If you’re on TikTok or Reddit, it’s likely you’ve come across a tenacious rumor: That it’s better to invest in life insurance than a 401(k) for retirement. So, is it true?
Life insurance vs. 401(k)
Life insurance isn’t an investment, while a 401(k) is a type of investment account offered through your employer. Permanent life insurance (which offers lifelong coverage) isn’t an investment, and its exorbitant fees erode the money you pay into your policy and any earnings you might make for the first decade.
“It was very strange to me that there were so many life insurance salespeople all over TikTok, basically soapboxing about life insurance, like it was the next big thing like it was the most amazing investment on Earth,” says Vivian Tu, founder of Your Rich Bff, a TikTok channel that focuses on financial education, based in Miami Beach, Florida.
Can life insurance grow like an investment account?
In some cases, yes. There are some types of life insurance, such as whole life insurance or universal life insurance, that have the ability to increase in cash value. But how do some of those policies earn money like an investment return? By tracking market indexes.
One of the features touted by TikTok influencers is that returns made on insurance policies aren’t affected by the overall stock market, but that isn’t necessarily true. The insurance companies may invest in the stock market with part of their portfolio, which is technically a portion of a policy owner’s premium. Though some policies provide fixed returns, some depend on current interest rates and investments. Some policies have you pick the stock or bond indexes for your policy to mirror, such as the S&P 500, and the insurance company pays you interest based on how those indexes perform.
Life insurance vs. 401(k): Fees
If life insurance can earn stock market interest in a way similar to that of a 401(k), what’s the issue?
The issue is that, depending on the policy, the staggering fees insurance policies charge often wipe out the amount you would get back from those premiums and any investment returns.
For example, if you pay the premium for seven to 10 years, most of those premiums go toward the cost of providing that insurance. In addition, there are administrative fees and the agent’s commission, though you may not see a commission listed on a statement and it may be difficult to figure out exactly how much those commissions are. Those commissions aren’t a one-time payment: You may continue to pay them for seven to 10 years, or as long as the policy is active.
The premiums you pay that cover fees don’t sit in an account waiting for you to cash them in. If you pay into a 401(k) for a decade, you get to keep all that money less any fees and investment losses. With an insurance product, it’s only after a decade (again, depending on your policy) of monthly payments that you actually start accruing premium money and interest in a cash value account the insurance company holds for you.
That interest percentage is less than you can get in a high-yield savings account and far less than the stock market’s long-term average of 10% (not accounting for inflation).
Insurance policies also have significant surrender charges, which are fees you have to pay if you withdraw money from your policy early. These charges are often so large that they can dramatically reduce the net value of your policy until the first few years pass.
For example, if you wanted to take money out of your policy after the first two years, your surrender charge would likely be so high that there would be little to no money to take out. These charges eventually reduce to zero, but it can take 10 to 16 years.
While 401(k)s do charge a 10% penalty if you want to take money out of your account before you’re 59½, that 10% is likely to be far less than a surrender charge. Plus, there are lots of exceptions to the 401(k)’s 10% penalty, including disabilities, the birth of a child, medical expenses and emergency personal expenses.
If you were to invest in the stock market through a 401(k), you wouldn’t lose 10 years’ worth of investment dollars to the cost of insurance, and your management fee would likely be less than 1%.
“The idea that 401(k) fees are higher than an insurance product that would be serving as an investment, I don’t even know how you support that idea,” says Georgia Lee Hussey, a certified financial planner and founder of Modernist Financial, a wealth management firm in Portland, Oregon.
Insurance fees are complex
In addition to paying commissions and exceptionally high fees, you may not even know how much you’re paying because insurance fee structures are so complicated.
“Whole life policies are basically called the black box of insurance policies. You can’t really see what’s happening inside them,” Hussey says. “You can understand the internal expense ratio sometimes but you usually have to go deep into the disclosure documents to understand what the insurance company is really getting paid.”
If you purchase insurance through an agent or broker (or a TikTok influencer), it’s possible that that person will be making a commission, and that’s on you to figure out.
“When you actually look into it, you realize that all of these people are, in fact, life insurance brokers. They don’t even work at life insurance companies that provide the policies,” Tu says. “The vast majority of them are not fiduciaries, so they are not legally obligated to do right by you financially.”
On the topic of using insurance to invest, it’s good to remember two cardinal rules of investing: If it sounds too good to be true, it probably is. And if you can’t explain it clearly to a friend, you probably don’t understand it, which could be a sign to steer clear.
As Tu says: “It’s insurance. It’s not an investment.”
Investing in stocks can seem overwhelming, but it doesn’t have to be. With a few simple steps, you can start your journey toward building wealth and securing your financial future. This guide will walk you through the basics of stock investing, from understanding what stocks are to choosing the right investments for your goals. Whether you’re a complete beginner or just looking to brush up on the fundamentals, these easy-to-follow steps will help you confidently enter the stock market and begin growing your money. Let’s dive into the simple steps to start investing in stocks.
What are stocks?
Stocks represent shares of ownership in a company. By buying stocks, you can own a part of a business and potentially grow your wealth as the company grows. They are a popular way to make money and increase your net worth over time.
Learning stock market basics
Understanding the stock market is key to successful investing. Learn the basic concepts like how stocks work, what affects their prices, and how you can start investing to grow your wealth and secure your financial future.
Investing in stocks for beginners
Investing in stocks can be a great way to make money, but you need a solid strategy. This guide offers simple tips for beginners to help you start investing, grow your wealth, and work towards financial independence.
To learn more: How To Invest In Stocks For Beginners: Investing Made Easy
Is Now a Good Time to Buy Stocks? The Real Answer
The stock market is on the rise. Is now the right time to buy stocks? If you want to make money, learn the proper steps to start investing today and take advantage of market opportunities to grow your wealth.
To learn more: Is Now a Good Time to Buy Stocks? The Real Answer
Waiting to Invest?
Why wait to invest in the stock market? Delaying your investments means missing out on passive income. Consistently investing, rather than trying to time the market, will lead to long-term, stable returns and increase your net worth.
The power of compounding
Compounding can significantly boost your investment returns. By reinvesting your earnings, you allow your money to grow faster, leading to greater wealth over time. It’s a powerful strategy for anyone looking to increase their net worth and secure a comfortable retirement.
Can you Make Fast Money in the Stock Market?
Can you make money quickly with stocks? As a day trader and long-term investor, I know how fast I can see returns. Learn how day trading or swing trading can increase your financial freedom and help you grow wealth.
To learn more: How Fast Can you Make Money in Stocks? The Real Answer
Know Your Risk
Understanding the risks involved in stock investing is crucial. Know your risk tolerance and make informed decisions to protect your investments and achieve financial success.
Avoid These Trading Mistakes
Avoid common trading mistakes that can cost you money. Learn how to improve your trades, minimize losses, and increase your profitability in the stock market.
To learn more: Day Trading Mistakes: How To Avoid Trade Errors And Win More
Dive into an Investing Education
Education is key to successful investing. Trade and Travel is a course that teaches you how to make money in the stock market. Read my personal review as a profitable student and see how an investing education can help you grow wealth and achieve financial goals.
To learn more: Trade and Travel Reviews – Join the $1000 in a Day Club
Start Your Investing Journey
Ready to start investing? Learn the basic steps to begin your investing journey, grow your wealth, and secure a comfortable future. It’s never too late to take control of your finances and work towards financial independence through smart investments.
To learn more: https://moneybliss.org/investing/
Know someone else that needs this, too? Then, please share!!
Did the post resonate with you?
More importantly, did I answer the questions you have about this topic? Let me know in the comments if I can help in some other way!
Your comments are not just welcomed; they’re an integral part of our community. Let’s continue the conversation and explore how these ideas align with your journey towards Money Bliss.
At both federal and state levels, financial institutions are governed by laws that protect consumers against unfair and unscrupulous treatment in the banking and finance sectors. In addition, guidelines are in place to combat fraud and monopolistic behavior, helping to ensure the smooth running of the free-market economy.
Granted, catastrophic historic events — such as the 2008 global financial crisis — occur despite the oversight of robust financial regulatory agencies. Because of this, laws and regulations are constantly being examined and updated to finesse the banking and finance legal framework.
Read on to understand more about finance watchdogs, their roles, and how regulations work to protect the public and the economy from fraud and illicit practices.
What Is Financial Regulation?
Financial regulation is a set of laws, rules, and policies set by governing institutions. These are designed to keep your money safer. Specifically, they aim to maintain confidence and stability in the financial system by eliminating fraud and monopolistic behavior.
In the United States, governing bodies try to balance the need for oversight with a free-market economy, which can be a challenging endeavor.
Why Financial Regulations Are Important
Without regulations, consumers have no protections. They might be subject to fraud, sold bad mortgages, and charged high interest rates and fees on credit cards. Large companies could create monopolies or duopolies, which allow them to control prices.
Laws and policies prevent companies from gaining too much market control and stifling competition, which threatens the free market economy. Regulations also prevent financial institutions from taking risks that put consumer funds in jeopardy.
Here’s a brief history lesson that shows how lack of regulation can negatively impact daily life: The 2008 financial crisis was precipitated by deregulation and the repeal of the Glass-Steagall Act of 1933. This allowed financial institutions to engage in risky hedge fund trading. To fund their investments, the banks created interest-only loans for subprime borrowers, which contributed to more home purchases (including to buyers who would not have otherwise qualified) and quickly rising prices. This created a housing bubble, and millions of people were left bankrupt and couldn’t sell their homes when home prices then plummeted.
But too much regulation can also be a threat to an economy. In a free-market economy, prices are largely determined by supply and demand. Competition among suppliers tends to keep prices at bay as they each try to grab market share.
If regulations become too onerous and costly, companies may use up capital to comply with federal rules. That means they aren’t using those funds to create innovative products. In some cases, specific industries or groups manage to influence regulators and persuade them to introduce or eliminate laws that benefit them and not their competitors.
Types of Financial Regulations
Different agencies focus on the safety and soundness of products and services, transparency and disclosure, standards, competition, and rates and prices for different entities. Here’s a closer look at some of the most important regulations to be aware of:
• Stock Exchange Regulations Laws and rules for stock exchanges ensure that the pricing, execution, and settlement of trades is fair and efficient.
• Listed Company Regulations Listed companies (public companies) are required to prepare quarterly financial statements and submit them to the Securities and Exchange Commission (SEC) and to their shareholders. Investors use this information to inform their trades.
• Asset Management Regulation Financial advisors and asset managers must follow strict rules set by financial services regulatory bodies so that clients are treated fairly and not defrauded. Any company that provides investment advice is considered an investment advisor, and the SEC oversees investment advisors with more $110 million in assets under management (AUM).
• Financial Services Regulation Banking and financial institutions must follow specific guidelines to ensure a functioning banking system. These rules are enforced by The Federal Reserve Board (the Fed), the Office of the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (CFPB), and the Federal Deposit Insurance Corporation (FDIC).
Recommended: What Is a Fiduciary Financial Advisor?
Types of Financial Institutions
There are a wide variety of financial institutions in America, some of which you may be familiar with. Here’s the rundown:
• Central banks, like the U.S. Federal Reserve, watch over the country’s monetary policy.
• Retail banks are probably what most people are familiar with. These are banks where the general public can have checking accounts and savings accounts, loans, and other financial services.
• Commercial banks are similar to retail banks (above) but they serve the business community. Large banks may act as both commercial and retail banks.
• Credit unions are similar to banks but they are nonprofits, and members are part owners of them. They offer the same kind of services as banks but may tailor themselves to specific communities.
• Community development financial institutions (CDFIs) are financial institutions that work to build financial knowledge, services, and wealth in communities that are less advantaged.
• Savings and loan associations are organizations that use savings to create housing loans.
• Brokerages manage securities trading (say, stocks and exchange-traded funds, or ETFs), which are regulated though not insured.
• Insurance companies help both businesses and individuals protect themselves from property loss and may provide services such as loans.
• Investment companies function by issuing securities to both businesses and individuals who seek to raise capital.
• Mortgage companies offer home loans and may also manage commercial real estate.
What Is a Financial Regulator?
A financial regulator is an organized governmental or formal body that has the jurisdiction to oversee other entities, such as stock markets, banks, and asset managers. Their mandate is to ensure fairness, protect the public and institutions from fraud, and to facilitate a well-functioning financial sector.
Examples of financial regulators are the Fed, the Securities and Exchange Commission (the SEC), and the Financial Industry Regulatory Authority (FINRA).
How Are Financial Institutions Regulated?
Banks and financial institutions are regulated by the Fed, the OCC, the CFPB, and the FDIC, while asset management companies and stock exchanges answer to the SEC and FINRA. (Also worth noting: Individual stock brokers, investment bankers, and other professionals likely need FINRA securities licenses.) State agencies may enforce regulations on financial institutions, notably insurance providers.
Each of these organizations requires documentation from financial institutions and companies that show compliance with laws. For example, listed companies have to submit quarterly financial statements to the SEC. If they fail to do so, they may be charged with “Failing to Comply” and may lose the ability to trade their shares on the stock market and be forced to pay penalties.
Recommended: FINRA vs. SEC: How are they Different?
The Most Common Financial Regulatory Bodies
The following is a list of the more recognized regulatory agencies and a brief description of what each one does.
The Federal Reserve Board (FRB)
The Fed is the central bank of the United States. As such, it ensures the U.S. economy functions effectively. The Fed is in charge of monetary policy and has the power to increase or decrease interest rates or to instruct banks on the quantity of reserves they must maintain. The Fed also monitors financial systems and their impacts, facilitates efficient settlement of U.S dollar transactions, and upholds laws that protect consumers.
The Federal Deposit Insurance Corporation (FDIC)
The FDIC was created by Congress to support the U.S. financial system. The FDIC insures deposits and monitors financial institutions and their compliance with consumer protection laws. The FDIC also manages bank failures, though they occur very rarely.
The Consumer Financial Protection Bureau (CFPB)
The is a relatively new agency that implements and enforces Federal consumer financial law. CFPB regulations protect consumers by making sure financial products and services are “fair, transparent, and competitive.”
The National Credit Union Association (NCUA)
The NCUA was created by Congress in 1970. The association insures consumer accounts with credit unions with up to $250,000 of share insurance. Enforcement tools of the association include letters of understanding and agreement, administrative orders, and consent orders.
The Securities Exchange Commission (SEC)
. The SEC strives to maintain the public’s trust in the capital markets by insisting on fair practices. Various acts have been passed over time including the Securities Act of 1933, the Sarbanes-Oxley Act of 2002, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The Commodity Futures Trading Commission (CFTC)
The CFTC was created in 1974 to oversee commodity trading in the agricultural sector. Commodity trading has been subject to government regulation since the 1920s. The CFTC supervises and monitors commodity traders and market activity. The commission investigates and prosecutes wrongdoers and educates customers about their rights and how to avoid fraud.
Recommended: What Are the Difference Between FDIC and NCUA Insurance?
How Financial Regulators Help Banking in the Way We Know Today
The banking and financial systems operate well under current regulation, but what about digital banking? Digital banking is a recent innovation, and existing banking laws and regulations generally apply to digital start-ups and fintechs. However, there are some regulatory frameworks specifically for digital banking.
An example of protection for digital banking consumers is Electronic Know Your Customer (e-KYC), which is used for digital onboarding and checks that a customer is who they say they are to avoid fraud and money laundering. E-signature is a way for customers to validate transactions remotely.
Another instance is the Electronic Fund Transfer Act (Regulation E) which aims to make applicable electronic transactions compliant with regulations as well as have “readily understandable” consumer disclosures.
Recommended: Online Banking vs Traditional Banking: What’s Your Best Option?
The Takeaway
Financial services regulatory bodies like the Fed, the FDIC, and the SEC oversee the banking and finance sectors in the United States. State agencies also play a role. Though many consumers are not aware of the details, these regulatory bodies have jurisdiction over stock markets, commercial and retail banks, investment banks, and asset managers. Their mandate is to ensure fairness for consumers, ensure entities comply with fraud protection rules, and to protect the financial sector and free-market economy.
Which is all good, of course. But if you are looking for a great bank for your personal accounts, see what SoFi offers.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.60% APY on SoFi Checking and Savings.
FAQ
Who regulates financial institutions in the United States?
In the United States, financial institutions are regulated by the Fed, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the SEC, FINRA, the CFPB, the NCUA, and the CFTC. State agencies also enforce regulations on financial institutions, especially insurance providers.
What are regulators in finance?
Finance and banking regulators are state- and government-appointed bodies that protect the safety and fair treatment of consumers. They also ensure smooth operations of the finance and banking sectors, the backbone of the economy.
Who regulates investment banks?
U.S investment banks are regulated by the SEC. For regulatory purposes, investment banks were declared separate for commercial banks following the passing of the Glass Steagall Act of 1933.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.
SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.
As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.
SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.
SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.
Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.
Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.
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.
As a type of alternative investment, real estate can add diversification to a portfolio and act as a hedge against inflation. Real estate investment trusts (REITs) and real estate crowdfunding offer two unique entry points to this alternative asset class.
Both allow you to invest in real estate without being required to own property directly. Comparing the pros and cons of real estate crowdfunding vs. REIT investing can help you decide which one makes the most sense for your portfolio.
Understanding Real Estate Investment Trusts (REITs)
Real estate investment trusts are legal entities that own or finance income-producing properties or invest in mortgage-backed securities. The types of properties a REIT may invest in can include:
• Hotels and resorts
• Office space
• Warehouses
• Storage space
• Multifamily apartment buildings
• Data centers
• Medical facilities
• Retail shopping centers
• Single-family homes
The primary attraction of REITs is the ability to enjoy the benefits of property investment — namely, dividend income — without purchasing real estate directly.
REITs are also considered a type of alternative investment. As with many alternative investments, real estate-based assets don’t tend to move in sync with the stock market. For this reason, investing in REITs may provide portfolio diversification.
REITs may be publicly traded, meaning they trade on an exchange like a stock. REITs must pay out 90% of their taxable income to shareholders as dividends, though some may pay as much as 100%.
If you compare REITs vs. real estate mutual funds, dividends aren’t always required with the latter. Real estate mutual funds can invest in REITs, mortgage-backed securities, or individual properties. While you may have access to a broader range of properties, you may enjoy less liquidity with real estate funds.
Recommended: SoFi’s Alt Investment Guide for Beginners
Alternative investments, now for the rest of us.
Start trading funds that include commodities, private credit, real estate, venture capital, and more.
💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.
Overview of Real Estate Crowdfunding
What is real estate crowdfunding? It’s a strategy that allows multiple investors to pool funds for property investment. In return, investors share in the profits generated by the investments. Regulation crowdfunding makes real estate crowdfunding possible, as entities can raise capital from investors without registering with the SEC, as long as they offer or sell less than $5 million in securities.
In terms of how it works, real estate crowdfunding platforms seek out investment opportunities and fully vet them before making them available to investors. Individual investors can then choose which properties they’d like to invest in.
Depending on the nature of the investment, you may collect interest payments, rental income, or dividends. Real estate crowdfunding can offer access to a variety of property types, including:
• Multifamily housing
• Industrial space
• Build-for-rent projects
The minimum investment varies by platform — it is commonly upwards of $5,000, but may be $500 or even lower in some cases. Some real estate crowdfunding platforms require investors to be accredited, meaning they must:
• have an income exceeding $200,000 (or $300,000 with a spouse or spousal equivalent) in each of the two prior years, with an expectation of the same income for the current year, OR
• have a net worth exceeding $1 million, alone or with a spouse/spousal equivalent, excluding the value of their primary residence, OR
• hold a Series 7, Series 65, or Series 82 license in good standing
Comparing REITs and Real Estate Crowdfunding
When choosing between a REIT vs. crowdfunding, it’s helpful to understand each option’s potential advantages and disadvantages.
Pros and Cons of REITs
Here are the main benefits of investing in REITs vs. crowdfunding.
• Risk management. Alternative investments like real estate may help you balance risk in your portfolio. REITs and real estate in general have a lower correlation with the stock market.
• Accessibility. Purchasing an actual investment property usually requires getting a loan and raising capital for down payments and closing costs. REITs can offer a much lower barrier to entry for investors.
• Dividends. REITs must pay dividends to investors, which may be attractive if you want to generate passive income with investments.
• Liquidity. Publicly traded REITs offer liquidity since you can buy and sell shares as needed, similar to a stock.
• Returns. REITs can potentially generate significant returns in a portfolio compared to stocks or other investments.
Now, here are some of the drawbacks of REIT investing.
• Fees. You’ll typically pay management fees to invest in REITs, as with any investment, but some may charge more than others. Paying attention to investment costs is key, as the more fees you pay, the less of your investment returns you keep.
• Overweighting. You can choose which REITs to invest in, but you don’t have a say in the underlying properties. Investing in REITs that own similar properties could overweight your portfolio in a single sector (e.g., malls or office buildings) and thus increase your risk profile.
• Interest rate risk. Changing interest rates can affect the value of REITs, which can influence the yield you might get. When rates rise, REIT values can decline, requiring you to adjust your expectations for a profit.
• Taxes. REIT dividends are typically taxed as ordinary income, up to 37% (plus a 3.8% investment surtax). But investors may also see a short- or long-term profit from the REIT, which would be taxed as capital gains. There is also the potential for return on capital, which can be complicated. It may be wise to consult a professional.
Pros and Cons of Real Estate Crowdfunding
Here are the main pros of crowdfunding real estate investments.
• Diversification. As with REITs, real estate crowdfunding allows you to diversify beyond traditional stocks and bonds.
• Low minimums. Some, though not all, real estate crowdfunding platforms allow you to get started with as little as a few hundred dollars. That can make entering this alternative asset class or spreading your investment dollars out over multiple property types easier.
• Geographic diversification. Real estate crowdfunding platforms can offer investors exposure to markets across the country. That can make it easier to target a specific region if you’re looking for the next “hot” market.
• Returns. Crowdfunded real estate may generate above-average returns, or exceed the returns you could get with REITs.
• Passive income. Owning a rental property can be time-intensive if you’re managing the property yourself. Real estate crowdfunding allows you to reap the benefits of rental income, without the typical headaches that go along with being a property owner.
And now, here are the cons.
• Fees. Just like REITs, real estate crowdfunding platforms can charge fees. Fee structures can sometimes be complex, making it difficult to assess what you’ll pay to invest.
• Illiquidity. Liquidity in the stock market is one thing, but when it comes to real estate crowdfunding, it’s an even bigger consideration owing to the length of time your capital may be locked into an investment. Once you invest in a property, you’re essentially committed to owning it for the duration of the holding period. It’s not unusual for real estate crowdfunding platforms to offer investments with holding periods of five years or more, making them highly illiquid.
• Accreditation requirements. Some crowdfunding platforms only accept accredited investors. If you don’t meet the standards, you won’t be able to invest through those platforms.
• Taxes. Income from crowdfunded real estate investments is taxable, though not always in the same way. You may be subject to different tax rates based on how dividends and interest are paid out to you. You may want to consult with a professional.
Which Investment Strategy Is Riskier?
It’s difficult to pinpoint which is riskier when comparing a REIT vs. real estate crowdfunding, as each one has different risk factors.
With REITs, the biggest risks may include:
• Liquidity risk, which could make it difficult to sell your shares if you’re ready to leave an investment.
• Changing market conditions or rising and falling trends, either of which could directly impact real estate values.
• Interest rate sensitivity, which can influence REIT values.
The main real estate crowdfunding risks may include:
• Platform risk, or the risk that the marketplace you’re using to invest could shut down before you’re able to withdraw your capital.
• Poor vetting, which may allow unsuitable investments to make it onto the platform.
• Changing regulations, which may affect the real estate crowdfunding space as a whole.
Whether you choose a REIT vs. crowdfunding, lack of education or understanding is also a risk factor. If you don’t understand the basics of how either type of investment vehicle works, you could be putting yourself in a position to lose money.
Due Diligence Considerations
REITs and real estate crowdfunding platforms should perform due diligence in vetting investments to make sure they’re suitable. However, it’s wise to do your own research to understand what you’re investing in, who you’re investing with, and the potential risks.
As you compare REITs or real estate crowdfunding platforms, keep the following in mind:
• Minimum requirements to start investing, including accredited investor status
• Range of investment options
• Transparency concerning fees and investment selection
• Holding periods
• Performance track record
• Overall reputation
Talking to other investors who have used a particular crowdfunding platform or invested in a certain REIT can offer perspective on the good and bad.
The Takeaway
Real estate can be an addition to your portfolio if you already have some experience in the market, and have an affinity for real estate. As a type of alternative asset class, investing in real estate can add diversification to your portfolio, and potentially act as a hedge against inflation. Both REITs and real estate crowdfunding enable you to invest in real estate without the hassle of actual property ownership and maintenance, but come with different risk factors than you’d find with traditional securities.
Ready to expand your portfolio’s growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi’s easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it’s important to consider your portfolio goals and risk tolerance to determine if they’re right for you.
Invest in alts to take your portfolio beyond stocks and bonds.
FAQ
What are the main advantages and disadvantages of investing in REITs?
Investing in REITs can offer the benefits of dividend income and portfolio diversification, without requiring you to own property directly. The disadvantages of REITs can include interest rate risk and market risk, both of which can affect the value of your investments.
How does real estate crowdfunding differ from traditional REIT investments?
Real estate crowdfunding allows investors to pool funds together to invest in property and collect interest, dividends, and/or rental income. REITs own and operate investment properties and pay dividends to investors. REITs and real estate crowdfunding can differ concerning the types of properties you can invest in, the minimum investment required, and the fees you’ll pay.
How are taxes treated for REITs and real estate crowdfunding?
REIT dividends are primarily treated as ordinary income for tax purposes (although you may face capital gains on any profits). Real estate crowdfunding returns may be subject to capital gains tax and/or ordinary income tax rates, depending on how they’re structured. Because the tax treatment of these two entities can be complicated, it’s probably wise to consult a professional.
Photo credit: iStock/kate_sept2004
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing. Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor’s risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds. Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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.
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.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. SOIN-Q224-1900951-V1
In the investing ecosystem, the term “margin” is used to describe the money that may be borrowed from a brokerage to execute trades or a strategy. Buying assets on margin can help magnify gains and returns, but it can do the same with your losses.
When you buy on margin, you’re purchasing assets using money that you borrow from your broker. Margin trading might seem more complicated than some other ways to invest in the stock market, but it’s a method that many investors favor — especially experienced investors. If there’s one thing to know about margin trading, though, it’s that it can cut both ways, and may incur serious risks.
Table of Contents
What Is Margin Trading?
Margin trading, or “buying on margin,” is an advanced investment strategy in which you trade securities using money that you’ve borrowed from your broker to potentially increase your return. Margin is essentially a loan where you can borrow up to 50% of your security purchase, and as with most loans, a margin loan comes with an interest rate and collateral.
Trading on margin is similar to “buying on credit.” Using margin for a trade is also known as leveraging. Margin interest rates are determined by your broker, and collateral types can be stock holdings or cash. Traders must also maintain a margin balance, known as the maintenance margin, in their accounts to cover potential losses.
As noted, margin trading is a bit more complicated (and risky) than some other ways to invest in the stock market, but it’s a tactic used by many investors.
How Does Margin Trading Work?
While margin trading may seem straightforward, it’s important to understand all the parameters.
For all trades, your broker acts as the intermediary between your account and your counterparty. Whenever you enter a buy or sell trade on your account, your broker electronically executes that trade with a counterparty in the market, and transfers that security into/out of your account once the transaction is completed.
To execute trades for a standard cash account vs. margin account, your broker directly withdraws funds for a cash trade. Thus every cash trade is secured 100% by money you’ve already deposited, entailing no risk to your broker.
In contrast, with margin accounts, a portion of each trade is secured by cash, known as the initial margin, while the rest is covered with funds you borrow from your broker.
Consequently, while margin trading affords you more buying power than you could otherwise achieve with cash alone, the additional risk means that you’ll always need to maintain a minimum level of collateral to meet margin requirements.
While margin requirements can vary by broker, we’ve defined and outlined the minimums mandated by financial regulators.
Term
Amount
Definition
Minimum margin
$2,000
Amount you need to deposit to open a new margin account
Initial margin
50%
Percentage of a security purchase that needs to be funded by cash
Maintenance margin
25%
Percentage of your holdings that needs to be covered by equity
💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.
Increase your buying power with a margin loan from SoFi.
Borrow against your current investments at just 12%* and start margin trading.
Example of Margin Trading (Buying on Margin)
Here’s an example of how margin trading works, or could work, in the real world. Imagine you open a margin account with $2,000 at a brokerage firm. It’s helpful to keep the maintenance margin in mind, too, when reading through this example.
Now, say you have your eyes set on Stock X, that’s trading at $100 per share. You can afford to buy 10 shares with the cash in your account. But, you want to buy more — margin allows you to do that. Given your margin account’s 50% initial margin requirement, that means you can effectively double your purchasing power.
So, you can buy 20 shares of Stock X for a total of $2,000, and $1,000 of that purchase would be buying on margin.
If Stock X appreciates in value by, say, 100% (it’s now worth $200 per share), you could sell your holdings and end up with $4,000. You could then pay back your brokerage for the margin loan, and have realized a greater return than you would have without using margin.
But the opposite can happen, too. If Stock X depreciates by 50% (it’s now worth $50) and you sold your holdings, you’d have $1,000, and owe your broker $1,000. So, you’ve wiped out your cash reserves by using margin — one of its primary risks.
To recap: In both scenarios, the margin loan balance remains the same ($1,000), while the equity value took the entire gain or loss.
Bear in mind, too, that for simplicity, this example ignores interest charges. In a real margin trade, you would need to also back out any interest expense incurred on the margin loan before calculating your return; this would act as an additional drag on earnings.
Potential Benefits of Margin Trading
As noted, margin trading has some pretty obvious benefits or advantages. Those may include the following:
• Potential to enhance purchasing power. A primary benefit of margin trading is the potential expansion of an investor’s purchasing power, sometimes exponentially. This could possibly help boost returns if the price of the stock or other investment purchased with a margin trade goes up.
• Possible lower interest rates. Benefits of margin loans might include lower interest rates relative to other types of loans, such as personal loans, if the investor is borrowing money to make trades. Plus, there typically isn’t a repayment schedule.
• Diversification. You could also use margin trading to diversify your portfolio.
• Selling short. Another potential advantage might be a complicated trading method called short selling. Margin trading might make it possible for you to sell stocks short. Short selling differs from most other investment strategies in that investors make a bet that a stock’s price will fall.
Note, however, that the rules for short selling with a margin account can get even more complicated than a traditional margin trade. For instance, Regulation T of the Federal Reserve Board requires margin accounts to have 150% of the value of the short sale when the trade is initiated.
While the benefits of being able to buy more investments — and potentially generate larger returns — might seem appealing to some investors, there are also some potential risks to using margin. It might be worth considering these before you decide if trading on margin is right for you.
Potential Risks of Margin Trading
There are potential benefits, and there are potential risks associated with margin trading. Here are some of those risks:
• Possible loss beyond initial investment. While a primary benefit of margin trading may be increased buying power, investors could lose more money than they initially invested. Unlike a cash account, the traditional way to buy stocks or other investments, losses in a margin account can actually extend beyond the initial investment.
For example, if an investor purchases $20,000 worth of stock with a cash account, the most they can lose is $20,000. If that same investor uses $10,000 of their own money and a margin — essentially a loan — of $10,000 and the stock loses value, they may actually end up owing more money than their initial $10,000.
• Possibility of margin call. Another potential negative aspect of margin trading is getting a margin call. Investors might need to put additional funds into their account on short notice if a margin call is triggered because the investment lost value. Moreover, a drop in value might mean an investor needs to sell off some or all of the investment, even at an inopportune time.
The SEC warns investors that they must sell some of their stock, or deposit more funds to cover a margin call. If you get a margin call, it is your responsibility to deposit more funds, add securities or sell holdings in your account. If you don’t meet the margin call after a number of warnings from your broker, then the broker has the right to sell all or some of the current positions to bring the account back up to minimum value.
💡 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.
How to Get Started With Margin Trading
Typically, the first step to getting started with margin trading is to open a margin account with a brokerage firm.
Even if you already have a stock or investment account, which are cash accounts, you still need to open a margin account because they are regulated differently. First-time margin investors need to deposit at least $2,000 per FINRA rules. If you’re looking to day trade, this dollar figure goes up to $25,000 according to FINRA rules. This is the minimum margin when opening a margin trading account.
Once the margin account has been opened and the minimum margin amount deposited, the SEC advises investors to read the terms of their account to understand how it will work. The SEC advises investors to hedge their risks by making sure they understand how margin works, understanding that interest charges may be levied by your broker, knowing that not all assets can be purchased on margin, or even communicating with your broker to get a sense if a margin account is the right tool for you.
The Takeaway
Margin trading, as discussed, means that investors are trading securities with borrowed funds from their brokers. This allows them to potentially increase their returns, but also carries the risk of ballooning losses. As with most investing strategies and vehicles, margin trading comes with a unique set of potential benefits, risks, and rewards. Margin trading can seem a little more complicated than some other approaches to investing. As the investor, it is up to you to decide if the potential risks are worth the potential rewards, and if this strategy aligns with your goals for the future.
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
Get one of the most competitive margin loan rates with SoFi, 12%*
FAQ
Is margin trading profitable?
Margin trading can be profitable, but there are no guarantees for investors that it will be. It can also lead to outsized and substantial losses for investors, so it’s important to consider the risks and potential benefits.
What happens if you lose money on margin?
If you lose money on margin, you may have a negative balance with your brokerage, and owe the broker money. You may also be subject to interest charges on that balance, too.
Should beginners trade on margin?
It’s best to consult with a financial professional before trading on margin, but generally, it’s likely that professionals would recommend beginners do not trade on margin.
How do you pay off margin?
Typically, if you have a negative balance in your margin account, you can reduce or pay it off by simply depositing cash into your account, or selling assets.
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
*Borrow at 12%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information. Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
Understand how much extra income you could get from a side hustle like DoorDash and get a budgeting and investing basics refresh.
This Week in Your Money: How much extra money can you really make from side hustles? What are budgeting and early investment strategies for young professionals? Hosts Sean Pyles and Sara Rathner discuss the realities of gig economy jobs with Tommy Tindall, a NerdWallet writer who tried working for DoorDash to see what kind of income it would give him. He shares tips and tricks on the ease of starting with DoorDash, the practical challenges involved, and how your location and lifestyle can impact your earnings.
Today’s Money Question: Host Elizabeth Ayoola joins Sean and Sara to help answer a listener question from a recent college graduate about early investment strategies. They discuss how young professionals can apply the 50/30/20 rule to their finances, the importance of setting clear savings goals, and how to start investing at a young age. They discuss the benefits of starting investments early, the differences between active and passive investing options, and the importance of automating investments to build wealth over time.
Check out this episode on your favorite podcast platform, including:
NerdWallet stories related to this episode:
Episode transcript
This transcript was generated from podcast audio by an AI tool.
Sean Pyles:
Have you ever gotten a food delivery or a ride in an Uber and wondered whether these gigs are really worth the effort as a side hustle? Well, this episode will deliver some answers.
Sara Rathner:
Cute. Welcome to NerdWallet’s Smart Money Podcast. I’m Sara Rathner.
Sean Pyles:
And I’m Sean Pyles. This episode, Sara and I are joined by our co-host, Elizabeth Ayoola, to answer a listener’s question about money goals, especially when you’re early on in your financial journey. How do you get a grip on your finances and set yourself up for long-term success?
Sara Rathner:
But first, we’re turning to side hustles. This month on Smart Money, we’re running a special series about how you can increase your income, whether you want more money to invest or you’re working on building up your savings, or you really just want some extra cash to spend on whatever junk appears in your social media feeds.
Sean Pyles:
And we are not here to judge you for whatever you spend your money on, but watch any social media influencer or read any article about ways to increase your income and inevitably someone mentions taking up a part-time job in the gig economy like Uber, DoorDash, Airbnb, take your pick. And I’ve always been pretty skeptical that these gigs will net you meaningful amounts of cash, especially considering all the time and effort involved.
Sara Rathner:
Absolutely. If you’re going to put miles on your car or let strangers sleep in your rental property, it needs to be worth it. And we don’t have access to a vacation house for the purposes of this podcast, but we do have a Nerd on staff at NerdWallet who actually did DoorDash for a couple of days to get a feel for whether these jobs live up to the hype. Tommy Tindall is here to share his insights with us. Tommy, welcome back to Smart Money.
Tommy Tindall:
Hey there. Thanks for having me.
Sean Pyles:
So Tommy, you recently made a really fun video for NerdWallet’s YouTube channel where you test drove DoorDash for a few days. What were your hopes and expectations going into this journalistic exercise?
Tommy Tindall:
Yeah, so I study and write quite a bit about side hustles and for this one, I really wanted to go the extra mile, get it, and test it out myself, try to make the advice a little more valuable, right? Give it a true test. And delivery driving is super popular and seemingly accessible, at least that’s what I thought, was my hypothesis, I should say, an easy way to make side money. So I really wanted to answer a couple questions that I think people have about a gig like this, and one is just how easy is it to get started? Can you really sign up on your phone, get a red bag in the mail and start driving? And spoiler alert, yes, that’s what I did. You can. And also can you make real money?
Sean Pyles:
Okay, so what were the main things that you were tracking as you weighed whether this side hustle was worth it?
Tommy Tindall:
I wanted to keep it easy, so I was just keeping a close eye on the time I spent driving while delivering, the miles I drove, and of course how much I earned and really wanted to get to what’s the real pay when you factor in the cost of driving.
Sara Rathner:
So talk with us a little bit about the experience of doing this. Was it fun? Was it boring? Did you get chased by any wild animals? Did you use this as an opportunity to catch up on episodes of Smart Money?
Tommy Tindall:
Well, I wanted it to be fun, but it was kind of hectic. I mean, I remember there were a couple moments of zen where I was just cruising, windows down, just looking outside thinking this is the life. But as soon as I started thinking that way, ding, ding, I’d get another delivery. And I think hustle is a real good term for this because it was kind of a grind. And what really got me, which I thought was interesting, was the constant interaction with my phone. It was draining. I was using maps to navigate, to take orders, and it was just a lot of interaction with the phone while driving.
At one point I, quick story had a 16-mile delivery, which was good pay. It was like $18 of base pay, which was really good. So I took it, but I was so distracted kind of trying to figure out where I was going, that I went the wrong way on 95 and was screaming, pounding the wheel, as you can imagine, and just like, efficiency. That’s what I was going for. Also, keep in mind, I was filming this experience for the video and that totally added to my stress. So maybe more practice without trying to film myself, I could be a little more efficient, get a little more time to enjoy solitude and catch up on my favorite podcasts like this one. But yeah, it was hectic.
Sean Pyles:
Yeah. But you can’t forget that this is a job, right? It’s going to have stressful, difficult moments like any job.
Tommy Tindall:
I was reminded of that quickly, that this is a job and I kind of felt the stress. When I would get a delivery, I wanted to make sure the food was hot and get there quickly, know where I was going. So I had that sense of, hey, you’re on the clock, you’re working.
Sara Rathner:
That distracted driving element is also pretty terrifying.
Sean Pyles:
Tommy Tindall:
Yeah. Now when I see people on the road, I’m wondering are they delivering right now? So before I yell “get off your phone,” I’m wondering that.
Sara Rathner:
Sean Pyles:
Sara Rathner:
They might be.
Sean Pyles:
Either way, get off your phone.
Tommy Tindall:
Sara Rathner:
Tommy Tindall:
Sara Rathner:
I know. So Tommy, you mentioned this in your video, you live in a smaller town, a more remote area. How does that affect your ability to make money from DoorDash or any other app-based job like this?
Tommy Tindall:
I mean, it matters a lot because it’s how busy it’s going to be around you. So location matters. It’s where you live, which towns you have access to with a short drive that may be more populated. So I live, it’s a smaller, more rural but kind of suburban town outside of Baltimore. And what I did before I started was I would watch the DoorDash app, the map section of the app and just kind of see where the hotspots were.
And of course areas closer to Baltimore where it’s more densely populated, more restaurants within close proximity of each other, they were regularly busy during the peak times and they were shaded in pink on the maps. That’s how you know you can go out. When the map is like pink or red, you can Dash on a whim. When it’s gray, which it was sometimes in my town, you have to wait or schedule a Dash for later. But luckily where I live during the busier lunch hour, the option to Dash now was available during the weekday when I tried this. So I was able to stay closer to home, which I think was more realistic, because if I did this, I don’t think I’d want to drive that far. I’d want to stay closer to home, so.
Sean Pyles:
You don’t want to have to commute for your side gig.
Tommy Tindall:
Exactly. You want to get out there and do it maybe on the lunch hour during work, which I was thinking, which we’ll talk about. Probably kind of hard to do because I did find myself going from one end of my town to another because it’s not that populated, so it cost me some time.
Sean Pyles:
Well, that also makes me think about wear and tear on your vehicle and other related expenses like gas. Was that a worry of yours as you were doing the side hustle?
Tommy Tindall:
Yeah, this was a big worry for me because I am somebody who loves cars and I can be a little obsessive about keeping our vehicles maintained. So just all the stop and go driving, it was just kind of giving me a nervous tick. That was on my mind the whole time. I think I kind of make that clear in the video a little bit, and I should also mention that I drive a full size Ram pickup truck, which I thought would be fun to test for this, but not the ideal gig economy vehicle. It’s inefficient, hard to maneuver.
Sean Pyles:
Yeah, lots of storage space, but maybe more than you need for a Starbucks run or something like that.
Tommy Tindall:
Oh, yeah. And the maneuverability. I think at one point I pulled off a busy road into the wrong driveway and I had to sort of Austin Powers my way out. You remember that 20 point turn he had to do in the first movie and all while the customer, the next house over was watching me. So when I finally got over there, we had a little laugh about it and I think she did tip me. I don’t know if she tipped me after the fact or not, which you can do in the app.
Sean Pyles:
You were providing some entertainment along with the delivery?
Tommy Tindall:
Oh, yeah. When I did get to interact with customers like that, I made it kind of fun. I’d be like, “Yeah, you don’t see people driving a truck very often, do you?” But yeah, I was a little anxious about my own vehicle and the wear and tear.
Sean Pyles:
Okay, so Tommy, after three days of Dashing, tell us how much time you spent driving, how far you drove, and how much you earned.
Tommy Tindall:
All right, well here are the stats. I went on three Dashes for this test and drove about six and a half hours on deliveries altogether. I put 90 miles on my personal vehicle, which was my big dump truck as I mentioned. Earned a total of $86, but factor in the 17 MPG that I was getting. And gas was I think around $3.60 a gallon when I was doing this. So less than $19 in fuel costs. True earnings are more like $67 or $10.31 cents an hour. So I mean, not a lot of money.
Sean Pyles:
So I’m going to wager that’s less than you’re making at NerdWallet on an hourly basis.
Tommy Tindall:
Yeah, yeah, yeah. Not giving up the main hustle.
Sean Pyles:
Yeah. Do you think this was worth it?
Tommy Tindall:
So yes and no, and I’ll start by saying I’m glad gigs like this exist because I was really blown away by the accessibility of this gig. I mean, I was signed up and through the background check in literal minutes, and if you, the listener, meets the basic qualifications, I mean you can probably start working and start earning, and I like that. It’s not like saying side hustle options, go be an influencer and wait a couple years to build a following before you make your first dollar. I mean, you sign up and you can make money, which I think is great. And flexibility of course is the selling point of a delivery driving job like this. But at the expense of what? I felt like I was really hustling. I didn’t make a lot of money and thinking back, I mean this would be a real grind for me to do on the side.
It’s really about where I’m in my life. I mean, I have a main job, I have a family, I have young kids in school and sports, a home that continues to break that I have to maintain, I serve in my church and I really covet kind of that little free time that I have left. So I guess all that to say, not quitting my day job. And I think doing this made me more grateful of my main hustle and reminded me that I think there’s merit in what’s become kind of an older way of thinking where you find a good company, work hard, build your skills, grow your confidence, gain expertise, and hopefully increase your salary over time. So whether it’s worth it I think depends on personal situation, because you do make money.
Sara Rathner:
So who do you think a side hustle like this is good for?
Tommy Tindall:
People who do have some extra time or need extra cash and can take advantage of the flexibility to work whenever, because again, that is the selling point of a job like this. Also people who can work the system to their advantage. And you see a lot of YouTube videos of people sort of gaming this and chasing something called peak pay, which is an incentive where you can add plus one, two, three, or more dollars to a delivery if it’s really busy. So the competitive types, which is not me, admittedly, but I do wonder if I would’ve tried this at a different time in my life, like back in college or in my first years working a job when I lived in Washington, DC, had it been available.
Sean Pyles:
Well, Tommy Tindall, thanks so much for talking with us.
Tommy Tindall:
Absolutely. Thanks for having me.
Sean Pyles:
So listener, you just heard Tommy describe an interesting way that he earned some money. Ahead of this month’s series about increasing your income, we have our new Nerdy question of the month for July, which is: what is the most creative thing that you’ve done to earn more money? Maybe you negotiated a significant raise or you’re one of those job hoppers that has a new gig every couple of years. Tell us what is the most interesting thing that you’ve done to increase your income?
Sara Rathner:
I mean, I’ve rented out my basement for a commercial shoot, so there’s that.
Sean Pyles:
Okay. Interesting.
Sara Rathner:
Made 1,400 bucks and bought new storm doors. What a day. Anyway, if you’ve done something like that or something else, call or text us on the Nerd Hotline at (901) 730-6373. That’s (901) 730-NERD, or email us at [email protected]. We might just share your story on a future episode. Maybe inspire some of our other listeners to take up an interesting side hustle.
Sean Pyles:
And while you’re at it, send us your money questions, too. It is our job as Nerds to answer whatever your money question is. So send it our way on the Nerd Hotline, (901) 730-6373 or email it to us at [email protected]. Well now let’s get into this episode’s money question segment after a quick break. Stay with us. We’re back and answering your money questions to help you make smarter financial decisions. This episode’s question comes from Adrian, who left us a voicemail. Here it is.
I’m a recent college graduate. I graduated college in June of 2023 and I am six months into my new corporate world job. I’m trying to save 25% of my income per month and I’m trying to start investing. I don’t really know what my savings goals should be. I’m down for some high risk investments, but I don’t know, I’m trying to just learn the basics of investing, how to plan for life. What would you do if you were in my shoes, if you could go back in time and be 23 and not have kids or a mortgage or anything?
Sara Rathner:
To help us answer Adrian’s question on this episode of the podcast, Sean and I are joined by our co-host, Elizabeth Ayoola. Hey Elizabeth.
Elizabethy Ayoola:
Hey, my favorite dynamic duo.
Sean Pyles:
I love getting a question from a listener who is so young because even though they’re only 10 years younger than me, it does feel like a lifetime ago that I was 23 and making these financial decisions for the very first time. One thing that I find really interesting about Adrian’s question is that while they are so early in their financial journey, their questions really can apply to anyone, because as I’m sure we all know well, plenty of people in their 30s and 40s and beyond are still trying to figure out their budgets and their financial goals. So with that in mind, I think that our listener and all listeners really could benefit from a little bit of budgeting 101. So Elizabeth, where do you think they should start?
Elizabethy Ayoola:
Basically, I think they need to start with a budget. That’s going to tell you how to slice and dice your money. You should probably maybe start with the 50/30/20 budget, which we are advocates for at NerdWallet, or it might be the 60/30/10 budget depending on your cost of living and where you are. Now, for those who don’t know what the 50/30/20 budget is, 50% go to your needs, 30% to your wants and 20% to debt, paying down debt and also saving money. I do think it’s important to know, however, these numbers are not set in stone. It really just depends on your finances and you can adjust the numbers to fit where you are in your financial life right now. I myself currently save above that 20 bucket, but luckily I don’t have that much debt, so that’s why I’m able to save more money and save more than the 20.
Sean Pyles:
Yeah. And our listener wants to save 25% of their income, which is really ambitious, especially for someone who is so young. I think when I was 23, I was saving maybe 2% of my budget, and it wasn’t even intentionally, it was just by chance, because that’s what I had left over at the end of the month.
Elizabethy Ayoola:
You were doing great, Sean, because let me tell you, I was saving 0% of my budget at 20 something. So that is ambitious. I think it’s possible, but it just again depends on where your finances are.
Sara Rathner:
I like an ambitious savings goal, especially when you’re young. Some of the best advice I was given by a CFP that I used to work with was save as aggressively as you can for as long as you can because life only gets more complicated and more expensive. So if aggressive for you is 3%, that’s great. If aggressive for you is 25%, that’s great, and if you have to change it up from month to month, that’s fine too.
Elizabethy Ayoola:
So our listener is dedicated to being a hardcore saver, and I love that for you, listener. So Sean, I know you’re also big on saving and you have some tricks for effectively saving money. What do you think?
Sean Pyles:
So I would start by encouraging Adrian to have something to save for. Again, I’m thinking a lot about myself in my early 20s, I didn’t really have any sort of short, medium, or long-term goals or priorities of any sort because I was just focusing on paying my rent and having fun. So I understand how it can be hard to understand what your priorities might be, and this is where I think something that’s very woo woo but effective can come into play. And that is a visualization exercise. Now, if you’re rolling your eyes, just bear with me because I swear it can be super helpful. So when you are 23, 33, 43, think about where you see yourself in the future in five years, in one year, in 20 years. So maybe that means do you want to move to a new city in the next year? Do you want to buy a house in five years? Do you want to retire in 40 years? Imagine where you will be at these different points in your life and think about how you can save money to get there.
Elizabethy Ayoola:
I would not even say that’s woo woo, Sean. I mean, so I definitely started doing that in my late 20s and honestly, the life I have today was a lot of the woo woo stuff. So it worked for me.
Sean Pyles:
The manifesting is real.
Elizabethy Ayoola:
It’s a real thing.
Sara Rathner:
And if you’re not really into the whole idea of manifesting as a term, that’s fine too. You could also think about it in terms of just naming your goals. Instead of just being like, I’m going to save 25% of my salary. For what? So say what the “what” is. So maybe online savings accounts like high yield savings accounts, you could actually name the account. So you could have, this is the account because I need to replace my car, or this is the account because I need to buy a new computer. Or this is the account that I’m saving up for a down payment on a home for. And then beginning to say, okay, I’m going to put this amount of money in this month for this goal and this goal. Makes it so much easier to stay organized and there’s some science behind it, making it so that you actually are more successful in terms of reaching your savings goals by just naming the goal. So if you don’t want to do the woo woo thing, you could do the practical thing and just put some names on stuff.
Sean Pyles:
Yeah. And what you’re talking about there is really the marriage of the woo woo and the super practical and tactical, where you can start with knowing what you want and then getting the accounts that can help you save the money for that. So for a lot of people, that’s going to mean starting out with an emergency fund, building up over time three to six months of the needs budget that you have. That’s like rent and medicine and groceries, things like that. And then building out the other savings buckets for things like a vacation fund, a house fund, a wedding fund. I have 10 savings accounts across all of the banks that I partner with. And they are all specifically allocated for my different goals. I know 10 is kind of a ridiculous amount, but it works for me.
And what makes it easy is that I automate my deposits into these accounts. So I don’t even have to think about it. One of my accounts is only getting $40 a month, and that’s enough for me to save, to build on that goal over time. But I don’t have to be worried about, oh, okay, am I going to have enough for when I need a new rug for my house eventually. I just know it’s already going in the background.
Sara Rathner:
Yeah, I love this. It’s that concept of reverse budgeting where you automate transfers into your various accounts for different goals every month.
Sean Pyles:
And whenever we talk about savings accounts, it can be easy for we Nerds who are steep in this to maybe even take for granted the fact that high yield savings accounts are such an amazing thing for people to have. People can be getting even around 5% back for what they have sitting in their savings. And if you think about some average returns from the stock market some years are around 7%, and that can be much riskier than just having a savings account. I really do recommend people shop around, look at some of our roundups on NerdWallet and see what sort of high yield savings account might help you meet your goals, because you’ll be getting a much greater return on your money than you would get from a traditional brick and mortar bank.
Sara Rathner:
So our listener, Adrian, is a spring chicken in the world of finance and in the world of investing, which they also mention, having a long time horizon can be one of your best assets. And if you’re in your 30s and listening to this, you still have a long time horizon. So don’t think it’s all over if you didn’t invest in your 30s. Now let’s talk about investing at a younger age. Elizabeth, what are your thoughts there?
Elizabethy Ayoola:
Oh my gosh. I totally get the feeling of being overwhelmed and not understanding where to start. But it’s really important I think, not to let that paralyze you and to just start as soon as you can. And the first step in doing that is creating a strategy. And what the strategy is going to do is it’s going to tell you what your goals are and how much you need to save to achieve them and by what timeline. Now, it doesn’t have to be over complicated because I think that’s where people get tripped up, especially because there’s so many retirement and saving calculators online to help with this. And yes, I’m going to shamelessly plug NerdWallet. We have lots of those, go check them out. But yeah, knowing what age that you want to retire and how much you need will help guide your investing strategy. It’s also going to help you decide what to invest in, the best vehicles to use, and how much to put in each. What do you think, Sara, about time horizons in that sense?
Sara Rathner:
Oh, it’s probably one of the best things you have working for you because the way compound interest works mathematically is the longer of a time horizon you have, the less you can save per month or per year and still come out with a higher amount of money in the end versus waiting an extra 10 years, an extra 15 years, then you have to invest so much more per month just to catch up and still end up with less money overall.
Sean Pyles:
And I would recommend Adrian or anyone else who’s getting started in investing or just taking it seriously for the first time, is to get a lay of the land and understand all of the different investment accounts that are out there. Because there are all these different ones, like a 401k and a Roth and a Roth IRA that people have probably heard about, but really understanding what they are and when one is more beneficial than another for your circumstances can help you make the most of your investments. And something to think about too, since Adrian is so young, is that your younger years are often the best time to take advantage of an IRA because you are getting taxed at a lower rate when you’re earning less money than you will be taxed at later on in your career. So really use these early years to your advantage.
Elizabethy Ayoola:
Yeah, I’m with you Sean. You guys also should decide for those people listening whether you want to do active or passive investing. If you are like me and you ain’t got time for that, and when I say that, I mean checking the stock market every day, then you may want to consider passive investing and some passive investing options include ETFs or robo-advisors and kind of securities like that. But yeah, once you do all those things, the most fun part is automating your investments and knowing that you’re probably growing both while you’re sleeping.
Sean Pyles:
Yeah, I think for a lot of people, sometimes the best strategy to start can be the strategy of “I want my money to make me more money.” And that’s where I started out in my mid 20s when I first started taking investing seriously. I didn’t want to spend a lot of time actively managing investments. And guess what? Actively managed investments often perform worse than passively managed investments. So passive is probably going to be the easiest thing for most people to do. And I just set up an account with a robo-advisor that was trusted and well-reviewed on nerdwallet.com, and I just have automated deposits and it makes it super simple. I’ve been doing it for years and I’m already receiving literal and metaphorical dividends from that.
Elizabethy Ayoola:
Also, you want to think about fees when you’re looking at things like that and what has low fees and performance and other things, but don’t let that stop or overwhelm you as well. Just check out some resources on how to pick an ETF also.
Sara Rathner:
Yeah, I will also add that whenever I hear somebody in their early 20s say that they are, “Down for some high risk investments,” I think somebody’s been talking to their friends about crypto and I don’t know. I mean, for all I know Adrian just means, oh, I really want to dabble in a more stock forward portfolio. Sure. Honestly, you’re probably talking about crypto, aren’t you? Before you dabble in speculative investments, things like cryptocurrency, things like, I don’t know, precious metals and real estate and all sorts of stuff like that, you want to set aside a solid foundation. Just the things that we’ve been talking about, automating transfers of money into retirement accounts, either through your employer or on your own, diversifying those investments. And then, only then, if you have money left over, then you can dabble a little bit, sprinkle a little spice onto your investments, maybe 10% of your portfolio at the most into the higher risk, like crazy stuff. But set a good foundation first. Don’t put all of your money into speculative investments and then wonder why you don’t have any money left because you probably won’t.
Sean Pyles:
And I will just quickly add for the sake of our compliance department, that we are not financial or investment advisors. If you want specific individualized investment advice, speak with a financial advisor, hopefully a fiduciary financial advisor. Okay. Now, I know we’ve been kind of talking around this question for this conversation, but I would love to hear what you two would have done differently if you could go back to when you were 23 and maybe improve your finances, knowing all that you know now?
Elizabethy Ayoola:
That’s a deep, deep, deep sigh. So honestly speaking, the first thing I thought is like, oh my God, I would’ve stopped partying and buying alcohol and save more money. But then I remembered that I was living in Nigeria earning like $400 a month, which was seen as a good salary. So I barely had any money to live, quite frankly. And I think that’s a reminder that sometimes you just ain’t got really barely enough money to save and you just need to earn more. But I definitely would have educated myself more on personal finance and I would’ve at least stashed away something into an investing account. So that’s what I would’ve done. But then again, if I started investing too early, I might be in Turks and Caicos right now instead of chatting to you all. So I guess it worked out how it was supposed to.
Sean Pyles:
I’m glad you’re here with us, but also I would be happy for you if you were traveling the world instead of doing this. Sara, what about you?
Sara Rathner:
So I think a lot of people in their early 20s are, there’s just a lot of fear and uncertainty at that point in your life, and I definitely felt that at that time where there are all these big life milestones that are coming up for you eventually and you just don’t know when they’re going to happen. And so I was so worried about whether or not I’d be able to get to that point. But you’re 23.
Knowing how fast the next 10 to 20 years will go for you, just savor it because everything else is going to pile on really, really fast. And the way you spend your weekends is going to look really different. Do take a couple of steps to improve your position in life later on and use that gift of time. But then, yeah, you should have the wants budget, you should go travel with your friends, go out with your friends. Once you all get partnered up, you’re not going to see your friends as often, so enjoy it.
Sean Pyles:
Well, as someone who definitely enjoyed themselves a lot in their early 20s, I don’t regret any of it, really, shockingly, but it did come at the expense of my financial health in some senses. I really didn’t invest until my mid 20s. I barely had a budget until around the same time. So I would go back and encourage myself to be a little bit more balanced in the having fun and the forward planning aspect of life. But you’ve got to learn your lessons as you learn them. And that’s where I was at the time.
And one thing I think is important to realize and think about as you are trying to map out what having an adult financial life looks like is that the beginning of this financial journey is always going to be the hardest because you simply don’t know what you don’t know. There’s so much to learn. When you’re 23, you’re paying rent on your own for the first time. You’re figuring out how to make meals for yourself for the first time and building these good habits does take time. So don’t feel like you have to do everything all at once, but do make that concerted goodwill effort to try to better your relationship with money and use it to build the life that you want. Well, Elizabeth, thanks so much for coming on and talking with us.
Elizabethy Ayoola:
Thanks for having me.
Sara Rathner:
And that’s all we have for this episode. Remember, we’re here for you, whatever life phase you’re in, and we want to hear your real world questions because we’re here to make you smarter about your money decisions. So turn to the Nerds and call or text us your questions at (901) 730-6373. That’s (901) 730-NERD. You could also email us at [email protected]. Also visit nerdwallet.com/podcast for more info on this episode.
Sean Pyles:
And remember, you can follow the show on your favorite podcast app, including Spotify, Apple Podcasts and iHeartRadio, to automatically download new episodes. This episode was produced by me. Tess Vigeland helped with editing. Sara Brink mixed our audio. And a big thank you to NerdWallet’s editors for all their help. And here’s our brief disclaimer again. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.
Sara Rathner:
And with that said, until next time, turn to Nerds.
Inside: The answer is so obvious! Stop the assumptions with the 3 percent or 4 percent rule of retirement. Learn how much money to save for retirement today.
We all know that saving money for retirement is something we should do.
Maybe you are contributing the minimum to your 401K through work to get the match. Possibly saving money in a Roth IRA.
But, are you truly saving enough for retirement?
More than likely not.
Don’t feel like you are alone. According to a new study, only half of households actually have money saved in retirement accounts. The good news for those who have saved is the dollar amount saved for retirement has been increasing in the past 10 years.
Here is the real reason you don’t save for retirement… you have absolutely no clue how much money you need to be saved to retire.
You have tried to use all of the online retirement calculators from all of the big companies. Your results are millions of dollars different. You have no clue where to start, or what to believe.
And then you just get unmotivated because you’re like there’s absolutely no way I can make that dollar amount work.
So, What is Our Retirement Number
Personally, I completely get it this is a conversation. My husband and I have had it for years.
What is our retirement number?
What amount do we need to retire with?
And honestly, even can I actually save that much before I am too old to work?
It is all a complete unknown, it is a best-guess scenario.
There is absolutely no way for you to truly understand how much you need because there are so many things that go into it, including inflation, your savings rate, your withdrawal rate, and your anticipated expenses. So there’s a lot of variables and that’s when the variables get too confusing you don’t know which way to start.
One Guaranteed Truth…
The financial advisors believe they are the know-all-be-all with their calculations while charging you an asset management fee that is putting a drag on your overall portfolio.
And then October 27, 2020, Bill Bengen announced that instead of using the 4% rule is outdated, and now you can use a 5% rule. (Bill Bengan is a financial advisor who made the 4% rule of thumb famous 25 years ago.) So, this latest information just throws a curveball into everything that has previously been used for the past 25 years, and now you’re left wondering…
Well, I have no idea what is the proper amount I need to save for retirement.
Do you know what the amount that you need to save for retirement is?
So, let’s dig in for a little bit and we’re gonna talk about the three different percentages that are talked about the most. It’s the 3% rule, the 4% rule, and the 5% rule is one better than another. We’ll debate that and shortly.
How does Withdrawal Rate work?
But first of all, you have to realize that not everything works the way you want, so let’s show some examples before we dig into the specifics of the different rules.
Basically, the whole concept is if you save $1 million and you start withdrawing either 3%, 4%, or 5%. That withdrawal amount is the amount of income that you would live on each and every year, while the rest of your portfolio is continuing to grow and increase in value.
The ultimate, perfect-scenario goal is that you would withdraw as much as you possibly could without depleting the portfolio.
Withdrawal Rate Example:
Here are the assumptions:
Plan to spend $50,000 a year
7% rate of return on your money
Age doesn’t matter and not accounting for taxes or inflation (we want to keep this simple)
The amount you would need to save based on each of the withdrawal rates:
3 percent rule, you would need: $1,666,667
4 percent rule, you would need: $1,250,000
5 percent rule, you would need: $1,000,000
This post may contain affiliate links, which helps us to continue providing relevant content and we receive a small commission at no cost to you. As an Amazon Associate, I earn from qualifying purchases. Please read the full disclosure here.
The Withdrawal Rate Confusion
In our example, we used simple calculations that don’t account for age, taxes, or inflation and the amount you need to save for retirement is $666,667 different.
The numbers are too much for the average person to understand and have faith in.
This is why the confusion on how much to save for retirement and what model and which retirement calculator is the best.
Shortly, we are going to give you the simple answer of how much to save for retirement. But, first, a little background on the various percent rules for retirement.
3 Percent Rule
The 3% rule has gotten very popular with the FIRE movement.
The FIRE movement is Financial Independence Retire Early.
Because most of these people aren’t looking at retiring in the normal typical retirement age of 60s, they’re looking to retire in their 30s or 40s. They feel like they need to be super conservative because they are trying to estimate how much they need each month to live off their money for possibly the next 50 years.
That’s a lot of variables that you have to take into account.
The good news is you can always learn and figure out ways to make money in retirement so it’s not a complete waste, you can always go back to work because you are younger, and have youth on your side. So, is 3% a safe withdrawal rate?
The golden advice is you want to plan for the worst but hope for the best. The goal is that 3% would cover all of your necessities and basic expenses.
4 Percent Rule
Is the 4 percent rule viable?
The 4 percent rule of retirement was made famous by Bill Bengen 25 years ago (and just recently he said that number is outdated.)
The assumptions were if you withdraw 4% of your investment account every year, you will still have enough to live on throughout retirement.
This was based on what has happened in the markets, accounted for inflation, and the age you want to retire. He conducted many possible case scenarios and concluded that by only withdrawing 4 percent will make sure your money lasts. That is why it has been what is called a golden rule for retirement.
How long will my money last using the 4% rule? If you do all the calculations, it should last for at least 30 years. Obviously, you are looking at many variables of the stock market doing well and your living expenses staying low. Once again, the other big factor is what inflation will do in the future.
So, is the 4% rule that much better?
5 Percent Rule
And then, October 2020 rolls in. The breaking news is that Bill Bengen announced the 4 percent rule for retirement is too conservative and now you can actually use 5%.
So, that leaves the average person going… Okay. My head is spinning. I’m not sure how much I need to save for retirement. What is a good number?
Can I safely withdraw 5% of my investment accounts and still have enough money? That means I need less money to retire.
Can you Overcome Why Most People don’t save for Retirement?
There are too many variables, there are too many unknowns, and they don’t understand how it all works.
That is the real reason people don’t save for retirement.
I get it. I’m there with you. I feel it. I hear it from readers. But, we are going to break down some of the key items so that way you know how much you need for retirement.
And just remember, even if you messed up your numbers, the market went down, or you want to spend more in retirement than you are, then you could always go back to work. Even better, learn how to make money online for beginners, pick up a side hustle, make a little bit of extra money, and actually do something that you truly enjoy doing.
Learn how much money should I have saved by 30.
How Much do I need to Retire?
The simple answer… aim for $1,000,000 in investment accounts.
You may be able to aim lower depending on some variables which we cover shortly.
Investment accounts can include any of the following:
401K
Roth IRA
IRA
HSA (health saving account)
Brokerage Accounts
High-interest bank accounts
Real estate
You want accounts with liquidity. Things that can be bought and sold for cash. Those are the assets we are counting on how much to retire with.
Don’t use equity in your house because you need a place to live. If you want to use equity, that is fine, but your calculations just become slightly more difficult. We want simplicity.
Right now, your money goal is to reach $1,000,000 in investment accounts. Specifically in liquid net worth.
(Of course, this number may be lower if you live in a low cost of living area, plan to move with overall lower costs or another country, or have good options with lower health care costs. There have been plenty of people who retired with less and love life.)
Based on these variables, you may just need $500,000 to retire. Or somewhere in that range.
Realistic Retirement Savings for Motivation
We shared what a realistic retirement savings amount of $1 million dollars is. Is your first reaction – yikes, there is absolutely no way I can reach that amount.
However, you can!
Just break it down into smaller chunks.
For instance, make your next goal to save $100,000. You do that 10 times and you hit that realistic retirement savings amount.
If that seems like a stretch, then break it down even further. To stay motivated you can strive to save $50K or even $20K.
Break it into bite-sized manageable pieces to help you save for retirement and stay on track.
Learn what happens if you don’t save for retirement.
Best Ways to Save for Retirement
This is the basics to start saving for retirement.
You already know much should you really save for retirement. Now, you just to need to do it.
Here is the safest way to save for retirement. First, open up one or all of these accounts (pending where you are on your money journey). Then, look at investing in S&P 500 Index funds. The most highly recommended index fund for beginners is VTSAX.
1. Contribute to 401K
This is the simplest way to start saving.
Make sure you are contributing at least the minimum to your employer’s 401K.
Every year you can contribute up to a maximum amount. In 2023, an employee can contribute $22,500 to their 401k (the employer is eligible to contribute as well for a combined amount not to exceed $66,000 or 100% of your compensation, whichever is less). For the latest contribution limits, check out the IRS site.
Each year, increase your percentage by 1%. A simple way to reach maxing out your 401K.
Pro Tip: Check if your employer offers a ROTH IRA option. These are becoming more and more popular with companies. A Roth 401K will let your money grow tax-free because you pay taxes when you contribute money. If they don’t offer one, pester the human resources department.
2. Open Roth IRA
The next best option is the ROTH IRA. You want to contribute to a Roth IRA because you pay taxes upfront rather than at withdrawal like a traditional IRA.
Since ROTH IRAs have tax advantages, there are also contribution limits set by the IRS. The contribution amounts have remained the same for a couple of years now. The annual contribution limit is $6,000 per year, or $7,000 if you’re age 50 or older.
The downside to Roth IRAs… the amount you can contribute may be limited based on your income and filing status. However, for the average American, you should be able to max out the amount you can save each year.
Learn if can you have multiple Roth IRAs as it may be a smart financial move.
Pro Tip: Even if one spouse is a stay-at-home parent, you can still contribute to a Roth IRA for the non-working spouse.
3. Health Savings Account
Say what? Yes, a health savings account is on the list as a way to save for retirement. It is a great way to grow your money tax-free going in and on withdrawals.
You must have a High Deductible Health Insurance Plan to open a health savings account.
This is something you want to do and contribute the maximum amount each year. For 2023, you can contribute $3,850 for individuals and $7,750 for family coverage. Typically, the limits go up $50 each year, which helps you save more every year.
Pro Tip: This account will stay with you even when you leave your current employer and insurance. Plus you can use the HSA funds forever – even to pay Medicaid premiums. (Hopefully, nothing changes on these tax-advantaged accounts).
4. Traditional Brokerage Account
The last avenue has no tax benefits, but you are still saving money to be used later. That is what really matters.
Since there are no tax advantages to these basic brokerage amounts, there also are no limits on how much you can contribute.
This is where you would save the remaining money after you exhausted all the other methods listed above.
Side Note…
Yes, there are other ways to save for retirement. For this post and the average investor, the above-mentioned accounts are a great place to start. Once you become savvier and want to invest more money, then you can look at back door IRAs, 529s, or whole life insurance.
Saved $1 million for retirement, Now What?
Once you reach that 1 million dollars retirement mark, congratulations!!
That is a huge milestone that many people never reach. So, what is the next step?
Now, that you are closer to finally being able to live off your investments, you must start to look at the retirement calculators more seriously and factor in all of those variables (age, taxes, and inflation). It is much easier to predict the future once you have built a solid nest age and are closer to living off your investments.
Everyone started the financial independence journey at a different age and will reach their million-dollar mark at different times.
For the average person, you know learned how to save for retirement. You know what you need to do and where to start.
In this post, we took out all of the confusion on how much to save for retirement. Don’t worry about is the 4 percent rule is viable – or if it should be the 3 percent rule or the new 5% rule. The assumptions and variables will hold you back from starting. You know the dollar amount to start with, move on with that.
This simple advice for hitting your first milestone is the motivation to keep you going. Along the way, you will become savvier with finances and investing.
When it is time to move to the question of “can I retire” at such and such age, you have already taken out many of the variables, and the decision becomes more and more clear.
Take steps to reach that $1000000 mark today.
Get ahead now…
Know someone else that needs this, too? Then, please share!!
Did the post resonate with you?
More importantly, did I answer the questions you have about this topic? Let me know in the comments if I can help in some other way!
Your comments are not just welcomed; they’re an integral part of our community. Let’s continue the conversation and explore how these ideas align with your journey towards Money Bliss.
Spot Bitcoin ETPs are a type of investment vehicle that seeks to track the spot price of Bitcoin. ETPs, or exchange-traded products, are a broader basket of investments that include both exchange-traded funds (ETFs) and exchange-traded notes (ETNs), and are listed on an exchange, and can be purchased or sold much like a stock.
But what’s critical to know is that generally, ETFs are regulated by the Investment Company Act of 1940 (the “1940 Act”). While the most common type of ETPs are structured as ETFs, not all are, and spot Bitcoin ETPs are a specific type of ETP that are not registered under the 1940 Act. As such, these ETPs are not subjected to the 1940 Act’s rules, and investors holding shares of Bitcoin ETPs may not or do not have the same protections as those that are regulated by the 1940 Act, which may mean these investments have relatively higher associated risks.
What Is a Bitcoin ETP?
As noted, Bitcoin ETPs are a type of exchange-traded fund or product that allow investors to gain exposure to Bitcoin without directly owning it. These seek to track the price of Bitcoin. That means when the price of Bitcoin in U.S. dollars goes up, a spot Bitcoin ETP, trading on the stock exchange should also see its share values go up, and vice versa.
But it’s critical to note that Bitcoin ETPs have a much narrower focus than most other exchange-traded funds, which started out with the aim of giving investors broad exposure to the stock market. But, like all investments, they have various risks associated with them. In fact, it’s possible that an investor could lose the entirety of their investment.
An Introduction to Bitcoin ETPs
Bitcoin ETPs are exchange-traded products that, effectively, allow investors to gain exposure to the crypto markets as easily as they would buy or sell a stock, as discussed. Again, a Bitcoin ETP seeks to track the price or value of Bitcoin, and so the value of a Bitcoin ETP share is designed to rise or fall in relation to the change in value of the underlying cryptocurrency.
It also means that investors don’t necessarily need to directly own Bitcoin to gain exposure to the market in their portfolio — they can invest in a security, the ETP, that seeks to track it, instead. Note, too, that all ETPs have related fees and expenses, which vary.
💡 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.
Get up to $1,000 in stock when you fund a new Active Invest account.*
Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.
*Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
What Are Spot Bitcoin ETPs?
Spot Bitcoin ETPs are investment vehicles that trade at “spot” value. “Spot” value, in this case, refers to the price of the underlying asset at any given time. So, if a buyer and seller come together to make a trade, they would do so at the spot price. There are spot markets for all sorts of commodities.
Where Can Investors Buy Spot Bitcoin ETP Shares?
Investors can buy spot Bitcoin ETP shares via numerous exchanges and platforms. While previously, investors interested in Bitcoin or other cryptocurrencies would need to trade on platforms that supported cryptocurrencies, since Bitcoin ETPs are exchange-traded vehicles, investors are likely to find them available on many other platforms — that includes SoFi, which allows investors to buy spot Bitcoin ETP shares as well.
Are There Other Spot Crypto ETPs?
Spot Bitcoin ETPs seek to track the price of a fund’s Bitcoin holdings, and other spot crypto ETPs, if and when they are approved and hit exchanges, will do the same.
Spot Bitcoin ETPs were first approved for trading by regulators in early 2024. There are ETPs that seek to track Bitcoin-exposed or Bitcoin-adjacent companies, too, as well as Bitcoin futures. Spot Ethereum ETPs could be similar vehicles to to spot Bitcoin ETPs, in that they would seek to track the price of Ethereum, and allow investors to gain exposure to Ethereum in their portfolios without owning it directly.
What Are Bitcoin Futures ETPs?
Bitcoin futures ETPs are another type of ETP that give investors exposure to the price movements of Bitcoin via futures contracts. Futures are a type of contract that dictates the terms of a trade at a future date, and typically have underlying assets such as precious metals or other commodities — including crypto.
Accordingly, Bitcoin futures ETPs are crypto futures ETPs that specifically seek to track Bitcoin futures contracts. Regulators approved Bitcoin futures contracts in 2021, but again, investors should know that they don’t seek to track the price or value of the underlying asset exactly — which differentiates them from spot Bitcoin ETPs.
💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
Are There US-listed Spot Bitcoin ETPs?
There are U.S.-listed spot Bitcoin ETPs. When the Securities and Exchange Commission (SEC) first granted their approval in January 2024, it opened the door to several Bitcoin ETPs hitting the market. As a result, investors were able to start buying and selling them via the stock market.
The SEC’s approval led to new spot Bitcoin ETPs being listed on a few different exchanges. Here’s a list of the first 11 spot Bitcoin ETPs that gained approval from the SEC:
• Grayscale Bitcoin Trust (GBTC)
• Bitwise Bitcoin ETF (BITB)
• Hashdex Bitcoin ETF (DEFI)
• ARK 21Shares Bitcoin ETF (ARKB)
• Invesco Galaxy Bitcoin ETF (BTCO)
• VanEck Bitcoin Trust (HODL)
• WisdomTree Bitcoin Fund (BTCW)
• Fidelity Wise Origin Bitcoin Fund (FBTC)
• Franklin Bitcoin ETF (EZBC)
• iShares Bitcoin Trust (IBIT)
• Valkyrie Bitcoin Fund (BRRR)
Note, too, that it’s anticipated that additional spot cryptocurrency ETPs will become available.
How Are Bitcoin ETPs Regulated?
Bitcoin ETPs are regulated by the SEC, which sets out guidance in terms of legality. Regulation in the crypto space is and has been murky — it’s been largely unregulated for the entirety of the crypto space’s existence. But the advent of crypto ETPs is likely to change that to some degree, as spot Bitcoin ETPs’ underlying asset is and can be Bitcoin itself, rather than Bitcoin derivatives.
Remember, too, that Bitcoin ETPs are not regulated under the Investment Company Act of 1940, as discussed. That differentiates them from most ETFs on the market.
That’s another important distinction investors should note: Spot and futures Bitcoin ETPs may be regulated under slightly different terms, as futures are derivatives. Investors should pay attention to the space and to any SEC guidance released regarding crypto regulation, as it may impact the value of their holdings in crypto ETPs, too.
Pros & Cons of Bitcoin ETPs
Like all investments, there are pros and cons of ETFs and ETPs — including Bitcoin ETPs.
Benefits of Bitcoin ETPs
Proponents of Bitcoin ETPs appreciate that they can give investors exposure to the complicated and volatile cryptocurrency market, without the need to personally hold actual crypto.
Convenience and Ease
Buying a spot Bitcoin ETP requires little tech know-how beyond knowing how to use a computer, open a brokerage account, and place a buy order.
ETPs provide a way for investors to indirectly add exposure to certain assets — like Bitcoin, in this case — to their portfolio. That may result in a return on investment, or a possible loss of principal. On the other hand, holding actual Bitcoin may require a somewhat advanced level of technical expertise.
Secure Storage Options
Some cryptocurrency exchanges might be trustworthy, but some users have also had a controversial history of being hacked, stolen from, or defrauded. Even reliable exchanges open investors up to risk.
Securely storing cryptocurrencies — for example, storing the private keys to a Bitcoin wallet — is most often done by using either a paper wallet that has the keys written in the form of a QR code and a long string of random characters, or by using an external piece of hardware called a hardware wallet.
Risks of Bitcoin ETPs
First and foremost, investors should be aware that it’s possible that they could lose the entirety of their investment when investing in Bitcoin ETPs. There are, of course, other risks to consider as well, including volatility, costs, and the unpredictable and still largely-unregulated nature of the crypto market.
Volatility
The volatility comes from the occasional wild swings experienced in the price of Bitcoin and Bitcoin futures against most other currencies. This could scare investors that have a lower risk tolerance, enticing them to panic and sell.
Fees
One of the risks that comes from holding an ETP of any kind involves its expense ratio. This number refers to the amount of money a fund’s management charges in exchange for providing the opportunity for investors to invest in their fund.
If a fund comes with an expense ratio of 2%, for example, the fund management would take $2 out of a $100 investment each year. This figure is usually calculated after profits have been factored in, cutting into investors’ gains. In other words, some Bitcoin ETPs could be relatively expensive for investors to hold, but it’ll depend on the specific fund.
There can be other various types of fees that may apply to an investment in ETPs as well. While the specific fees will vary from ETP to ETP, investors will likely encounter one or a combination of commissions, account maintenance fees, exchange fees, and wrap fees (a type of management fee). Again, investors will want to look at an ETP’s prospectus or related documents to get a better sense of the costs associated with a specific ETP.
Fraud and Market Manipulation
Regulators have cited fraud and market manipulation as reasons for why they were cautious about approving a spot market Bitcoin ETP. It’s unclear how the SEC’s approval of spot Bitcoin ETPs may affect fraud and market manipulation in the crypto space, but it’s something investors should be aware of.
The Takeaway
Spot Bitcoin ETPs were approved for trading by the SEC in early 2024, and as a result, it’s likely that many more crypto ETPs will also hit markets and exchanges in the future — though nothing is guaranteed. Investors may use them to gain exposure to the crypto markets. For investors curious about the cryptocurrency market but not yet ready to invest in crypto itself, a Bitcoin ETP may represent another option. It may be best to speak with a financial professional before investing, too.
If you’re ready to bring crypto into your portfolio, you can invest in a Bitcoin ETP with SoFi. Along with many other types of investments, SoFi’s platform offers investors access to the crypto space through spot Bitcoin ETPs.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.
FAQ
What are the options for Bitcoin ETPs?
There are Bitcoin futures ETPs and spot Bitcoin ETPs listed in the U.S., which investors can buy. Given the SEC’s approval of Bitcoin ETPs for trading in early 2024, there may soon be additional spot crypto ETPs available to investors in the future.
Are there US-listed Bitcoin ETPs?
As of July 2024, there are U.S.-listed spot Bitcoin ETPs after the SEC approved an initial batch of them, and it’s likely there will be more in the subsequent months and years.
Where can Bitcoin ETP shares be purchased?
Crypto ETPs can be purchased and traded on the stock market, alongside other ETPs.
Photo credit: iStock/JuSun
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Fund Fees If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
Imagine you’re a gardener. You spend a weekend building a few raised beds, planting sunflowers and corn, etc. It’s a nice little hobby. Your first summer gardening ends up successful and fulfilling.
You come back for Year 2 with vigor! You want to expand. You spend a month preparing your beds and double the size of your garden. You plant new veggies and a few flowers, and all goes well.
You rinse and repeat for a few more years. Not only is your garden blooming, but its size is blooming. After years of doubling in size, it occupies a couple acres in your side field (we’re putting you in the countryside).
Eventually, you grow so big that an annual doubling size is no longer feasible. You don’t have the time or equipment to build twice as many new beds. You don’t have the resources to water and fertilize the full area. You don’t have the patience to weed the weeds and scare away the hungry deer and rabbits.
Growth, in other words, cannot be exponential forever.Eventually, size becomes the enemy of growth. Growth is easy when you’re small. It’s much harder when you’re big.
We see similar “rules” all over the natural world. Small children grow and learn unbelievably quickly in their early years. They “grow like a weed” – how punny. But eventually, that child becomes a “full-grown” adult who, if they’re learning at all, certainly is no longer learning at an exponential pace.
While the governing rules might differ (Mother Nature vs. something economic), a similar phenomenon applies to the business world and thus to the stock market: growth can’t be exponential forever, and growth becomes harder the bigger you are.
Forward Growth, Backward Growth
Let’s go back to the garden.
Imagine I have a bed of fully grown sunflowers —10 feet tall, giant heads, full of seeds.
Next to that, I have a bed of corn. The corn is only halfway grown—3 feet tall, barely a sign of any “ears” yet.
If I wanted to see which crop has the bestgrowing potential, how should I measure it?
The natural tact to measure backward and say, “It’s the sunflowers – look, they’re huge! They’ve grown like crazy this past month!”
But I could also measure forward and say, “The sunflowers are ‘exhausted’ – fully grown! The corn, though, still has a huge potential in front of it.”
The same idea applies to the stock market.
If we measure backward, the best-performing stocks of the past 5 years are the biggest stocks right now (kind of like our sunflowers). Ben Carlson shared this idea and data in a recent post. The right-most columns below show that today’s largest stocks are also the best performers of the past 5 years:
But as investors, is it good for us to “measure the sunflowers” after they’re fully grown?!
The wise skeptic would retort, “Jesse – you don’t know if those large stocks are fully grown or not.” It’s true. For all we know, those “sunflowers” could double in size again. We’ll come back to this idea later.
Still, I think it makes more sense to measure from the beginning and ask, “Which stocks will grow most in the future?” The problem is that we don’t have crystal balls. We don’t know what the future will hold.
The middle ground, then, is to combine the past and the present. For example: what if we took the stock market’s values from 2019, ranked the size of those companies at that time, and then tracked their performance from 2019 until today?
That’s exactly what this chart shows:
If we measure forward instead of backward, we see that smaller companies have been the best performers of the past five years (not that large companies performed all that poorly).
Here’s another terrific way of visualizing that idea. I’ve been using the following chart with some clients recently, especially when they ask questions about Apple, Microsoft, or NVIDIA, etc.
The data examines companies when they reach the Top 10 largest companies in the U.S. stock market. The left side of the graphic shows companies before they reach the Top 10, and the right side shows companies after they reach the Top 10. The left shows “future world-record sunflowers as they’re growing” and the right shows “world-record sunflowers once they’ve set those records.”
The chart pulls together our various ideas today.
It’s hard to grow forever. Instead, growth has an upper limit. Once a company has become “one of the largest companies in the US, or even the world,” odds are that its growth is tapped out.
While investing in “full-grownsunflowers” might be appealing – after all, look how tall they are! – the smart money knows investors don’t make money on past growth. They make it on future growth.
I’m not guaranteeing it. The future might be different than the past. Maybe NVIDIA will continue taking over the world. But get this:
In the five years from July 2019 to July 2024, NVIDIA’s market cap grew from $100 billion to $3 trillion, a 30x increase.
If NVIDIA did the same thing from now until July 2029, its then-$90 trillion market cap would be:
as large as every other publically traded company in the world, all combined.
about 2x the rest of the entire U.S. stock market, combined.
about 3x the annual GDP of the U.S.
and roughly ~$90 trillion more than my personal net worth. Ouch.
Uncle Warren, Cousin Rubin
In 1995, Uncle Warren Buffett wrote to his investors:
The giant disadvantage we face is size: In the early years, we needed only good ideas, but now we need good bigideas. Unfortunately, the difficulty of finding these grows in direct proportion to our financial success, a problem that increasingly erodes our strengths.
When you have one garden bed, it’s easy to double in size. Just build one more bed. It’s not so easy when you’re running an entire farm.
Buffett’s company, Berkshire Hathaway, is in the business of buying other companies – great companies, ideally, at fair prices.
But Berkshire is worth $900 billion dollars. They can’t afford to buy a $1 million company that they think will double to $2 million – it’s a tiny drop compared to their $900 billion value. Instead, Berkshire is looking to acquire multi-billion dollar companies. But those companies aren’t flying under the radar. They’re well-known and accurately priced. The opportunity for large investment gains simply isn’t there.
A similar idea comes from Rubin Miller, writing about Nvidia. Rubin said:
The stock market has averaged ~ 10%/year over the last 100 years, so if that continued while NVIDIA averaged 32% (which it has since its IPO in 1999)….
In 10 years, NVIDIA would be ~ 27% of the U.S. stock market.
In 15 years, NVIDIA would be ~ 68% of the U.S. stock market.
In 25 years, NVIDIA would be ~ 420% of the U.S. stock market.
But nothing can be more than 100% of something that it’s a part of.
That’s the impossibility (meaning if anything like this remotely occurred in reality, the entire market’s return would of course be pulled higher than 10%, simply by NVIDIA’s weight and return).
But this is the rub. You cannot compound returns at high rates forever.
On an infinite timeline, anything compounding at a higher rate than something else will eventually completely subsume it.
Rubin Miller
Eventually, in other words, NVIDIA would be so big and the rest of the market so small (comparatively) that “market returns” wouldn’t tell us anything about “the market” – they would only tell us about NVIDIA!
This is not poo-poo’ing on NVIDIA. It can still be a great company. But that’s different than being a great investment. You can be a good company, but a bad stock..
Or, back to our sunflower analogy, here’s a fact: a sunflower grows 100x in height over ~70 days. Then it withers and dies. But if it didn’tdieand instead continued 100x’ing its height every 70 days, that sunflower would reach the Moon in just over 1 year.
You tell me. Maybe we’ll soon see a sunflower reach the moon.
But I’m not betting the farm on it.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
Want to learn more about The Best Interest’s back story? Read here.
Looking for a great personal finance book, podcast, or other recommendation? Check out my favorites.
Was this post worth sharing? Click the buttons below to share!
Bonds are a cornerstone of smart investing, providing a dependable way to balance the ups and downs of the stock market. These financial instruments, though not entirely risk-free, offer a steadier income stream and a sense of financial security that can be particularly appealing during uncertain times.
By understanding how bonds work and their potential benefits, investors can make more confident and informed decisions. Whether you’re a seasoned investor or just starting out, incorporating bonds into your portfolio can help achieve a more stable and balanced investment strategy.
Definition of a Bond
A bond is a loan between a borrower and a lender. As the investor, you would essentially buy an I.O.U. note from a borrower. The note will include the term of the loan, the payment schedule, and any other relevant details.
The bond boils down to a promise from the borrower to the lender to pay you back in full, plus interest.
Who issues bonds?
Any organization can issue them. The typical institutions that issue bonds are large companies, the federal government, cities, and states.
The issuer of the bond will often explain why they need the money. For example, the government may need it to build new roads, or a company may need it to fund new research. The reason behind the issuance of bonds varies, but for one reason or another, the organization needs money.
Types of Bonds
There are several types of bonds, including:
Corporate bonds: These are issued by companies and can be traded on public markets. They are used to raise capital for business operations, expansion, or to refinance debt.
Municipal bonds: These are issued by cities, states, and other local governments to finance public projects such as schools, highways, and utilities. They are tax-exempt, which means the interest paid to investors is not subject to federal income tax.
Treasury bonds: These are issued by the federal government and are considered to be among the safest investments because they are backed by the full faith and credit of the U.S. government.
High-yield bonds: Also known as “junk bonds,” these are issued by companies with lower credit ratings and therefore carry a higher risk of default. They offer higher interest rates to compensate for this risk.
Convertible bonds: These are bonds that can be converted into a predetermined number of shares of the issuing company’s stock. They offer the potential for capital appreciation in addition to the interest paid to bondholders.
Zero-coupon bonds: These are bonds that do not pay periodic interest to bondholders. Instead, they are issued at a discount to their face value and the bondholder receives the full face value at maturity.
Floating-rate bonds: These are bonds whose interest rate is tied to a benchmark rate, such as the London Interbank Offered Rate (LIBOR). The interest rate on floating-rate bonds adjusts periodically based on changes in the benchmark rate.
Are all bond issuers the same?
No. It may be obvious, but some issuers are more trustworthy than others.
Generally, U.S. government bonds are considered the safest possible bond. Many deem these bonds as practically risk-free. Of course, there is always risk involved, but it is rather unlikely that the U.S. government would default on its loan to you. Less trustworthy issuers are shady companies that you don’t trust.
A risky bond issuer will be forced to offer a higher interest rate than a stable issuer. That is because it is less likely that they will be able to repay the loan of the investor. If that happens, then the investor will lose their money. Bonds that offer high interest rates are considered junk bonds. That is because it is likely that the issuer will be unable to repay their investor.
The U.S. government offers the lowest interest rate on its bonds. That is due to the fact that they are most likely to repay the investor. Stable private companies will fall somewhere in between. Bonds that offer lower interest rates are considered investment-grade bonds.
How does a bond work?
When an organization needs money, it will issue bonds with the terms already set. As an investor, you will need to accept the terms or pass on the bond. The details of the bond will include the exact terms of the bond. Let’s look at what will be included in each bond offering.
Issue price – The issue price is the price that the investor will have to pay for the bond.
Face value – Typically, the face value of a bond is a nice whole number like $100 or $10000. It is unlikely that you would find a bond available for $99.47.
Coupon rate – A coupon rate is equivalent to the interest rate that is on the bond. The issuer of the bond will pay this rate of interest to the investor.
Coupon date(s) – Throughout the lifetime of the bond, the issuer may be required to make payments to the investor. The coupon dates will outline the amount of these payments and when they need to be made.
Maturity date – A maturity date is basically the end of the bond. On this date, the issuer of the bond must pay the face value of the bond to the investor.
When you have all the information, you will be able to make an informed decision about a bond purchase.
What impacts bond prices?
Many things go into the price of a bond, but these are the most common.
Issuer’s credibility. If a shady company is offering a high yield bond, it will likely be classified as a junk bond. The risk will be reflected in the price of the bond.
Maturity date. The longer you have to commit your money to the bond, the higher the yield you will receive. The bond issuer is paying for the long-term use of your money.
Interest rates. Interest rates have the largest impact on bond prices. Higher interest rates will lead to lower bond prices.
Are bonds a risk-free investment?
No. Some bonds are significantly riskier than others. If a bond offers a high yield, then it is likely a risky investment.
Some people associate bonds with guaranteed returns. That is just not the case. You can lose money through bond investment. However, if you choose your bonds carefully, then this may be less of a worry. For example, if you choose to stick with U.S. Treasury bonds, then it is likely that your money will stay safe.
How does an investor make money with bonds?
When you purchase a bond, you can make money in a couple of ways.
First, you will receive interest payments regularly based on the coupon rate of the bond.
Second, you can sell the bond for more than you paid for it. If interest rates go down, then bond prices will rise. At that point, you will have the option to sell your bond for a profit before maturity.
How to Buy Bonds
There are several ways to buy bonds:
Directly from the issuer: Some bonds, particularly municipal and Treasury bonds, can be purchased directly from the issuer. This may be a suitable option for investors who want to hold the bonds until maturity and receive the full face value.
Through a broker: Investors can also purchase bonds through a brokerage firm. Brokers can help investors find the bonds that best match their investment goals and risk tolerance, and handle the transaction on their behalf.
On a bond exchange: Some bonds, such as corporate bonds, are traded on public exchanges, similar to stocks. Investors can buy and sell these bonds through a brokerage account or through a bond exchange-traded fund (ETF).
Through a mutual fund or ETF: Investors can also invest in bond mutual funds or bond ETFs that holds a diverse portfolio of bonds. This can be a convenient way to gain exposure to a variety of bonds without having to purchase them individually.
Before buying any bonds, carefully consider the issuer’s creditworthiness, as well as the terms and conditions of the bond. It’s also a good idea to diversify your bond holdings to reduce risk.
Final Thoughts
Investing in bonds is one way to diversify your portfolio.
Remember, bonds are not entirely risk-free. Do not assume that you will make money on a bond investment. It is entirely possible to lose money by investing in bonds.
Before you make any decisions about investing in bonds, research your options. It is important to understand all the risks involved before you choose to invest your hard-earned money.