If you’ve ever tried to crowdsource an answer to an obscure question or find cool stuff to do in a random city, you’re probably familiar with Reddit. The internet forum may feel reminiscent of a ‘90’s chatroom, but the site has a strong internet presence, an influential base of users (GameStop, ever heard of it?), and now, a path to becoming a public company.
In Dec. 2021, Reddit announced it had confidentially filed its IPO paperwork with the Securities and Exchange Commission (SEC), but it held off on actually going public
. Now, Reuters is reporting the social network is planning to file publicly in late February and complete its IPO soon after. Reddit has even picked its future home: The New York Stock Exchange.
If you want to be ready to buy Reddit stock once it hits the market, here’s what you need to know.
How to buy Reddit stock
Once Reddit has gone public, you’ll be able to buy Reddit stock. If you want to invest in Reddit as an individual stock when it becomes available, you’ll need an investment account. Investment accounts, or brokerage accounts, are not investments themselves — they simply house the money you use to buy investments, and your actual investments once you purchase them. There are several types of investment accounts, and it’s worth investigating which type is best for you since some offer tax advantages.
Once you open an investment account and add money to it — and Reddit goes public — you’ll be able to buy the stock. That being said, some brokers do offer access to IPO shares before they’re more widely available, but they may have mandatory investor assessments, account minimums or trade minimums.
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What to consider when buying Reddit stock
While Reddit serves a slightly different function in a different format than its competitors (think more question-and-answer and in-depth discussion than Instagram pics and platitudes), the company is still entering a ring that already has a few heavyweight champs in it.
With competition such as Meta, TikTok and Pinterest, it may be difficult for Reddit to hold its own. Plus, sources from inside Reddit told Bloomberg that the company has yet to turn a full-year profit
. Reddit relies on two main income streams: Advertising revenue, and a paid plan called Reddit Premium lets users pay $5.99 per month to avoid that advertising. Both sources of revenue were met with protest from Reddit users when they were introduced.
When purchasing any stock you’ll want to consider the company’s fundamentals, such as its revenue, net income and earnings per share. When looking into a company that is new to the public sphere, such as Reddit, it can be difficult to find that information since private companies don’t have to produce regular reports. Once Reddit becomes public, that information will be more readily available because the company will be required by the SEC to provide regular financial updates.
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How much should you invest in Reddit stock?
No one will know how much a share of Reddit stock will cost until its IPO price is announced, and even then, the market will have its say about the company’s value. But like any large or significant purchase, it’s a good idea to know how much you feel comfortable spending before you hit “buy.”
A good rule of thumb is to not invest more than 5% to 10% of your overall investment portfolio (that includes all your investment accounts, such as a 401(k), an IRA and any traditional brokerage accounts) in individual stocks. For easy math, that means if you have $100 to invest, you may only want between $5 and $10 to be allocated to individual stocks such as Reddit.
The rest of your account could be made up of funds, such as index funds. Funds offer instant diversification for your portfolio since they invest in lots of companies at once. That way, if one company performs poorly, your overall portfolio is bolstered by the performance of the other companies.
Once Reddit IPOs and is a publicly-traded company, you can decide how much you want to spend on its stock. If you open an investment account with a broker that offers fractional shares, you’ll be able to pay for your stock in a dollar amount rather than a share amount. That means if the price per share is more than you want to spend, you can purchase a fraction of a share rather than a full share.
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If you are new to trading stocks, the sheer volume of stock market terms can be off-putting. But learning some basic stock trading terminology is a great place to begin before investing any money. For any new investor just getting into trading, getting a grasp on some basic stock market terms can be extremely helpful.
The Significance of Knowing Stock Market Terminology
It’s important to have at least a grasp of some basic stock market terms if you plan on trading or investing. If you don’t do a bit of homework beforehand, you may find yourself feeling in over your head, and grasping for help from family members, friends, or a financial professional.
While there are a multitude of different stock market terms out there, it isn’t terribly difficult to develop an understanding of the basics. Yes, it’ll take some time and practice, but like learning anything else, once you get the hang of it, it should become easier as you move along in your investment journey. 💡 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.
Fundamental Terms
To get a fundamental understanding of the stock market, it can be helpful to start with some relatively basic terms, including the following.
Asset Allocation
Asset allocation involves investing across asset classes in a portfolio in order to balance the different potential risks and returns, and there are three main asset classes, which are typically stocks, bonds, and cash. Asset allocation is closely tied with portfolio diversification.
Asset Classes
There are several asset classes, or types of assets, that investors can invest in. This can include, but is not limited to, stocks, bonds, money market accounts, cash, real estate, commodities, and more. You can also think of certain assets as equities, debt securities, and more.
Bid
Bid, in the context of bid-ask spread, refers to the “bid price” that an investor is willing to pay for a security or investment.
Ask
Ask, in the context of bid-ask spread, is the opposite of bid, and is the lowest price that investors are willing to sell a security for.
Bid-Ask Spread
The bid-ask spread is the difference between the bid and ask price, and can be a measure of liquidity. When the bid and ask prices match, a sale takes place, on a first-come basis if there is more than one buyer. The bid-ask spread is the difference between the highest price a buyer is willing to bid, and the lowest price a seller is willing to ask.
Market Phrases
There are a number of market phrases, or types of jargon that may be used in and around the stock market, too. Here are some examples.
Bull Market
A bull market describes market conditions when a market index rises by at least 20% over two months or more, and is often used to describe high levels of confidence and optimism among investors.
Bear Market
A bear market describes a 20% fall in a market index, and is the opposite of a bull market. It can signal overall pessimism among investors.
Market Volatility
Market volatility refers to how much a market index’s value increases or decreases within a specific period of time. Volatility can occur for a number of reasons.
Investment Vehicles
There are many specific investment vehicles that investors should know about, too, including different types of stocks, bonds, and more.
Bonds
Bonds are a type of debt security, which effectively means that investors are loaning money to the issuer. There are many types of bonds, and they’re often considered to be a less-risky investment alternative to, say, stocks.
Common Stock
Common stock, also known as shares or equity, is like owning a piece of a company. You purchase stock in a company, and receive a proportional part of that corporation’s assets and earnings. The price of stock is different for each company and fluctuates over time.
Preferred Stock
Preferred stock is similar to common stock, but usually grants shareholders some sort of preferential treatment, such as advanced dividend payments, and more.
ETFs
ETFs, or “exchange-traded funds,” are types of funds that trade on exchanges like stocks. Investors can purchase shares of ETFs, which incorporate numerous different types of securities (like a “basket” of different investments), and may offer built-in diversification as an advantage for investors.
Mutual Funds
Mutual funds are companies or entities that pool money from numerous different investors and then invest it on their behalf. A manager oversees a mutual fund, and actively manages it. Investors can purchase shares of mutual funds, which are similar to ETFs in many ways.
Stock Analysis Terms
Analyzing the stock market incorporates its own set of terminology, and it can be helpful for investors to know a bit of the vernacular.
Earnings Per Share (EPS)
Earnings per share, often shortened as “EPS,” is a ratio that helps determine a company’s ability to drive profits for shareholders. It’s a common and oft-cited business metric for investors.
Dividends
A dividend is a payment made from a company to its shareholders, often drawn from earnings. Usually, these are made in cash, but sometimes they are paid out as additional stock shares. They are typically paid on an annual or quarterly basis, and typically only come from more established companies, not startups.
Dividend Yield
Dividend yield refers to how much a company pays out to shareholders on an annual basis relative to its share price. It’s a ratio that’s calculated by dividing the company’s dividend by its share price.
The Price-to-earnings (P/E) Ratio
The price-to-earnings ratio (often written as the P/E ratio, PER, or P/E) is a ratio of a company’s current share price relative to the company’s earnings per share. It can be used to compare performances of different companies. 💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.
Price Movements and Pattern Terms
There are also a number of movement and pattern terms that investors may want to familiarize themselves with.
Trading Volume
Trading volume refers to how much trading is happening on an exchange. For a stock trading on a stock exchange, the stock volume is typically reported as the number of shares that changed hands during any given day. It’s important to note that even with an increasing price, if it’s paired with a decreasing volume, that can mean a lack of interest in a stock. A price increase or drop on a larger volume day (i.e., a bigger trading day) is a potential signal that the stock has changed dramatically.
Volume-weighted Average Price (VWAP)
Volume-weighted average price, or VWAP, is a short-term price trend indicator used when analyzing intraday, or same-day, stock charts. It’s a type of technical analysis indicator.
Trading Order Types and Execution
Investors need to know the types of orders that they’re likely to use throughout their investing journey. Those include market orders, limit orders, and stop-loss orders.
Market Order
A market order is the most common type of order, and it means that an investor wants to buy or sell a security as soon as possible at the current market price.
Limit Order
Limit orders are another common type of order, and involve an investor placing an order to buy or sell a security at a specific price or within a specific time frame. There are two types: Buy limit orders, and sell limit orders.
Stop-loss Orders
Stop-loss orders, or sometimes called stop orders, are orders that specify a security to be sold at a certain price.
Day Trading Terms
For the prospective day-trader, there are a slate of terms to know as well.
Day Trading
Day trading involves an investor making short-term trades on a daily or weekly basis in an effort to generate returns off of price fluctuations in the market. There are numerous day trading strategies that investors can utilize.
Pattern Day Trader
A pattern day trader is a designation created by FINRA, and refers to traders who trade securities four or more times within five days. There are rules and stipulations that pattern day traders, and their chosen trading platforms, must follow.
Trading Halt
A trading halt can refer to a specific stock or the entire market, and involves a halt to all trading activity for an indefinite period of time.
Long-term Investment Terms
The opposite of day trading, long-term investing also ropes in its own jargon.
Averaging Down
Averaging down involves a scenario in which an investor already owns some stock but then purchases additional stock after the price has dropped. It results in a decrease in the overall average price for which you purchased the company stock. Investors can profit if the company’s price subsequently recovers.
Diversification
Diversification refers to investing in a wide range of assets and asset classes, as opposed to concentrating investments in a specific area or class.
Dollar-cost Averaging
Dollar-cost averaging is a strategy to manage volatility in a portfolio, and involves regularly investing in the same security at different times, but with the identical amount. Effectively, the cost of those investments will average out over time.
Derivatives and Market Predictors
Getting into the weeds now — derivatives and market predictors are more high-level market elements, but it can be helpful to know some of the terminology.
Futures
Futures, or futures contracts, are a form of derivatives that are a contract between two traders, agreeing to buy or sell an asset at a specific price at a future date.
Options Trading
Options trading involves buying and selling options contracts, of which there are many types.
Arbitrage
Arbitrage refers to price differences in the same asset on different markets. Traders may be able to take advantage of those differences to generate returns.
Financial Health Indicators
We’re not done yet — these terms involve financial health indicators.
Debt-to-equity (D/E)
Debt-to-equity is a financial metric that helps investors determine risks with a specific stock, and is calculated by dividing a company’s equity by its debts.
Liquidity
Market liquidity is essentially how easily shares of stock can be converted to cash. The market for a stock is “liquid” if its shares can be sold quickly, and the act of selling only minimally impacts the stock price.
Profit Margin
Profit margin refers to how much profit is generated from a trade when expenses are considered. Lowering related expenses can increase profit margin, all else being equal.
Economic Terms
Knowing some key economic terms can be helpful when trying to size up larger economic and market trends.
Volatility
Volatility refers to the range of a stock price’s change over time. If the price stays stable, then the stock has low volatility. If the price jumps from high to low and then back to high often, it would be considered more of a high-volatility stock.
Economic Bubbles
Economic bubbles or market bubbles are often created by widespread speculative trading, and involve a runup or buildup of prices for a given asset, which can be detached from its actual value. Eventually, the bubble tends to burst and investors may incur a loss.
Recession
A recession is a period of economic contraction, and is usually accompanied by higher unemployment rates, business failures, and lower gross domestic product figures. Recessions are officially declared by the Business Cycle Dating Committee at the National Bureau of Economic Research.
Adaptation and Risk Management
For particularly savvy investors, knowing some terms relating to adaptation and risk management can also be helpful when navigating the markets.
Sector Rotation
Sector rotation involves investing in different sectors of the economy at different times, and rotating holdings between those sectors in an effort to generate the biggest returns.
Hedging
Hedging is an investment strategy that involves limiting risk exposure within different parts of a portfolio, and there are many methods or strategies for doing so.
The Takeaway
Learning some basic stock market terms can go a long way toward helping an investor navigate the markets, and there are a lot of terms and jargon to get familiar with. But doing a bit of homework early on can be enormously helpful so that you’re not trying to figure things out on the fly as an investor.
While you’re not going to learn everything right off the bat, if you start to spend a lot of time investing and trading, you’re likely to quickly catch on to certain terms, while others will come with time. As always, if you have questions, you can reach out to a financial professional for help — or do a bit more research on your own.
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The Fear and Greed Index (developed by CNN Business
) is a measure of investor sentiment, which ranges from extreme fear to extreme greed. The thinking is that “excessive fear” leads to lower stock prices, and “too much greed” leads to higher stock prices, according to the index. Thus, it can help investors determine whether stocks are priced fairly.
How does the Fear and Greed Index work?
The index — a score from 0 to 100 — is calculated by analyzing seven different indicators that measure market volatility, investor sentiment and other factors that impact the stock market.
The seven indicators are:
Market Momentum: This measures the performance of the S&P 500 index against the moving average over the past 125 days. If the S&P 500 index is rising, it indicates that investors are optimistic about the economy and the stock market.
Stock Price Strength: This measures the number of stocks on the New York Stock Exchange (NYSE) that are trading at their 52-week highs, compared to the number of stocks trading at their 52-week lows. More highs than lows indicates that the market is strong and investors are optimistic.
Stock Price Breadth: This measures the number of stocks that are rising versus falling. If more stocks are rising, it indicates that investors are bullish.
Put and Call Options:This measures the ratio of put options (which are like a contract that gives the owner the option to sell an underlying asset) to call options (which gives the owner the option to buy an underlying security). If more investors are buying put options, it indicates that they are trying to protect their investments against a potential downturn in the market.
Junk Bond Demand:This measures the difference in yields between high-risk, high-yield junk bonds and safer government bonds. Increasing demand for high-yield bonds indicates that investors are willing to take on more risk, which the index factors as a sign of “greed.”
Market Volatility: This references the Cboe Volatility Index (VIX), a predictive measure of expected changes in the S&P 500 Index options over the next 30 days. Over time, a low VIX index indicates a bull market and high index indicates a bear market.
Safe Haven Demand: This measures the demand for Treasury bonds compared to riskier stocks. If the demand for bonds is higher, it indicates that investors are fearful and are seeking safe havens to protect their investments.
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How is the Fear and Greed Index used?
The Fear and Greed Index is used by investors to gauge the overall sentiment of the market and to help make informed decisions about buying or selling stocks.
Each indicator is given equal weight in determining an index between 0 and 100. When the index is high — showing greed or extreme greed — it indicates that investors are optimistic and are buying stocks. When the index is low — showing fear or extreme fear — it indicates that investors are fearful and are selling stocks.
Fear and Greed Index
Index score
Extreme Fear
Extreme Greed
Source: CNN Business
For example, in March 2020 at the beginning of the COVID-19 pandemic, the Fear and Greed Index dropped to an annual low of 2. This was due to the uncertainty and fear surrounding the pandemic, including a travel ban. Investors moved to sell their stocks and seek safe havens, and the stock market experienced a significant decline
.
Limitations of the Fear and Greed Index
While the Fear and Greed Index can be a useful tool for investors, it is not a perfect indicator of market sentiment. The index is based on a limited number of indicators and doesn’t predict other factors that can impact the stock market, such as geopolitical events and economic data.
The Fear and Greed Index is also not the only tool that investors use to assess the market’s mood.
An IPO, or initial public offering, refers to privately owned companies selling shares of the business to the general public for the first time.
“Going public” has benefits: It can boost a company’s profile, bring prestige to the management team, and raise cash that can be used for expanding the business.
But there are downsides to going public as well. The IPO process can be costly and time-consuming, and subject the business to a high level of scrutiny.
Key Points
• An IPO, or initial public offering, is when a privately owned company sells shares of the business to the general public for the first time.
• Companies typically hire investment bankers and lawyers to help them with the IPO process.
• Reasons for a company IPO include raising capital, providing an exit opportunity for early stakeholders, and gaining more liquidity and publicity.
• Pros of an IPO include an opportunity to raise capital, future access to capital, increased liquidity, and exposure.
• Cons of an IPO include costs and time, disclosure obligations, liability, and a loss of managerial flexibility.
IPO Definition
IPO stands for “initial public offering,” which marks the first time a private corporation offers its securities for sale to the public.
In such a process, a portion of the firm’s shares are transferred from private ownership by company insiders to public markets, so that both retail and institutional investors can buy IPO shares.
How Do IPOs Work?
To have an IPO, a company must file a prospectus with the SEC. The company will use the prospectus to solicit investors, and it includes key information like the terms of the securities offered and the business’s overall financial condition.
Behind the scenes, companies typically hire investment bankers and lawyers to help them with the IPO process. The investment bankers act as underwriters, or buyers of the shares from the company before transferring them to the public market. The underwriters at the investment bank help the company determine the offering price, the number of shares that will be offered, and other relevant details.
The company will also apply to list their stock on one of the different stock exchanges, like the New York Stock Exchange or Nasdaq Stock Exchange.
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IPO Price vs Opening Price
The IPO price is the price at which shares of a company are set before they are sold on a stock exchange. As soon as markets open and the stock is actively traded, that price begins to go up or down depending on consumer demand, which is known as the opening price.
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History of IPOs
While there are some indications that shares of businesses were traded during the Roman Republic, the first modern IPO is widely considered to have been offered by the Dutch East India Company in the early 1600s. In general, the Dutch are credited with inventing the stock exchange, with shares of the Dutch East India Company being the sole company trading in Amsterdam for many years.
In the U.S., Bank of North America conducted the first American IPO, which likely took place in 1783. A report claims investors hiding cash in carriages evaded British soldiers to buy shares of the first American IPO.
Henry Goldman led investment bank Goldman Sachs’ first IPO — United Cigar Manufacturers Co. — in 1906, pioneering a new way of valuing companies. A challenge for retail companies at the time was that they lacked hard assets, as other big businesses like railroads had at the time. Goldman pushed to value companies based on their income or earnings, which remains a key part of IPO valuations today.
Why Does A Company IPO, or “Go Public”?
Answering the question, “what’s an IPO?” doesn’t explain why a company “goes public” — an important detail in the process. Because an IPO requires a significant amount of time and resources, a business probably has good reason to go through the trouble.
Raising Money
A common reason is to raise capital (money) for possible expansion. Prior to an IPO, a private company may procure funding through angel investors, venture capitalists, private investors, and so on.
A company may reach a size where it is no longer able to procure enough capital from these sources to fund further expansion. Offering sales of stock to the public may allow a company to access this rapid influx of investment capital. 💡 Quick Tip: Keen to invest in an IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.
Exit Opportunity
An IPO may be a way for early stakeholders, such as angel investors and venture-capital firms, to cash out of their holdings. Venture-capital firms in particular have their own investors that need to provide returns for. IPOs are a way for them to transfer their share of a private company by selling their equity to public investors.
More Liquidity
Venture-capital firms and angel investors aren’t the only ones who may be seeking more liquidity for stakes in companies. Liquidity refers to the ease with which an investor can sell an asset. Stocks tend to be much more liquid assets than private-company stakes.
Hence, employees with equity options can also use IPOs as a way to gain more liquidity for their holdings, although they are usually subject to lock-up periods.
Publicity
From the roadshow that investment banks hold to inform potential investors about the company to when executives may ring the opening bell at a stock exchange, an IPO can bring out greater publicity for a company.
Being listed as a public company also exposes a business to a wider variety of investors, allowing the business to obtain more name recognition.
Pros and Cons of an IPO
As with any business decision, there are downsides and risks to going public that should be considered in conjunction with the potential benefits. Here’s a look at a few:
Pros
Cons
An IPO may allow a company to raise capital on a scale otherwise unavailable to it. It can use these funds to expand the business, build infrastructure, and to fund research and development.
Public companies must keep the public informed about their business operations and finance. They are subject to a host of filing requirements from the SEC, from initial disclosure obligations to quarterly and annual financial reports.
After an IPO, companies can issue more stock, which can help with future efforts to raise capital.
Companies and company leaders may be liable if legal obligations like quarterly and annual filings aren’t met.
IPOs increase liquidity, which allows business owners and employees to more easily exercise stock options or sell shares.
Public companies must consider the concerns and opinions of a potentially vast pool of investors. Private companies on the other hand, often answer to only a small group of owners and investors.
Public companies may use stock as payment when acquiring or merging with other businesses.
Public companies are under more scrutiny than their private counterparts, as they’re forced to disclose information about their business operations.
IPOs can generate a lot of publicity.
Going public is time consuming and expensive.
Participating in an IPO: 3 Steps to Buying IPO Stock
1. Read the Prospectus
IPOs can be hard to analyze: It’s difficult to learn much about a company going public for the first time. There’s not a lot of information floating around beforehand since when companies are private, they don’t really have to disclose any earnings with the SEC. Before an IPO, you can look at two documents to get information about the company: Form S-1 and the red herring prospectus.
2. Find Brokerage
If you want to purchase shares of a stock in an IPO, you’ll most commonly have to go through a broker. Some firms also let you buy shares at the offering price as opposed to the trading price once the stock is on the public market.
3. Request Shares
Once a brokerage account is set up, you can let your broker know electronically or over the phone how many shares of what stock you’d like to buy and what order type. The broker will execute the trade for you, usually for a fee, although many online brokerages now offer zero commission trading.
Who Can Buy IPO Stock?
Not everyone has the ability to buy shares at the IPO price. When a company wants to go public, they typically hire an underwriter — an investment bank — that structures the IPO and drums up interest among investors. The underwriter acquires shares of the company and sets a price for them based on how much money the company wants to raise and how much demand they think there is for the stock.
The underwriter will likely offer IPO shares to its institutional investors, and it may reserve some for other people close to the company. The company wants these initial shareholders to remain invested for the long-term and tries to avoid allocating to those who may want to sell right after a first-day pop in the share price.
Investment banks go through a relatively complicated process in part to help them avoid some of the risks associated with a company going public for the first time. It’s possible that the IPO could become oversubscribed, e.g when there are more buyers lined up for the stock at the IPO price than there are actual shares.
When Can You Sell IPO Stock?
Shortly after a company’s IPO there may be a period in which its stock price experiences a downturn as a result of the lock-up period ending.
The IPO lock-up period is a restriction placed upon investors who acquired company stock before it went public that keeps them from selling their shares for a certain period of time after the IPO. The lock-up period typically ranges from 90 to 180 days. It’s meant to prevent too many shares in the early days of the IPO from flooding the market and driving prices down.
However, once the period is over, it can be a bit of a free-for-all as early investors cash in on their stocks. It may be worth waiting for this period to pass before buying shares in a newly public company.
Things to Know Before Investing in an IPO
An IPO, by definition, gives the investing public an opportunity to own the stock of a newly public company. However, the SEC warns that IPOs can be risky and speculative investments.
IPO Market Price
To understand why investing in an IPO can be risky, it is helpful to know that the business valuation and offering price have not been determined not by the market forces of supply and demand, as is the case for stocks trading openly in a market exchange.
Instead, the offering price is usually determined by the company and the underwriters who negotiate a price based on an often-competing set of interests of involved parties.
Post-IPO Trading
Purchasing shares in the market immediately following an IPO can also be risky. Underwriters may do what they can to buoy the trading price initially, keeping it from falling too far below the offering price.
Meanwhile, IPO lock-up periods may stop early investors and company executives from cashing out immediately after the offering. The concern to investors is what happens to the price once this support ends.
Data from Dealogic shows that since 2010, a quarter of U.S. IPOs have seen losses after their first day.
IPO Due Diligence
Investors with the option to invest in an IPO should do so only after having conducted their due diligence. The SEC states that “being well informed is critical in deciding whether to invest. Therefore, it is important to review the prospectus and ask questions when researching an IPO.”
Investors should receive a copy of the prospectus before their broker confirms the sale. To read the prospectus before then, check with the company’s most recent registration statement on EDGAR, the SEC’s public filing system.
IPO Alternatives
Since the heady days of the dot-com bubble, when many new companies were going public, startups have become more disgruntled with the traditional IPO process. Some of these businesses often complain that the IPO model can be time-consuming and expensive.
Particularly in Silicon Valley, the U.S. startup capital, many companies are taking longer to go public. Hence, the emergence of so many unicorn companies — businesses with valuations of $1 billion or greater.
In recent years, alternatives to the traditional IPO process have also emerged. Here’s a closer look at some of them.
Recommended: Guide to Tech IPOs
Direct Listings
In direct listings, private companies skip the process of hiring an investment bank as an underwriter. A bank may still offer advice to the company, but their role tends to be smaller. Instead, the private company relies on an auction system by the stock exchange to set their IPO price.
Companies with bigger name brands that don’t need the roadshows tend to pick the direct-listing route.
SPACs
Special purpose acquisition companies or SPACs have become another common way to go public. With SPACs, a blank-check company is listed on the public stock market.
These businesses typically have no operations, but instead a “sponsor” pledges to seek a private company to buy. Once a private-company target is found, it merges with the SPAC, going public in the process.
SPACs are often a speedier way to go public. They became wildly popular in 2020 and 2021 as many famous sponsors launched SPACs.
Crowdfunding
Crowdfunding is collecting small amounts of money from a bigger group of individuals. The advent of social media and digital platforms have expanded the possibilities for crowdfunding.
The Takeaway
Initial public offerings or IPOs are a key part of U.S. capital markets, allowing private businesses to enter the world’s biggest public market. Conducting an IPO is a multi-step, expensive process for private companies but allows them to significantly expand their reach when it comes to fundraising, liquidity and brand recognition.
For investors, buying an IPO stock can be tempting because of the potential of getting in on a company’s growth early and benefiting from its expansion. However, it’s important to know that many IPO stocks also tend to be untested, meaning their businesses are newer and less stable, and that the stock price can fluctuate — creating considerable risk for investors.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it’s wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
Invest with as little as $5 with a SoFi Active Investing account.
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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.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.
New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures. Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Shares of Countrywide Financial plummeted today on rumors that the company was in serious trouble, with some saying the company would declare bankruptcy this week.
Shares of the embattled mortgage lender were trading down $1.71, or 22.38%, to $5.93 in early afternoon trading on the New York Stock Exchange, the largest single drop since 1987, and the lowest price since March 2000.
Credit default swaps tied to Countrywide’s debt also rose to record levels today, indicating that investors fear the possibility of a bond default.
Interestingly, just months ago Countrywide said it expected to be profitable in the fourth quarter despite a huge decline in lending activity and a $1.2 billion third-quarter loss, its first third-quarter loss in 25 years.
And the big fear now is that depositors will likely pull their money out in droves, and any potential depositors will look elsewhere, creating huge liquidity problems for the struggling lender.
The U.S.’s top mortgage lender is expected to disclose December mortgage lending results as soon as Friday, and will report fourth-quarter results later this month.
***Countrywide halted trading on the NYSE to allow officials to formerly address market speculation that it was planning to seek bankruptcy protection.
“There is no substance to the rumor that Countrywide is planning to file for bankruptcy, and we are not aware of any basis for the rumor that any of the major rating agencies are contemplating negative action relative to the company,” Countrywide said in a statement.
When trading resumed, shares of Countrywide (NYSE:CFC) began to improve, but later in the day fell even lower.
Shares of Countrywide dipped as low as $5.05 in trading Tuesday, eventually ending the day at $5.47 despite a flat out denial of a looming bankruptcy.
Bond issuers and mortgage insurers fell sharply on the news, with MBIA Inc. plummeting more than 16% and hitting a record low of $14.77, while Ambac Financial Group Inc. fell more than 21% to a record low of $18.37.
Private mortgage insurance provider MGIC Investment Corp. (NYSE:MTG) dropped more than 13% and PMI Group (NYSE:PMI) shed more than 11%.
The Wall Street Journal reported today that Bank of America is in advanced talks to acquire ailing mortgage lender Countrywide Financial.
According to the Journal, two people familiar with the matter said it may happen very soon, but noted that it’s also possible that any agreement could be delayed or fall apart altogether.
It is believed that an announcement regarding the matter will be made either late today or tomorrow morning.
In August, many believed Bank of America was gearing up to take over Countrywide after buying $2 billion in preferred shares convertible to about a 16% stake in the company.
But since then, Countrywide shares have fallen tremendously, briefly dipping to $4.43 Wednesday, an all-time low for the struggling Calabasas-based lender.
Shares of Countrywide rocketed shortly after the report was released, climbing $3.27, or 63.87%, to $8.39 in late afternoon trading on Wall Street, while Bank of America rose marginally.
Bank of America now holds 9.88% of the country’s deposits after its acquisition of LaSalle Bank in September, just below the federal limit which prohibits a bank from controlling more than 10% of U.S. deposits.
However, the law does not apply to federally chartered thrifts, one of which happens to be Countrywide Bank.
If successful, the deal would bring together the top U.S. mortgage lender with the second largest bank in the United States.
Nearly a year ago, the two financial giants met to discuss a possible alliance when Countrywide was trading around $42.
Bank of America declined to comment, as it doesn’t respond to rumors or speculation, while Countrywide representatives failed to respond to a request for a comment.
Shares of related companies surged as well, with IndyMac up over 16%, MGIC up 12%, Fannie up more than 6%, and Washington Mutual gaining more than 11%.
In similar news, Legg Mason revealed a 9.08 percent passive stake in Thornburg Mortgage, up from 4.35 percent, according to a previous SEC filing.
Updates: The New York Stock Exchange said it has contacted Countrywide, asking the company to make a statement regarding the unusual activity of its stock.
Analysts believe regulators would likely approve the takeover because a possible bankruptcy would further disrupt the market.
Countrywide CEO Angelo Mozilo could receive $36.4 million if the company were to be taken over, according to regulatory filings and compensation experts.
The deal looks like a go…and should be announced tomorrow. Sources say it’s an all-stock deal valued at just over $4 billion.
Rumors: There are some interesting rumors floating around regarding the takeover news.
Some say that the deal was facilitated by Washington, who couldn’t possibly let the top lender fail. Apparently the Countrywide bankruptcy rumors may have been true.
Others say there was another interested buyer, but Bank of America has the right of first refusal.
Failed mortgage lender NovaStar Financial said today that it will cut roughly 170 jobs, or 85 percent of its remaining staff, and give up both its mortgage-origination and brokerage business licenses.
The company, which will be left with about 30 employees after the latest cuts, said in an SEC filing that the reduction in staff is part of its plan to discontinue its retail and brokerage operations.
NovaStar noted that the discontinuation “may hinder or otherwise negatively affect the ability of the company to recommence a mortgage origination and mortgage brokerage business if market conditions improve.”
The Kansas City-based lender said the layoffs will result in a pre-tax charge of about $1.3 million to $1.8 million, mainly related to severance costs, with most of it realized in the first quarter.
Yesterday, the company said it had received another waiver from Wachovia Bank until February 4 to help it avoid defaulting on credit agreements.
It’s unclear to what extent the company is still operating, as a bulletin on their website reads:
“At present, we are no longer originating new loans, but we thank you for your interest and for considering us.
If you are a former customer, NovaStar Mortgage is no longer servicing any loans. You should have received a notice from both NovaStar and your new Servicer by now and will need to reference this material for their contact information.”
It is believed that the company may still be processing loans that were already submitted.
Shares of NovaStar were down 22 cents, or 6.71%, to $3.06 in late afternoon trading on Wall Street, far below their 52-week high of $97.64.
Check out the latest list of mortgage layoffs, closed lenders, mergers, and rumors.
Update: The New York Stock Exchange plans to delist the common and preferred stock for NovaStar Financial Inc. effective January 17.
The stock plummeted more than 40% in after hours trading on the news.
Bear Stearns CEO James Cayne is expected to resign today amid increasing pressure from investors over record losses and the collapse of two hedge funds last summer.
He will join Citigroup’s Charles Prince and Merrill Lynch’s Stan O’Neal, who now sit on the sidelines.
Cayne will likely be replaced by current President Alan Schwartz, a 57-year-old investment banker known for his strong deal-making ability.
Punk Ziegel analyst Richard Bove believes Schwartz is the “right choice” for the job, but warned that the position wouldn’t be easy.
“The task facing Mr. Schwartz is sizable. Outsiders may now be attempting to take control of the company. He must fight this off,” Bove said.
“I believe, as I have written for about a year, that Mr. Cayne must go. He was the architect of what now appears to have been a failed business strategy,” Bove wrote in a note to clients.
The analyst, who maintained a “sell” rating on the stock, slashed his price target on Bear Stearns to $67 from $94 and again reduced his 2008 earnings estimate.
For fiscal 2008, he cut his estimate to $6.59 a share from a previous $7.96 a share, and lowered his 2009 estimate to $7.10 a share from $8.54 a share.
“Its core businesses like mortgages, credit derivatives, prime brokerage, and investment banking may all be facing contraction while the company is losing market share in these shrinking markets. This firm needs to shrink rapidly and then rebuild on a more solid base,” Bove recommended.
Bear Stearns, the fifth-largest U.S. investment bank, took a $1.9 billion write-down in the quarter ended November 30 related to the falling value of subprime mortgage-related securities, leading to its first quarterly loss ever.
And Bove believes the struggling bank and mortgage lender will likely see further writedowns and post higher loan loss reserves in coming quarters.
Shares of Bear Stearns, which have lost 52 percent of their value over the past year, closed at $76.25 Monday on the New York Stock Exchange.
Investing is more than just saving for the future. It’s about creating a wealth-building strategy to truly make your nest egg grow. That’s because investing typically earns you a higher interest rate than if you put all of your money in a traditional savings account.
While historically low rates are great for when you need to borrow money, they’re pretty dismal when you’re ready to start saving. Investing does come with a higher risk, but you can generally mitigate it with diversified holdings and long-term positions. Plus, it’s easier than ever.
You’re not limited to working with an expensive brokerage or saving a huge amount to reach a minimum investment threshold. Now you can even invest by using an app on your smartphone with the leftover change from your checking account.
Ready to learn how to invest? We’ve got you covered with everything you need to know.
What is investing, and why is it important?
Investing is the act of putting money into financial instruments, such as stocks, bonds, or mutual funds, with the expectation of earning a profit. It allows individuals to save and grow their wealth over time, and can provide a financial cushion for the future, such as during retirement.
The Benefits of Investing
The reason money grows so aggressively through investing is that it’s powered by compound returns. Investments are typically meant for a long-term strategy, rather than taking out money every few months.
When you leave your money untouched in an investment vehicle that offers greater returns than a savings account, your gains continue to compound.
No matter what age you are, it’s a good time to start investing. If you’re younger, you can create a strong foundation to truly accumulate wealth over the coming years.
Even if you’re older, you may be able to catch up faster because of those higher returns. Don’t worry about getting started — even if you can only contribute a small amount each month, you’ll set up the infrastructure and challenge yourself to contribute more as you begin to earn more.
How to Reduce Your Risks in Investing
When investing long-term, you can’t think about your everyday gains and losses; instead, think about how your allocations are performing in the long run. You do want to review your investment choices as you reach different stages in your life; in particular, becoming less aggressive as you get older.
In fact, most investors don’t partake in volatile day trading. They spread their money over diversified investment types to help reduce risk and maximize returns over time.
There will always be economic cycles with highs and lows. But even downturns can be mitigated in your investment portfolio by spacing out your money over different product categories as well as different economic sectors. This can go a long way in protecting your money over time.
If you do want to try out some riskier investments, make sure you view that money as discretionary risk capital, meaning your livelihood and well-being won’t be impacted if you lose it all.
How to Invest Your Money
Diversification is essential, as is setting reminders to review the performance of your picks, such as a quarterly review. It also helps you adjust your asset allocation based on your own financial goals. Are you trying to retire earlier than you initially planned? Are you able to contribute more each month?
With these strategies in mind, here is a comprehensive review of different investment vehicles you can take advantage of to accumulate wealth over time.
Retirement Accounts
Retirement accounts are probably the most common and accessible types of investment accounts. You may be able to open a retirement account through your employer or open one on your own. Each type comes with a different tax treatment, so review the details carefully.
Traditional IRA
A traditional IRA is a tax-advantaged account that allows you to deduct your contributions each year. Once you start making retirement withdrawals, you’ll pay the IRS based on the tax bracket you’re in at that time.
They do have annual contribution limits. For 2024, it’s $7,000 unless you’re 50 years or older, in which case you can contribute up to $8,000.
If you want to take a distribution before you reach the age of 59 ½, you’ll have to pay a 10% penalty on top of your taxes. There are a few exceptions to the penalty, such as when you use the funds for a down payment on a house or qualified college expenses.
Another plus is that there is no income limit for qualifying, unlike other IRA options.
Roth IRA
A Roth IRA is another tax-advantaged retirement account. However, it comes with a few key differences compared to a traditional IRA. You don’t get a tax deduction when you make your contributions, but you do get to deduct your withdrawals once you reach retirement age.
If you think you’ll be in a higher tax bracket once you hit retirement, this could be a useful tool to save on your taxes later in life. For Roth IRAs, the contribution limit is between $7,000 and $8,000, depending on your age.
However, there’s another qualification you’ll have to meet: the income limit.
The more you earn, the less you’re able to contribute. Your contribution limit is reduced when you earn more than $230,000 for those married filing jointly and more than $146,000 for those filing single or as head of household.
Rollover IRA
A rollover IRA is one way to transfer an existing 401(k) from your employer once you decide to leave the company. Sometimes an employer lets you leave it there or transfer your funds to a retirement plan at your new place of work. Whether those two scenarios don’t apply to you or you prefer the flexibility of an IRA, a rollover may be a suitable option for you.
Both traditional and Roth IRAs generally allow you to bring in transfer retirement accounts. Just be sure to check your eligibility for either type, as well as any relevant fees you may incur during the transfer process.
SEP IRA
This type of IRA is designed specifically for self-employed individuals. While traditional and Roth IRAs are often used to supplement retirement savings accrued through employer plans, a SEP IRA allows for higher contribution limits when you work for yourself. The contribution is the lesser of either 25% of your income or $69,000.
Its tax treatment is the same as traditional IRAs. If you have employees, however, you must provide each one with their own SEP IRA and contribute the same salary percentage as you contribute to your own. Still, this can be a strong option to speed up your retirement investments, particularly if you don’t have employees or only have a few.
Stocks
Investing in stocks is typically best for active investors, and ideally, someone who already has experience in the stock market. If you’re just getting started, consider your stock investments as play money rather than something you need to rely on to meet your future financial goals. Because individual stocks are riskier, be sure to diversify the ones you choose to invest in.
Buying and selling stocks can result in hefty commission fees. Consider a buy-and-hold approach to avoid accumulating too many expenses, especially when you’re first getting started.
While you no longer need an established broker to execute trades, you can instead create a brokerage account with one of the larger brokerage firms. Your best bet is to compare fees as well as available research to help you make informed trading decisions.
Mutual Funds
Mutual funds combine your money with other investors to purchase securities for the entire group. The portfolio is professionally overseen by a manager, who then selects different types of stocks, bonds, and other securities on your behalf.
You can gauge the performance of a particular mutual fund by comparing it to its chosen benchmark, such as the S&P 500. If it regularly performs better over the course of a three to five-year period, then it could be a good investment choice.
Mutual funds are a popular choice because you generally don’t need a lot of money to get started. You can often choose one within your retirement account to get around any minimum requirements, or even set up a recurring investment amount.
Plus, mutual funds are extremely diversified, often holding as much as 100 securities in each one. This helps to minimize your risk as well as the amount of time you spend managing your portfolio.
Index Fund
An index fund is a popular type of mutual fund that follows a predetermined investment methodology rather than having a portfolio manager pick the included securities.
For example, you could choose a Dow Jones Industrial Average index fund, which includes 30 powerhouse companies in the U.S. Whiles that’s a large-scale example, different investment firms create their own index funds for investors to conveniently choose from.
Another benefit of investing in an index fund is that transaction costs are often lower, as are their mutual fund expense ratios. Many index funds are also geared toward investors with lower balances. While some firms have high minimum opening balances of $100,000 or more, you can get started with much less when you pick an index fund.
Exchange-Traded Funds (ETFs)
An exchange-traded fund, or ETF, trades the same way a stock does while tracking a certain basket of assets. There are countless types of ETFs to choose from based on your investment goals.
Common options include market, bond, commodity, foreign market, and alternative investment ETFs. They’re bought and sold like stocks throughout the day, but a major difference is that ETFs can issue and redeem their shares at any point.
There are many benefits that go along with an ETF. For starters, you have more control over when you pay your capital gains tax. There are also lower fees, although you’ll still pay brokerage commissions. Finally, while mutual funds can only be settled after the stock market closes for the day, an ETF allows you to trade at any time.
Bonds
Bonds are a good tool to have in your investment portfolio because they are a low-risk option. Different types of bonds include corporate, municipal, and Treasury bonds. Bonds are fixed-income investments, so you know exactly what to expect when those payout dates come throughout the year. Such predictability does come with a few downsides, though.
First, bonds come with a fixed investment period. If you invest in a longer-term bond, then you’re stuck with it until it matures — unless you decide to sell. But there’s a bit of risk involved there, involving the interest.
Bond rates aren’t locked in, so yours could be devalued if the same issuer bumps up the interest rate at a later time. So if new investors get a better interest rate than you did, you’re still locked into your lower rate. In general, bonds generally come with lower growth than other investments, but that’s considered the trade-off for a lower-risk vehicle.
Real Estate
People always need a place to live, so real estate investing can be an attractive option for investors. There are several ways to do this that account for your desired risk tolerance as well as your desired level of involvement.
Investment Properties
If you feel the drive to own property, an investment property is one way to make a real estate investment. Depending on how you choose to manage your property, this can amount to a steady stream of passive income.
Over time, you could also benefit from market appreciation, although that’s not necessarily guaranteed. There are risks involved with investment properties. Unlike investing in a stock or fund, a physical property involves expenses, such as upkeep, marketing, and a management firm if you want a hands-off experience.
You’ll also need some cash to get started, since most investment property loans require at least a 25% down payment. Moreover, the mortgage is considered part of your debt-to-income ratio, which could affect your future financing opportunities.
If you ever want to cash out on your investment, you’ll be subject to the market value of that moment. Plus, it’s a cumbersome, illiquid way to invest money. Still, the returns can be much greater than traditional investments, making investment properties an attractive option to some people.
REITs
If you would like to invest in real estate without the hassle of acting as a landlord, consider a real estate investment trust, or REIT. These are traded on the stock exchange and can also be offered in the form of a mutual fund or ETF.
Returns can increase as property values rise and generally focus on a portfolio of commercial properties. Shareholders also benefit because REITs don’t pay corporate tax, which helps boost returns as well.
You can pick what sector you want to invest in, such as healthcare, residential, hotel, or industrial REITs. Each comes with separate risks that should be weighed thoughtfully. REIT shares can be purchased through a broker, and each one will have its own fee structure to review as well.
Crowdfunding
Real estate crowdfunding is a type of peer-to-peer lending that is growing traction among investors of all levels. New fintech companies are popping up to compete with REITs, claiming better returns. So, what’s the difference between REITs and real estate crowdfunding sites?
The most significant difference is that instead of choosing a portfolio of properties within a certain asset class, you can choose specific commercial properties in which to invest. While individual investors traditionally wouldn’t be able to invest directly in projects like these, crowdfunding lets you enter these markets with a much smaller amount of cash.
One of the benefits is that you can do much more specialized research to determine what property to invest in. The process is much less passive than REITs. On the downside, however, the risk potential could be higher since your money is riding on one single building rather than a diversified portfolio.
See also: How to Build Generational Wealth
Platforms for Investing Your Money
There are many ways to start investing your money. A financial advisor, though charging extra fees, may provide you with much-needed guidance and education, especially if you’re a beginner. But if you prefer a little less hand-holding, you can consider two other options as well.
Online Brokers
Online brokerages give you the convenience of investing online with the added benefit of controlling what you invest in. So, it’s definitely a more hands-on process than the robo-advisor. Like robo-advisors, however, most online brokers don’t have a minimum balance requirement, so they’re still quite accessible to all types of investors.
Instead of paying a percentage of your funds, online brokers usually charge transaction fees for trades, as well as one-off fees. On the plus side, you’re not limited to your choosing certain funds, as you are with a robo-advisor. If you’d like, you can even select individual stocks. Online brokers and robo-advisors cater to two different types of investors, so the best choice depends on your specific goals.
Robo-Advisors
Enlisting the help of a robo-advisor can be helpful for beginning investors or anyone who wishes to utilize a “set it and forget it” mentality for their portfolio.
Robo-advisors don’t use human financial advisors; instead, they rely on computer algorithms to determine your portfolio allocations. Many of them also use tax harvesting strategies to decrease your tax burden at the end of the year.
Service fees are low and generally charged as a percentage of your invested funds. The transparency is excellent for new investors, and you can also benefit from the low minimum balances. Different robo-advisors offer different investment vehicles you can choose from. You can also pick one based on their investing strategy; most, for instance, pick from ETFs and index funds.
Bottom Line
There are a slew of intricacies for building your investment strategy and making your money work for you. Start with a plan that makes sense for your risk tolerance while still leaving room for growth.
You can access countless resources, from free online tutorials to paid financial advisors, to ensure you have a robust investment plan that will generate a passive income strategy to meet your goals.
How to Invest FAQs
What are the different types of investments?
There are many types of investments. The most popular investments include stocks, bonds, mutual funds, exchange-traded funds (ETFs), and real estate. Each type of investment carries its own level of risk and potential return.
What are the risks of investing?
Investing involves risk, including the potential for loss of principal. The value of investments can fluctuate and may be affected by market conditions, economic events, and other factors.
It’s essential to understand the risks associated with any investment and to consider your risk tolerance before making any investment decisions.
How do I choose the best investments for me?
The best investments for you will depend on your financial goals, how much risk you can tolerate, and other personal factors. It can be helpful to consult an investment advisor or do your own research to determine which investments are suitable for you.
It’s also wise to diversify your portfolio, or invest in various assets, to spread risk and potentially maximize returns.
How much money do I need to start investing?
There is no minimum amount required to start investing. In fact, you can get started investing with $500 or less. However, you should first have a sufficient emergency fund in place before investing. Some investments may have minimum investment requirements, such as mutual funds or certain types of brokerage accounts.
What is a brokerage account?
A brokerage account is a type of investment account that allows you to buy and sell assets such as stocks, mutual funds, ETFs, and bonds. When you open a brokerage account, you typically do so with a financial institution, such as a bank, a credit union, or an online brokerage firm.
To open a brokerage account, you will generally need to provide some personal information, such as your name, address, and Social Security number. You will also typically need to make a deposit of money into the account, which you can use to buy investments.
Once you have a brokerage account, you can place orders to buy or sell investments online, over the phone, or through a broker. The brokerage firm will execute the trades on your behalf and will typically charge a commission or fee for the service.
Brokerage accounts offer a convenient way to manage your investments and to buy and sell assets easily and quickly. They also provide a range of tools and resources to help you make informed investment decisions, such as market research, news and analysis, and educational materials.
Can I invest in stocks with just $100?
Yes, it is possible to invest in stocks with a relatively small amount of money, such as $100. Many brokerage firms have no minimum initial deposit requirement and allow you to start investing with whatever amount of money you have available.
How do I diversify my investment portfolio?
Diversification is the process of investing in various assets to spread risk and potentially maximize returns. This can be achieved by investing in different types of assets, such as stocks, bonds, and real estate, or by investing in different sectors or industries within a particular asset class. To maintain a diversified portfolio, review and adjust it periodically.
What is a financial advisor and do I need one?
A financial advisor is a professional who provides advice on financial matters, such as investing and saving for retirement. Whether you need a financial advisor will depend on your financial goals, risk tolerance, and investment experience. Some people may prefer to handle their own investments, while others may benefit from the guidance of an investment advisor.
How do I determine my risk tolerance?
Risk tolerance is an individual’s willingness to accept financial risk in pursuit of potential returns. Factors that may affect how much risk you’re willing to take include age, financial goals, and personal comfort level with risk.
Can I lose money by investing?
Investing always carries some level of risk, as the value of your investments can fluctuate and be impacted by various market conditions and economic events. It’s crucial to understand the risks associated with any investment and to consider your risk tolerance and investment objectives before making any investment decisions.
Diversifying your portfolio and not investing more money than you can afford to lose can help mitigate potential losses. Always be sure to do your research and consider seeking investment advice from a financial advisor before making any decisions.
When an investor buys a security using a margin account, the initial margin or initial margin requirement is how much of the purchase price – represented as a percentage – that the investor must cover with either cash or the collateral in that account.
The Federal Reserve Board’s Regulation T sets the minimum initial margin at 50%, meaning investors trading on a margin account must have cash or collateral to cover at least half of the market value of the securities they buy on margin.
Using Initial Margin
Investors who want to open a margin account at a brokerage must first deposit the initial margin requirement. They can make that deposit in the form of cash, securities or other collateral, and the amount they deposit will vary depending on how much trading the investor plans to do on margin, and where the brokerage firm sets its initial margin.
Once the investor makes that initial margin deposit as collateral, they essentially have a line of credit with which they can begin margin trading. That line of credit allows the investor to buy securities with money borrowed from the brokerage.
As noted, Regulation T sets minimum initial margin levels. It’s important to note, however, that the Federal Reserve Board’s Regulation T only sets the minimum for margin accounts. Brokerage firms offering margin accounts can set their initial margin requirement higher than 50% based on the markets, their clients, and their own business considerations. But brokerages cannot set the initial margins for their clients any lower than 50%. The level that a brokerage sets for margin is known as the “house requirement.”
Risks of Margin Trading
Trading on margin brings its own unique set of opportunities and risks. It can lead to outsized profits if investors buy appreciating stocks on margin. But if investors buy sinking securities on margin, they can lose even more than if they’d purchased the securities outright.
In the unfortunate situation where the securities purchased on margin lose all value, the investor must deposit the full purchase price of the securities to cover the loss. Given these risks, you’re typically not able to trade on margin in retirement accounts such as an IRA or a 401(k).
Sometimes investors use margin to short a stock, or bet that it will lose value. In that instance, they’d borrow shares from the brokerage firm that holds a position in the stock and sell them to another investor. If the share price goes down, the investor can purchase them back at a lower price.
In general, investors looking for safer investments might want to avoid margin trading, due to their inherent risk. Investors with a high appetite for risk, however, might appreciate the ability to generate outsize returns. 💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.
How Do You Calculate Initial Margin?
An investor who wants to trade in a margin account, must first determine how much to deposit as an initial margin. While that will depend on how much the investor wants to trade, and how big a role margin will play in their strategy, there are some guidelines.
The New York Stock Exchange and some of the other securities exchanges require that investors have at least $2,000 in their accounts. For day traders, the minimum initial margin is $25,000. Each brokerage has its own set of requirements in terms of the amount clients need to keep as collateral, and the minimum size of the account necessary to trade on margin.
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Initial Margin Requirement Examples
It’s possible, for example, that a brokerage firm might require 65% initial margin. That’s the first number an investor needs to know. The next is how much they plan to invest. The initial margin calculation simply requires the investor to multiply the investment amount by the initial margin requirement percentage. For an investor who wants to buy $20,000 of a given security, they will take that purchase price, multiply it by the margin requirement is 65% or 0.65 – to arrive at an initial margin requirement of $13,000.
The advantage for the investor is that they get $20,000 of exposure to that stock for only $13,000. In a scenario where the investor is buying a stock at a 50% margin, that investor can buy twice as many shares as they could if they bought them outright. That can double their return if the stock goes up. But if the stock drops, that investor could lose twice as much money.
If the price falls far enough, the investor could get a margin call from their broker. That means that they must deposit additional funds. Otherwise, the broker will sell the stock in their account to cover the borrowed money. 💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
Initial Margin vs Maintenance Margin
For investors who buy securities on margin, the initial margin is an important number to know when starting out. But once the investor has opened a margin account at their brokerage, it’s important to know the maintenance margin as well.
The maintenance margin is the minimum amount of money that an investor has to keep in their margin account after they’ve purchased securities on margin. It is generally lower than the initial margin.
Currently, the minimum maintenance margin, as set by the Financial Industry Regulatory Authority (FINRA,) is 25% of the total value of the margin account. As with the initial margin requirements, however, 25% is only the minimum that the investor must have deposited in a margin account. The reality is that brokerage firms can – and often do – require that investors in margin accounts maintain a margin of between 30% to 40% of the total value of the account.
Some brokerage firms refer to the maintenance margin by other terms, including a minimum maintenance or a maintenance requirement. The initial margin on futures contracts may be significantly lower.
Maintenance Margin Example
As an example of a maintenance margin, an investor with $10,000 of securities in a margin account with a 25% maintenance margin must maintain at least $2,500 in the account. But if the value of their investment goes up to $15,000, the investor has to keep pace by raising the amount of money in their margin account to reach the maintenance margin, which rises to $3,750.
Maintenance Margin Calls
If the value of the investor’s margin account falls below the maintenance margin, then they can face a margin call, or else the brokerage will sell the securities in the account to cover the difference between what’s in their account and the maintenance margin.
With a maintenance margin, the investor could also face a margin call if the investment goes up in value. That’s because as the investment goes up, the percentage of margin in relation by comparison goes down.
The Takeaway
Initial margin requirements and maintenance margins are just two considerations for investors who are looking to trade on margin. They allow investors to understand how much cash they need to hand on hand in order to trade on margin — and when they might be susceptible to a margin call.
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FAQ
What is an example of initial margin?
If initial margin is 65% and an investor wants to purchase $20,000 of a given security, they will take that purchase price, multiply it by the margin requirement is 65% or 0.65 – to arrive at an initial margin requirement of $13,000.
Is initial margin refundable?
Yes, initial margin is refundable, as it acts as a deposit put forward to enact a transaction or trade.
Why is initial margin important?
Initial margin is important because it acts as a form of collateral to cover a loss in the event loses money using borrowed funds. It helps the lender – or brokerage – recoup some of those losses.
Why is initial margin paid?
Initial margin is paid or put forth to act as a deposit or a form of collateral and establish good faith between a borrower and lender, typically an investor or trader and their brokerage.
Who sets the initial margin requirement?
Initial margin requirements are established by the Federal Reserve’s Regulation T. But there can also be other requirements put in place by an individual brokerage, and FINRA’s additional margin rules can further increase the amount.
Does initial margin have to be cash?
Generally, initial margin needs to be in the form of cash deposits, but it’s possible that some brokerages will allow it to take the form of other securities, such as government bonds.
Is initial margin a cost?
Initial margin is not a cost per se, but a form of collateral, and is money that is returned or refunded like a deposit. As such, it’s not spent or a typical “cost,” though it may be a financial barrier of sorts for some traders.
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