not selling — i.e. using a classic buy-and-hold strategy — could lead to bigger returns over time.

So, barring some other reason, short-term issues or market fluctuations may not be a good reason to sell.

When to Sell Depends on You

Ultimately, whether you sell your stocks or not will boil down to your goals as an investor. That includes factors such as your investment style — are you looking at day trading, or employing a buy-and-hold strategy, for instance? — how much risk you’re willing to assume, and your overall time scale.

Many investors who are simply investing for retirement may very rarely sell stocks. Others, who are looking to turn a profit on a weekly or monthly basis, may sell much more frequently. It all depends on the individual. It’s more a matter of looking at what you’re hoping to generate from your investments, and how fast you’re hoping to generate it.

Risk, style, and how much time you have to do it are all critical variables.

Selling a Stock 101

These are the basic steps required to cash out and sell stocks:

1. Whether by phone or via an online brokerage account platform, let your broker know which of your stock holdings you’d like to sell.

2. Specify which order type (more on that below). This can determine at what price level your stock is sold.

3. Fill out any other information your broker requires in order to initiate the sale. For instance, some accounts may have a “time in force” option, or when the order expires. Keep in mind, the trade date is different from the settlement date. It usually takes a couple of days for a trade to settle.

4. Click “Sell” or “Submit Order.”

Different Sell Order Types

There are several different stock order types that can be useful in different situations.

Market Sell Order

This order type involves selling a stock immediately. The order will be executed without the investor specifying any price level to sell at. It’s important for investors to know however that because share prices are constantly shifting, they might not get the exact price they see on their stock-data feed. There may also be a difference due to delayed versus real-time stock quotes to consider as well.

Generally speaking, the advantage of using a market order is that your trade is likely to be executed quickly. That’s especially true for bigger or more popular stocks, which tend to be more liquid. But again: the biggest potential drawback is that you might not get the exact price you thought you were due to market volatility.

Limit Sell Order

Limit orders involve selling a stock at a specific price. For example, if you’re buying stocks, you can specify a price that you’re willing to pay — the trade will then be executed at that price, or lower.

If you’re selling stocks, the inverse is true — your stock will be sold at the specified price, or higher.

The upside to using limit orders is that they give investors some semblance of control by allowing them to name their price. The investor can then walk away, and let their brokerage handle the execution for them.

The downsides, though, include the fact that the trade may never execute if the specified price isn’t reached, and that using limit orders may take some practice and experience to properly execute.

Stop-Loss Sell Order

A stop-loss order is a level at which an automatic sell order kicks in. In other words, an investor specifies a price at which the broker should start selling, should the stock hit that level. This can also be referred to as a “sell-stop order.” But note that there are other types of stop-loss orders, such as buy-stop orders, and trailing stop-loss orders.

Stop-loss orders can be useful in that they can prevent investors from losing more than they’re comfortable with, or that they can afford to lose. They, as the name implies, are a very useful tool to prevent losses. But depending on overall market conditions, they can also work against an investor. If there’s a short-term drop in share prices, for instance, it’s possible that an investor could miss out on gains if share prices rebound in the medium or long term.

Stop-Limit Sell Order

A stop-limit sell order is an order that’s executed if your stock’s price drops to a certain price, but only if the shares can be sold at or above the limit price specified. They are, in effect, a sort of bridge between stop and limit orders. These types of orders can help investors dodge the risk that a stop order executed at an unexpected price, giving them more control over the price at which a sell order will execute.

Different Ways to Sell Stocks

There are desktop platforms and mobile phone apps that offer brokerage services. These are likely the most common platforms individual or retail investors use to currently buy or sell stocks. However, another option is through a financial advisor.

Financial advisors are professionals who have been entrusted to handle certain financial responsibilities and you can send them a stock sale order to execute. They can do a number of other things for you, too, including proffer advice and help you formulate an investing strategy. But there are costs to using financial advisors, so it may not be worth it, depending on how involved in the markets you are.

The Takeaway

Knowing when to sell stocks is not an intuitive thing — there are a lot of times when it may be a good idea to sell your stocks, and others when it’s not. For example, if you’ve lost faith in a company, need a cash infusion, or are doing some portfolio rebalancing, then it may be a good time to sell stock.

On the other hand, if you’re unnerved that your stock’s price fell after a bad earnings report, you may want to hold on and let things play out. It’s difficult, and is a true test of your risk tolerance. But over time, it should become easier and more natural as you gain experience as an investor.

With SoFi Invest®’s Automated Investing, a robo-advisor service, you can get an investment portfolio of ETFs suggested for you using your goals, risk tolerance, and investing time horizon as a guide. An alternative is SoFi’s Active Investing platform, which allows you to actively buy, sell, and trade stocks, ETFs and fractional shares.

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 can you tell when to sell a stock?

There’s no exact science, and determining whether it’s a good time to sell a stock will come down to the individual investor’s preference, risk tolerance, and time horizon. However, you can also keep an eye on a stock’s valuation, consider your opportunity costs, and weigh other factors in order to make a decision.

Should you ever sell stocks when they’re down?

You can sell stocks when they lose value for any number of reasons, but it’s likely best practice to make sure you’re doing so as a part of an overall investing strategy, e.g. tax-loss harvesting, and not simply because you’re making an emotional or irrational decision based on current market conditions.

How much profit do I need before I sell a stock?

There’s no exact science or answer to determine how much of a return you’d need to see before you sell a stock. That’s up to the specific investor, and there may be times when you actually generate a negative return when selling a stock.

SoFi Invest®
SoFi Invest refers to the two investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing 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, including state licensure of SoFi Digital Assets, LLC, 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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

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

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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Nov

2023

What Is a Dead Cat Bounce and How Can You Spot It?

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

A “dead cat bounce” is a colorful way of describing an unexpected price jump that occurs after a long, slow decline — and typically just before another price drop.

A dead cat bounce carries that morbid name because the price spike in a particular stock or market sector isn’t “live” (i.e. it’s not a real rebound), and characteristically it doesn’t last.

The danger can be that the apparent rebound creates false value, or optimism. That said, some investors may be able to take advantage of a dead cat bounce to create a short position. Unfortunately, it’s hard to identify a dead cat bounce until after the fact.

Nonetheless, investors may want to know some of the signs of this price pattern, as it can help them gauge certain market movements.

Key Points

• A dead cat bounce refers to a temporary price jump after a decline, often followed by another drop.

• It is difficult to identify a dead cat bounce in real-time, making it challenging for investors to take advantage of it.

• Dead cat bounces can occur in individual stocks, bonds, or entire markets.

• Investors should be cautious when interpreting price movements and consider other factors before making investment decisions.

• Active investors may use technical analysis and market indicators to help identify potential dead cat bounces.

What Is a Dead Cat Bounce?

The meaning of “dead cat bounce” comes from a bleak saying among traders that even a dead cat will bounce if it’s dropped from a high enough height.

Thus, when a security or market experiences a steady decline, and then appears to bounce back, only to decline again — it’s known as a dead cat bounce. The “recovery” doesn’t have a rhyme or reason; it’s merely part of a short-term market variation, perhaps driven by market sentiment or other economic factors.

Sometimes what appears to be a dead cat bounce can turn into a stock market crash.

A Dead Cat Bounce Is Specific

If you’re learning how to invest in stocks, bear in mind that a dead cat bounce is not used to describe the ups and downs of a typical trading day — it refers to a longer-term drop, rebound, and continued drop. The term wouldn’t apply to a security that’s continuing to grow in value. The revival must be brief, before the price continues to fall.

It’s also important to point out that this financial phenomenon can pertain to individual securities such as stocks or bonds, to stock trading as a whole, or to a market.

Why Identify a Dead Cat Bounce?

Even for experienced traders or short-term investors using sophisticated technical analysis, it can be difficult. Sometimes a rally is actually a rally; sometimes a drop indicates a bottom.

The point of trying to distinguish whether the rise in price will continue or reverse is because it can influence your strategy. If you have a short position, and you anticipate that a rally in stock price will end in a reversal, you may want to hold steady. If you think the rally will continue, you’ll want to exit a short position.

Example of a Dead Cat Bounce

To illustrate a dead cat bounce, let’s suppose company ABC trades for $70 on June 5, then drops in value to $50 per share over the next four months. Between Oct. 7 and Oct. 14, the price rises to $65 per share — but then starts to rapidly decline again on Oct. 15. Finally, ABC’s stock price settles at $30 per share on Oct. 16.

This pattern is how a dead cat bounce might appear in a real-life trading situation. The security quickly paused the decline for a swift revival, but the price recovery was temporary before it started falling again and eventually steadied at an even lower price.

History of Dead Cat Bounces

There are countless examples of the dead cat bounce pattern in stocks and other securities, as well as whole markets. One of the most recent affected the entire stock market during the Covid pandemic.

The U.S. stock market lost about 12% during one week in February 2020, and appeared to revive the following week with a 2% gain. But it turned out to be a false recovery, and the market dipped back down again until later that summer.

Why Does a Dead Cat Bounce Happen?

A dead cat bounce is often the result of investors believing the market or security in question has hit its low point and they try to buy in to ride the turnaround. It can also occur as a result of investors closing out short positions.

Since these trends aren’t driven by technical factors, that’s why the bounce is typically short-lived — usually lasting a couple of days, or maybe a couple of months on the outside.

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How to Spot A Dead Cat Bounce

Because a dead cat bounce is often an illusion of actual intrinsic value, investors may be tempted to jump on an investment opportunity before it makes sense to do so.

The following typical sequence of events may help an investor correctly identify a dead cat bounce as it might occur with a specific stock.

1. There is a gap down.

Typically the stock opens lower than the previous close, usually a significant amount like 5% (or perhaps 3% if the stock isn’t prone to volatility).

2. The security’s price steadily declines.

In a true dead cat bounce scenario, that initial gap down will be followed by a sustained decline.

3. The price sees a monetary gain for a short time.

At some point during the price drop, there will be a turnaround as the price appears to bounce back, close to its previous high.

4. A security’s price begins to regress again.

The rally is short, however, and the stock completes its dead cat bounce pattern with a final decline in price.

Dead Cat Bounce vs Other Patterns

How do you know whether the pattern you’re seeing is really a classic dead cat bounce versus other types of movements? Here are some clues.

Dead Cat Bounce or Rally?

One way to stay alert for a dead cat bounce with a particular stock is to consider whether the now-rising stock is still as weak as it was when its price was falling. If there’s no market indicator as to why the stock is rebounding, it might make sense to suspect a dead cat bounce.

Dead Cat Bounce or Lowest Price?

Since investors are looking for opportunities to profit, they try to find investment opportunities that allow them to buy low and sell high.

Therefore, when assessing investment opportunities, a successful investor might try to recognize emerging companies, and buy shares of their stock while the price is low and before other investors get wind of the lucrative company.

Since companies go through business cycles where stock prices fluctuate, pinpointing the lowest price point might be hard to determine. There’s no way to know if a dead cat bounce is happening, until the prices have resumed their descent.

Dead Cat Bounce or Bottom of a Bear Market?

Investors may also confuse a dead cat bounce for the actual bottom of a bear market. It’s not uncommon for stocks to significantly rebound after the bear market hits bottom.

History shows that the S&P 500 often sees substantial gains within the first few months of hitting bottom after a bear market. But these rallies have been sustained, and thus are not a dead cat bounce.

Investing Strategies to Avoid a Dead Cat Bounce

For investors who want a more hands-on investing approach — meaning active investing vs. passive — it’s generally better to use investing fundamentals to evaluate a security instead of attempting to time the market (and risk mistaking a dead cat bounce for an opportunity).

Investors who are just starting may want to consider building a portfolio of a dozen or so securities. Picking a few stocks allows investors to monitor performance while giving their portfolio a little diversification. This means the investor distributes their money across several different types of securities instead of investing all of their money in one security, which in turn can help to minimize risk.

Active investors could also consider selecting stocks across varying sectors to give their portfolio even more diversification instead of sticking to one niche.

Investors with restricted funds might consider investing in just a few stocks while offsetting risk by investing in mutual funds or exchange-traded funds (ETFs).

For investors who would prefer not to execute an active investing strategy alone, they can speak with a professional manager. Working with a professional manager may help the investors better navigate the intricacies of various market cycles.

Limitations in Identifying a Dead Cat Bounce

As noted several times here, a dead cat bounce can’t really be identified with 100% certainty until after the fact. While some traders may believe they can predict a dead cat bounce by using certain fundamental or technical analysis tools, it’s impossible to do so every single time.

If there were a way to accurately predict market movements or different patterns, people would always try to time the market. But there are no crystal balls in investing, as they say.

The Takeaway

With 20-20 hindsight, investors and analysts can clearly see that an individual security or market has experienced a steady drop in value, a brief rebound, and then a further drop — a phenomenon known as a dead cat bounce.

Unfortunately, though, it can be too hard for most investors to distinguish between a dead cat bounce and a bona fide rally, or the bottom of a given market or security’s price. Still, knowing what to look for may help investors make more informed choices, especially when it comes to making a choice around keeping or closing out a short position.

For investors who want to take an active role in investing, an online trading platform like SoFi Invest® offers the opportunity to manage your money the way you want. When you open an Active Invest account with SoFi, you can trade stocks you’re familiar with or explore different investment opportunities, including IPO shares, fractional shares, and more.

Build your portfolio with SoFi Active Investing, starting with as little as $5.

SoFi Invest®
SoFi Invest refers to the two investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing 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, including state licensure of SoFi Digital Assets, LLC, 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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

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

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

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

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