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what is risk on risk off | risk on risk off investing relies on and is driven by changes in investor risk tolerance risk on risk off roro can also sway changes in investment activity in response to economic patterns when risk is low investors tend to engage in higher risk investments investors tend to gravitate toward lower risk investments when risk is perceived to be high high risk vs low risk investmentsinvestors appetites for risk rise and fall over time risk is the uncertainty associated with investments that may negatively impact a financial portfolio because younger investors have a long term time horizon they commonly take more risk in contrast investors close to retirement may choose conservative investments and vehicles with lower risk not all asset classes carry the same risk investors tend to change asset classes depending on the markets stocks mutual funds and exchange traded funds etfs are generally considered riskier assets than government issued bonds 1risk capital is the money investors devote strictly to trades exposed to a possible loss in value risk onasset prices commonly follow the risk sentiment of the market investors look for changing sentiment through corporate earnings macroeconomic data and global central bank action an increase in the stock market or where stocks outperform bonds is said to be a risk on environment risk on environments can be carried by expanding corporate earnings optimistic economic outlook accommodative central bank policies and speculation as the market displays strong influential fundamentals investors perceive less risk about the market and its outlook risk off | |
when stocks are selling off and investors run for shelter to bonds or gold the environment is said to be risk off risk off environments can be caused by widespread corporate earnings downgrades contracting or slowing economic data and uncertain central bank policy | just like the stock market rises in a risk on environment a drop in the stock market equals a risk off environment investors jump from risky assets and pile into high grade bonds u s treasury bonds gold cash and other safe havens | |
what investments are considered safe havens | investors look to safe havens to offer protection against market downswing or upheaval investment vehicles that may be considered safe havens are gold cash and u s treasury bonds | |
what is a roro etfs | some financial institutions offer fund investment that follows a roro strategy a roro etf rotates offensively or defensively between higher risk equities and lower risk u s treasuries the atac us rotation etf is an example of a fund that follows this strategy 2 | |
how do investors limit their risk exposure | risk is inherent in all investments but investors who use asset allocation and diversification and choose multiple types of investments in varying sectors can help manage risk 1the bottom linerisk on risk off is an investment paradigm where asset prices reflect changes in risk tolerance risk on environments thrive with expanding corporate earnings and an optimistic economic outlook risk off environments occur under slowing economic data and uncertain market sentiment | |
what is risk parity | risk parity is a portfolio allocation strategy that uses risk to determine allocations across various components of an investment portfolio the risk parity strategy modifies the modern portfolio theory mpt approach to investing through the use of leverage mpt seeks to diversify an investment portfolio among specified assets to optimize returns while adhering to market risk parameters by viewing the risk and returns for the entire portfolio but only utilizing long and unmargined positions with risk parity strategies portfolio managers can derive exact capital contribution proportions of asset classes in a portfolio to achieve optimized diversification for a range of objectives and investor preferences understanding risk parityrisk parity is an advanced portfolio technique often used by hedge funds and sophisticated investors it requires a complex quantitative methodology which makes its allocations more advanced than simplified allocation strategies the goal of risk parity investing is to earn the optimal level of return at the targeted risk level simplified allocation strategies such as the 60 40 stocks bonds portfolio make use of mpt mpt provides a standard for diversification within one s investment portfolio that maximizes expected return for a given level of risk in simplified mpt strategies using just stocks and bonds allocations are usually more heavily weighted toward equities for investors who wish to take on more risk risk averse investors will instead have a higher weight in bonds for capital preservation risk parity strategies allow for both leverage and alternative diversification along with short selling in portfolios and funds following this approach portfolio managers can use any mix of assets they choose however instead of generating allocations to different asset classes to arrive at an optimal risk target risk parity strategies use the optimal risk target level as their basis for investing this goal is often achieved by using leverage to weight risk equally among different asset classes using the optimal risk target level risk parity methodswith a risk parity strategy an investment portfolio will often include stocks and bonds however instead of using a predetermined proportion of asset diversification such as 60 40 the investment class proportions are determined by a targeted risk and return level risk parity strategies have generally evolved and developed from mpt investing they allow investors to target specific levels of risk and to divide risk across the entire investment portfolio to achieve optimized portfolio diversification the security market line sml is another part of the risk parity approach the sml is a graphical representation of the relationship between the risk and return of an asset and is used in the capital asset pricing model capm the slope of the line is determined by the beta of the market the line slopes upward the greater the possibility for the return of an asset the higher the risk associated with that asset there is a built in assumption that the slope of the sml is constant the constant slope assumption however may not actually be realistic for the traditional 60 40 allocation investors must take greater risk to achieve acceptable returns and the diversification benefits are limited as more and riskier equities are added to the portfolio risk parity solves this issue by using leverage to equalize the amount of volatility and risk across the different assets in the portfolio real world examples of risk paritythe aqr risk parity fund invests globally across stocks bonds currencies and commodities and seeks to achieve optimal return through balanced risk parity investing horizon s global risk parity etf also uses a risk parity strategy in its investments the exchange traded fund etf employs an equal risk weighted volatility distribution to determine the amount of capital participation | |
what is a risk premium | a risk premium is the investment return an asset is expected to yield in excess of the risk free rate of return an asset s risk premium is a form of compensation for investors it represents payment to investors for tolerating the extra risk in a given investment over that of a risk free asset for example high quality bonds issued by established corporations earning large profits typically come with little default risk therefore these bonds pay a lower interest rate than bonds issued by less established companies with uncertain profitability and a higher risk of default the higher interest rates these less established companies must pay is how investors are compensated for their higher tolerance of risk investopedia michela buttignol | |
how a risk premium works | think of risk premium as a form of hazard pay for your investments an employee assigned dangerous work expects to receive hazard pay in compensation for the risks they undertake it s similar with risky investments a risky investment must provide the potential for larger returns to compensate an investor for the risk of losing some or all of their capital this compensation comes in the form of a risk premium which is the additional returns above what investors can earn risk free from investments such as a u s government security the premium rewards investors for the prospect of losing their money in a failing business and it isn t actually earned unless the business succeeds a risk premium can be construed as a true earnings reward because risky investments are inherently more profitable should they succeed investments in well penetrated markets and which tend to have predictable outcomes are not likely to change the world on the other hand paradigm shifting breakthroughs are more likely to come from novel and risky initiatives it s these types of investments that can potentially offer superior returns which a business owner may then use to reward investors this one underlying incentive is why some investors seek riskier investments knowing they can reap potentially bigger payoffs premium costa risk premium can be costly for borrowers especially those with doubtful prospects these borrowers must pay investors a higher risk premium in the form of higher interest rates however by taking on a greater financial burden they could be jeopardizing their very chances for success thus increasing the potential for default with this in mind it is in the best interest of investors to consider how much risk premium they demand otherwise they could find themselves fighting over debt collections in the event of a default in many debt laden bankruptcies investors recoup just a few cents on the dollar on their investment despite the initial promises of a high risk premium while economists acknowledge an equity premium exists in the market they are equally confused as to why it exists this is known as the equity premium puzzle the equity risk premiumthe equity risk premium erp refers to the excess return that investing in the stock market provides over a risk free rate this excess return compensates investors for taking on the relatively higher risk of buying stocks the size of the premium varies depending on the level of risk in a particular portfolio and also changes over time as market risk fluctuates as a rule high risk investments are compensated with a higher premium most economists agree the concept of an equity risk premium is valid over the long term markets compensate investors more for taking on the greater risk of investing in stocks 1the equity risk premium can be computed in several ways but is often estimated using the capital asset pricing model capm capm cost of equity r f r m r f where r f risk free rate of return beta coefficient for the stock market r m r f excess return expected from the market begin aligned text capm cost of equity r f beta r m r f textbf where r f text risk free rate of return beta text beta coefficient for the stock market r m r f text excess return expected from the market end aligned capm cost of equity rf rm rf where rf risk free rate of return beta coefficient for the stock marketrm rf excess return expected from the market the cost of equity is effectively the equity risk premium rf is the risk free rate of return and rm rf is the excess return of the market multiplied by the stock market s beta coefficient from 1928 to 2022 the u s erp averaged 5 06 compared with 4 6 for the 1871 1925 period and 2 9 for the earlier 1802 1870 period 23 from 1926 to 2002 the equity risk premium was particularly high at 8 4 which puzzled economists 45 from 2011 through 2022 the average market risk premium in the u s was 5 5 67at the beginning of may 2023 the erp stood at 4 77 according to aswath damodaran a professor at the stern school of business at new york university that is slightly less than average and a sharp drop from the 5 94 registered at the start of 2023 8lower erps generally make investing in stocks less compelling whereas higher erps imply higher potential rewards the year 2022 was a volatile one for stock markets and the erp subsequently moved quite a bit according to damodaran it started 2022 at 4 24 and began 2023 at 5 94 perhaps implying that the market was viewed as undervalued after a sharp sell off 9the drop in erp since the start of 2023 can be attributed to several factors including a rise in equity valuations and a series of interest rate hikes from the federal reserve boosting returns on safer fixed income investments the average u s equity risk premium in 2022 6 | |
what is the risk premium for an investment | the risk premium is the extra amount you re expected to get for taking on risk it is the percentage return you get over what you d receive if you made an investment with zero risk so for example if the s p has a risk premium of 5 it means you should expect to get 5 more from investing in this index than from investing in say a guaranteed certificate of deposit | |
what is an example of a risk premium | let s say you invest in a stock that is expected to deliver an annual return of 8 including dividends if you could get an annual return free of risk of 3 elsewhere the risk premium for this stock would be 5 | |
how is risk premium calculated | the risk premium can be calculated by subtracting the expected return of a risk free investment from the expected return of an investment with risk what you are left with is the compensation for the risk you re taking on the bottom linethe higher the risk of losing capital the more an investor expects to be compensated this compensation comes in the form of a risk premium which basically means the extra returns above what can be earned on an investment without risk over the past 90 odd years the risk premium of stocks in the u s has averaged about 5 equity markets can fluctuate a lot though and a higher erp doesn t necessarily mean you should buy just as a lower erp shouldn t necessarily force you to look elsewhere | |
what is a risk profile | a risk profile is an evaluation of an individual s willingness and ability to take risks it can also refer to the threats to which an organization is exposed a risk profile is important for determining a proper investment asset allocation for a portfolio organizations use a risk profile as a way to mitigate potential risks and threats risk profiles for individualsthe risk profile for an individual determines that person s willingness and ability to take on risk risk in this sense refers to portfolio risk the ability to take risks is evaluated through a review of an individual s assets and liabilities an individual with many assets and few liabilities has a high ability to take on risk whereas an individual with few assets and many liabilities has a low ability to take on risk an individual with a well funded retirement account sufficient emergency savings and insurance coverage and additional savings and investments with no mortgage or personal loans likely has a high ability to take on risk an individual who lacks some of these assets an emergency fund for example and has too many liabilities would be less able to take on risk willingness and ability to take on risk may not always match up of course for example someone with many assets and few liabilities may be capable of taking on risk but may also be quite conservative by nature and simply not want to take on risk this will affect how the portfolio is constructed risk can be thought of as the trade off between earning a higher return or having a lower chance of losing money in a portfolio 12risk profiles for companiesa risk profile can also illustrate the risks and threats faced by an organization 3 it may include the probability of negative effects and the potential costs and level of disruption for each risk 45it is in a company s best interest to be proactive when it comes to its risk management systems 6 some risks can be minimized if they are properly accounted for companies often create a compliance division which helps ensure that the organization and its employees are following regulatory and ethical processes many companies hire independent auditors to help discover any risks so that they can be properly addressed before they become external issues failing to minimize risk can lead to negative consequences for example if a pharmaceutical company doesn t properly test its new treatment via the proper channels it may harm the public and lead to legal and monetary damages failing to minimize risk could also leave the company exposed to a falling stock price lower revenues a negative public image and potential bankruptcy | |
what is meant by your own risk profile | a risk profile identifies the level of risk an individual is prepared and able to accept a company s risk profile attempts to determine how a willingness or aversion to take on risk will affect an overall decision making strategy 7 in some cases there is arguably too much willingness to take on risk in others there s arguably too little | |
what is a balanced risk profile | a balanced risk profile typically has half of its portfolio invested in conservative assets like treasury bonds and the other half in more aggressive assets like stocks | |
what is a risk profile example | risk profiles can be created in a number of ways but traditionally they begin with a risk profile questionnaire risk profile questionnaires and other strategies which might focus on an investor s environment and life experiences score an individual via various probing questions to come up with a risk profile which is later used by financial advisors both human and ai to help shape a portfolio s asset allocation 8this asset allocation will directly affect the risk in the portfolio so it s important that it aligns well with the individual s risk profile that is their willingness and ability to take on risk willingness to take on risk refers to an individual s risk aversion a risk averse investor for example is someone who says that they essentially never want to see the value of the account decline even if that means missing out on potential capital appreciation if on the other hand an individual expresses a desire for the highest possible return and is willing to endure large swings in the value of the account to achieve it this person would have a high willingness to take on risk 9 they may even be a risk seeker the bottom linea risk profile outlines how much or how little risk an individual or organization is willing and or able to carry an appetite for risk is not the same as a capacity to weather it an overly aggressive investor or company might be willing but not able to take on a certain level of risk whereas one who is overly conservative might be able but not willing to a risk profile is a way to tell that story | |
what is risk return tradeoff | risk return tradeoff states that the potential return rises with an increase in risk using this principle individuals associate low levels of uncertainty with low potential returns and high levels of uncertainty or risk with high potential returns according to risk return tradeoff invested money can render higher profits only if the investor will accept a higher possibility of losses sydney saporito investopediaunderstanding risk return tradeoffrisk return tradeoff is the trading principle that links high risk with high reward the appropriate risk return tradeoff depends on a variety of factors that include an investor s risk tolerance the investor s years to retirement and the potential to replace lost funds time also plays an essential role in determining a portfolio with the appropriate levels of risk and reward for example if an investor has the ability to invest in equities over the long term that provides the investor with the potential to recover from the risks of bear markets and participate in bull markets on the other hand if an investor can only invest in a short time frame the same equities have a higher risk proposition investors use risk return tradeoff as one of the essential components of each investment decision as well as to assess their portfolios as a whole at the portfolio level risk return tradeoff can include assessments of the concentration or the diversity of holdings and whether the mix presents too much risk or a lower than desired potential for returns uses of risk return tradeoff | |
when an investor considers high risk high return investments the investor can apply risk return tradeoff to the vehicle on a singular basis as well as within the context of the portfolio as a whole examples of high risk high return investments include options penny stocks and leveraged exchange traded funds etfs generally speaking a diversified portfolio reduces the risks presented by individual investment positions for example a penny stock position may have a high risk on a singular basis but if it is the only position of its kind in a larger portfolio then the risk incurred by holding the stock is minimal | risk return tradeoff also exists at the portfolio level for example a portfolio composed of all equities presents both higher risk and higher potential returns within an all equity portfolio risk and reward can be increased by concentrating investments in specific sectors or by taking on single positions that represent a large percentage of holdings for investors assessing the cumulative risk return tradeoff of all positions can provide insight on whether a portfolio assumes enough risk to achieve long term return objectives or if the risk levels are too high with the existing mix of holdings calculating risk return | |
when you want to determine excess returns on investment use the alpha ratio which refers to returns earned on investment above the benchmark return in other words it measures excess returns from the benchmark index | according to investopedia alpha often considered the active return on an investment gauges the performance of an investment against a market index or benchmark that is considered to represent the market s movement as a whole to calculate alpha in a simple way subtract the total return of an investment from a comparable benchmark in its asset category to take into account asset investments that are not completely similar calculate alpha using jensen s alpha which uses the capital asset pricing model capm as the benchmark here s an example of alpha a beta calculation shows how correlated the stock is vs a benchmark that determines the overall market usually the standard poor s 500 index or s p 500 the s p 500 is a market capitalization weighted index of 500 leading publicly traded companies in the united states to calculate beta divide the variance which is the measure of how the market moves relative to its mean by the co variance which is the measure of a stock s return relative to that of the market here s an example of beta beta gives investors additional insight when they do further analysis and ask is there a reason why a particular stock is underperforming or outperforming beta can help answer that question when evaluating relative performance overall because it might help shed light on the reason why the stock outperforms or underperforms during certain times a sharpe ratio is helpful to determine whether the risk is worth the reward it is used when comparing peers or etfs that hold similar assets the calculation for the sharpe ratio is the adjusted return divided by the level of risk or its standard deviation according to investopedia the sharpe ratio s numerator is the difference over time between realized or expected returns and a benchmark such as the risk free rate of return or the performance of a particular investment category generally when comparing similar portfolios the higher the sharpe ratio the better because it shows an attractive risk adjusted return meaning the return after taking into account the degree of risk that was taken to achieve it | |
is it better to use the alpha beta or sharpe ratio | all three calculation methodologies will give investors different information alpha ratio is useful to determine excess returns on an investment beta ratio shows the correlation between the stock and the benchmark that determines the overall market usually the standard poor s 500 index sharpe ratio helps determine whether the investment risk is worth the reward | |
how is risk reward ratio calculated | to calculate risk reward ratio take the expected return reward on the trade and divide by the amount of capital risked | |
do investments with higher risks yield better returns | not necessarily the appropriate risk return tradeoff depends on a variety of factors including an investor s risk tolerance the investor s years to retirement and the potential to replace lost funds time also plays an essential role in determining a portfolio with the appropriate levels of risk and reward according to risk return tradeoff invested money can render higher profits only if the investor is willing to accept a higher possibility of losses the bottom linerisk return tradeoff is the trading principle that links risk with reward according to risk return tradeoff if the investor is willing to accept a higher possibility of losses then invested money can render higher profits to calculate investment risk investors use alpha beta and sharpe ratios | |
what is a risk reversal | a risk reversal is a hedging strategy that protects a long or short position by using put and call options this strategy protects against unfavorable price movements in the underlying position but limits the profits that can be made on that position if an investor is long a stock they could create a short risk reversal to hedge their position by buying a put option and selling a call option in foreign exchange fx trading risk reversal is the difference in implied volatility between similar call and put options which conveys market information used to make trading decisions understanding risk reversalrisk reversals also known as protective collars have the purpose of protecting or hedging an underlying position using options one option is bought and another is written the bought option requires the trader to pay a premium while the written option produces premium income for the trader this income reduces the cost of the trade or even produces a credit while the written option reduces the cost of the trade or produces a credit it also limits the profit that can be made on the underlying position another protective strategy that uses three option contracts to provide a range around the underlying security is the fence strategy the objective of a risk reversal is to capitalize on potential price movements in an underlying asset while mitigating the upfront cost through the premium received from the options sold traders often use risk reversals when they have a directional bias on the underlying asset but want a way to creatively offset the expenses associated with buying options it s important to note that risk reversals themselves carry risk if the underlying asset does not move in the way you think it will you can lose money risk reversal mechanicsif an investor is short an underlying asset the investor hedges the position with a long risk reversal by purchasing a call option and writing a put option on the underlying instrument if the price of the underlying asset rises the call option will become more valuable offsetting the loss on the short position if the price drops the trader will profit on their short position in the underlying but only down to the strike price of the written put if an investor is long an underlying instrument the investor shorts a risk reversal to hedge the position by writing a call and purchasing a put option on the underlying instrument if the price of the underlying drops the put option will increase in value offsetting the loss in the underlying if the price of the underlying rises the underlying position will increase in value but only up to the strike price of the written call risk reversal and foreign exchange optionsa risk reversal in forex trading refers to the difference between the implied volatility of out of the money otm calls and otm puts the greater the demand for an options contract the greater its volatility and its price a positive risk reversal means the volatility of calls is greater than the volatility of similar puts which implies more market participants are betting on a rise in the currency than on a drop and vice versa if the risk reversal is negative thus risk reversals can be used to gauge positions in the fx market and convey information to make trading decisions ratio risk reversalsratio risk reversals are a variation of the traditional risk reversal strategy that involves an uneven number of bought and sold options in a ratio risk reversal an investor might buy a greater number of options calls or puts than the number of options they sell this creates an asymmetrical exposure to market movements allowing the trader to capitalize on their directional bias while potentially improving the cost structure of the strategy you often choose the difference in the ratio based on your risk tolerance for instance in a bullish ratio risk reversal you might buy two call options for every one put option sold this implies a stronger conviction in an upward price movement while still providing a downside protection the ultimate goal here is to leverage the potential gains from a favorable market direction while adjusting the position to align with your risk preference note that the name of this financial strategy is risk reversal not risk elimination it is still possible to lose money in a risk reversal position calendar risk reversalsanother variation of a traditional risk reversal is the calendar risk reversal in this strategy an investor simultaneously buys and sells options with different expiration dates while maintaining a specific ratio this approach allows the trader to benefit from both the directional movement of the underlying asset and the time decay of the shorter term option creating a dynamic risk reward profile in a bullish calendar risk reversal an investor might buy a longer term call option and sell a shorter term call option the key advantage here is the ability to capitalize on the different rates of time decay the longer term option serves as a way to maintain exposure to the underlying asset s price movements while the shorter term option helps offset the cost through premium received from the sale and takes advantage of quicker time decay limitations of risk reversalsone significant limitation to risk reversals is the potential for losses if the market does not move as anticipated despite the name this investment strategy increases risk should markets play out not as expected another limitation is the impact of transaction costs and bid ask spreads when you simultaneously buy and sell options you ll incur higher transaction costs this is especially true if you re trying to buy options for illiquid securities additionally the bid ask spreads can widen further eating into potential profits the effectiveness of risk reversals is also influenced by changes in implied volatility if implied volatility increases the cost of options generally rises meaning you may get a lower reward for the same amount of risk last risk reversals may not be suitable for all market conditions or trading objectives they are designed for investors who have a specific view on an underlying asset and are willing to take a stance on which way the market will move for that good in more uncertain or volatile markets alternative strategies or risk management techniques might be a better idea real world example of a risk reversalsay sean is long general electric company ge at 11 and wants to hedge his position he could initiate a short risk reversal let s assume the stock currently trades near 11 sean could buy a 10 put option and sell a 12 50 call option since the call option is otm the premium received will be less than the premium paid for the put option thus the trade will result in a debit under this scenario sean is protected against any price moves below 10 because below this the put option will offset further losses in the underlying if the stock price rises sean only profits on the stock position up to 12 50 at which point the written call will offset any further gains in the general electric s share price | |
how do risk reversals work | risk reversals work by establishing a position in the options market that is either skewed towards bullish or bearish sentiments for instance in a bullish risk reversal an investor might buy a call option this position would benefit from upward price movement at the same time the investor could sell a put option | |
when is the best time to implement a risk reversal | traders often consider factors such as upcoming events earnings announcements or anticipated market trends when timing the implementation of a risk reversal additionally you should assess the implied volatility levels and the cost of options as both can influence the decision of when to enter into a risk reversal position | |
how do risk reversals differ from other option strategies | unlike a basic call or put purchase a risk reversal combines elements of both bullish and bearish positions this unique structure allows investors to tailor their exposure to market movements while managing costs the bottom linerisk reversals are options trading strategies that involve simultaneously buying and selling options to create a position with a specific risk reward profile typically this entails buying a call option while selling a put option or vice versa investors use risk reversals to express a directional view on an underlying asset manage risk and potentially benefit from market movements while mitigating upfront costs | |
what is the risk reward ratio | the risk reward ratio also known as the risk return ratio marks the prospective reward an investor can earn for every dollar they risk on an investment many investors use risk reward ratios to compare the expected returns of an investment with the amount of risk they must undertake to earn these returns a lower risk return ratio is often preferable as it signals less risk for an equivalent potential gain consider the following example an investment with a risk reward ratio of 1 7 suggests that an investor is willing to risk 1 for the prospect of earning 7 alternatively a risk reward ratio of 1 3 signals that an investor should expect to invest 1 for the prospect of earning 3 on their investment traders often use this approach to plan which trades to take and the ratio is calculated by dividing the amount a trader stands to lose if the price of an asset moves in an unexpected direction the risk by the amount of profit the trader expects to have made when the position is closed the reward | |
how the risk reward ratio works | in many cases market strategists find the ideal risk reward ratio for their investments to be approximately 1 3 or three units of expected return for every one unit of additional risk investors can manage risk reward more directly through the use of stop loss orders and derivatives such as put options the risk reward ratio is often used as a measure when trading individual stocks the optimal risk reward ratio differs widely among various trading strategies some trial and error methods are usually required to determine which ratio is best for a given trading strategy and many investors have a pre specified risk reward ratio for their investments note that the risk return ratio can be computed as one s personal risk tolerance on an investment or as the objective calculation of an investment s risk return profile in the latter case expected return is often used in the denominator and potential loss in the numerator expected return can be computed in several ways including projecting historical returns into the future estimating the weighted probabilities of future outcomes or using a model like the capital asset pricing model capm to estimate the potential loss investors may use a variety of methods such as analyzing historical price data with technical analysis using the historical standard deviation of price action assessing company financial statements with fundamental analysis and models like value at risk var these methods can help investors identify factors that could impact the investment s value and estimate the potential downside estimating the expected return and potential loss is not an exact science and the actual amount of risk and return may differ from your estimates investors should also consider their own risk tolerance when evaluating the potential risk of an investment as the amount of risk they are willing to take on can vary depending on their personal circumstances and investment goals | |
what does the risk reward ratio tell you | the risk reward ratio helps investors manage their risk of losing money on trades even if a trader has some profitable trades they will lose money over time if their win rate is below 50 the risk reward ratio measures the difference between a trade entry point to a stop loss and a sell or take profit order comparing these two provides the ratio of profit to loss or reward to risk investors often use stop loss orders when trading individual stocks to help minimize losses and directly manage their investments with a risk reward focus a stop loss order is a trading trigger placed on a stock that automates the selling of the stock from a portfolio if the stock reaches a specified low investors can automatically set stop loss orders through brokerage accounts and typically do not require exorbitant additional trading costs | |
when the risk return ratio is abnormally low it could suggest that the potential gain is disproportionately large relative to the potential risk which may indicate that the investment is riskier than it might appear this is why some investors may approach investments with very low risk return ratios with caution as a low ratio alone does not guarantee a good investment | example of the risk reward ratio in useconsider this example a trader purchases 100 shares of xyz company at 20 and places a stop loss order at 15 to ensure that losses will not exceed 500 also assume that this trader believes that the price of xyz will reach 30 in the next few months in this case the trader is willing to risk 5 per share to make an expected return of 10 per share after closing the position since the trader stands to make double the amount that they have risked they would be said to have a 1 2 risk reward ratio on that particular trade derivatives contracts such as put contracts which give their owners the right to sell the underlying asset at a specified price can be used to similar effect if an investor prefers to seek a 1 5 risk reward ratio for a specified investment five units of expected return for each additional unit of risk then they can modify the stop loss order and thus adjust the risk reward ratio but it is important to understand that by doing so the investor has changed the probability of success in their trade in the trading example noted above suppose an investor set a stop loss order at 18 instead of 15 and they continued to target a 30 profit taking exit by doing so they would certainly reduce the size of the potential loss assuming no change to the number of shares but they will have increased the likelihood that the price action will trigger their stop loss order that s because the stop order is proportionally much closer to the entry than the target price is so although the investor may stand to make a proportionally larger gain compared to the potential loss they have a lower probability of receiving this outcome | |
how do you calculate the risk return ratio | to calculate the risk return ratio also known as the risk reward ratio you need to divide the amount you stand to lose if your investment does not perform as expected the risk by the amount you stand to gain if it does the reward the formula for the risk return ratio is risk return ratio potential loss potential gain | |
why is the risk return ratio important | the risk return ratio helps investors assess whether a potential investment is worth making a lower ratio means that the potential reward is greater than the potential risk while a high ratio means the opposite by understanding the risk return ratio investors can make more informed decisions about their investments and manage their risk more effectively can the risk return ratio of an investment change over time yes the risk return ratio can change over time as the investment s price moves its potential risk changes for example if a stock s price goes up the potential reward may become less than when it was initially purchased while the potential risk may have also increased it s important to regularly monitor the risk return ratio of your investments and adjust your portfolio accordingly to ensure that your investments align with your goals and risk tolerance | |
what is risk tolerance | risk tolerance is the degree of risk that an investor is willing to endure given the volatility in the value of an investment an important component in investing risk tolerance often determines the type and amount of investments that an individual chooses greater risk tolerance is often synonymous with investment in stocks equity funds and exchange traded funds etfs while lower risk tolerance is often associated with the purchase of bonds bond funds and income funds understanding risk toleranceall investments involve some degree of risk and knowing their risk tolerance level helps investors plan their entire portfolio determining how they invest based on how much risk they can tolerate investors are classified as aggressive moderate and conservative risk tolerance assessments are available online including risk related surveys or questionnaires an investor may also want to review historical returns for different asset classes to determine the volatility of the various financial instruments one factor that affects risk tolerance includes the time horizon for an investor having a financial goal with a long time horizon an investor may have greater returns by carefully investing in higher risk assets such as stocks conversely lower risk cash investments may be appropriate for short term financial goals 1an investor s future earning capacity and the presence of other assets such as a home pension social security or an inheritance affect risk tolerance an investor can take greater risk with investable assets when they have other more stable sources of funds available additionally investors with a larger portfolio may be more tolerant to risk as the percentage of loss is much less in a larger portfolio when compared to a smaller portfolio order your copy of investopedia s what to do with 10 000 magazine for more wealth building advice aggressive risk tolerancean aggressive investor or one with a high risk tolerance is willing to risk losing money to get potentially better results 1 aggressive investors tend to be market savvy with an understanding of the volatility of securities and follow strategies for achieving higher than average returns their investments emphasize capital appreciation rather than income or preserving their principal investment this investor s asset allocation commonly includes stocks and little or no allocation to bonds or cash moderate risk tolerancemoderate investors want to grow their money without losing too much their goal is to weigh opportunities and risks and this investor s approach is sometimes described as a balanced strategy commonly moderate investors develop a portfolio that includes a mixture of stocks and bonds perhaps as a 50 50 or 60 40 structure 2conservative risk toleranceconservative investors are willing to accept little to no volatility in their investment portfolios retirees or those close to retirement age are often included in this category as they may be unwilling to risk a loss to their principal investment and have a short term investment strategy a conservative investor targets vehicles that are guaranteed and highly liquid risk averse individuals commonly opt for bank certificates of deposit cds money markets or u s treasuries for income and preservation of capital | |
what is an example of a 60 40 portfolio structure | a moderate risk tolerant investor may choose to invest in a 60 40 structure which may include a 60 investment in stocks 30 in bonds and 10 in cash 2 | |
what financial instruments are considered high risk investments | high risk investments include investing in options initial public offerings ipo and foreign emerging markets | |
how does risk tolerance compare to risk capacity | while risk tolerance measures an investor s willingness to take risk an investor s risk capacity measures their financial ability to take a risk | |
what are risk weighted assets | risk weighted assets are used to determine the minimum amount of capital a bank must hold in relation to the risk profile of its lending activities and other assets this is done in order to reduce the risk of insolvency and protect depositors the more risk a bank has the more capital it needs on hand the capital requirement is based on a risk assessment for each type of bank asset for example a loan that is secured by a letter of credit is considered to be riskier than a mortgage loan that is secured with collateral and thus requires more capital investopedia sydney saporitounderstanding risk weighted assetsthe financial crisis of 2007 and 2008 was driven by financial institutions investing in subprime home mortgage loans that had a far higher risk of default than bank managers and regulators believed to be possible when consumers started to default on their mortgages many financial institutions lost large amounts of capital and some became insolvent 1basel iii a set of international banking regulations set forth certain guidelines to avoid this problem moving forward regulators now insist that each bank must group its assets together by risk category so that the amount of required capital is matched with the risk level of each asset type basel iii uses credit ratings of certain assets to establish their risk coefficients the goal is to prevent banks from losing large amounts of capital when a particular asset class declines sharply in value 2there are many ways risk weighted assets are used to calculate the solvency ratio of banks bankers have to balance the potential rate of return on an asset category with the amount of capital they must maintain for the asset class | |
how to assess asset risk | regulators consider several tools to assess the risk of a particular asset category since a large percentage of bank assets are loans regulators consider both the source of loan repayment and the underlying value of the collateral a loan for a commercial building for example generates interest and principal payments based on lease income from tenants if the building is not fully leased the property may not generate sufficient income to repay the loan since the building serves as collateral for the loan bank regulators also consider the market value of the building itself a u s treasury bond on the other hand is secured by the ability of the federal government to generate taxes these securities carry a higher credit rating and holding these assets requires the bank to carry far less capital than a commercial loan under basel iii u s government debt and securities are given a risk weight of 0 while residential mortgages not guaranteed by the u s government are weighted anywhere from 35 to 200 depending on a risk assessment sliding scale 3special considerationsbank managers are also responsible for using assets to generate a reasonable rate of return in some cases assets that carry more risk can also generate a higher return for the bank because those assets generate a higher level of interest income to the lender if the management creates a diverse portfolio of assets the institution can generate a reasonable return on the assets and also meet the regulator s capital requirements | |
what are examples of risk weighted assets | examples of risk weighted assets include government bonds and debentures banks have different assets that are classified by their risk weight where lower risk assets are assigned a lower risk weight | |
what is the rwa ratio | rwa stands for risk weighted asset and it is used in the risk adjusted capital ratio which determines a financial institution s ability to continue operating in a financial downturn the ratio is calculated by dividing a firm s total adjusted capital by its risk weighted assets rwa | |
what is a tier 1 asset | tier 1 assets or tier 1 capital are the main assets of a financial institution they consist of retained earnings disclosed reserves and common stock it may also include some preferred stock it is the capital used to fund the institution s business activities for its clients the bottom linerisk weighted assets are a risk management measure indicating to banks the number of assets they need to hold in relation to their risk they help reduce instability in the financial marketplace particularly after the great recession | |
what is a rival good | a rival good is a product or service that can only be consumed by one user or a limited number of users the rivalry is among consumers whose competition to obtain the good can create demand and drive up its price a non rival good on the other hand can be used simultaneously by many consumers most common household products and supermarket foods are rival goods a bar of soap or a bottle of beer can only be consumed by a single person if the product is in short supply the rivalry among consumers is intensified a limited edition designer t shirt is a rival good that may increase in price simply because demand outweighs supply a non rival good may be consumed by many people at the same time without any pressure on its supply streaming videos are an example understanding rival goodscertain goods such as a bottle of beer or a designer t shirt are subject to consumption rivalry if someone drinks the bottle or buys the t shirt it is no longer available for anybody else to consume because these types of goods can only be used by one person competition to purchase them is created consumers become rivals in an attempt to obtain them | |
how much competition there is of course depends on availability if there are lots of the same bottles of beer on supermarket shelves it s easy to procure another one provided that thousands of other people aren t eager to buy them at that particular moment | if the good is rare by its nature such as a limited edition designer t shirt consumers may engage in a price war and be willing to pay over the odds to get their hands on it competition for this type of rival good is also compounded by the availability of apparel in sizes that meet each consumer s needs manufacturers might only produce limited quantities of products for certain sizes as a result consumers who require hard to find sizes must compete with each other to procure the items they need the covid 19 pandemic led to a shortage in toilet paper causing panic buying and leading some businesses to increase prices for this consumer staple common examples of rival goods include food clothing electronic goods cars plane tickets and houses some rival goods can be reused by another consumer at a later stage for example a durable good such as a skateboard might be sold after the current owner is finished with it a non durable good such as a cup of coffee or an apple does not fall into this category because it perishes after consumption after it is gone there will be nothing left to consume rival goods vs non rival goodsgoods are either classified as rival or non rival a rival good is something that can only be possessed or consumed by a single user a good that can be consumed or possessed by multiple users is said to be a non rival good internet sites and radio stations are examples of goods that are nonrival many people can access them at the same time and they can be consumed over and over again without impacting their quality or running the risk that supply will be depleted rival goods vs non excludable goodsnon excludable goods are products that cannot exclude a certain individual or group of individuals from using them a public road is a non excludable good everyone has access to a public road even if they are just walking on it rather than driving a vehicle the opposite of a non excludable good is an excludable good which is a good that some people are restricted from using excludable goods are private goods while non excludable goods are public goods a rival good is a type of excludable good because it can only be possessed or consumed by a single user procuring a rival good impacts its overall supply potentially leading to price increases and a lack of availability special considerationsthe competitive nature of rival goods can increase their value to the individuals who seek them this is especially true for the travel hospitality and entertainment industries goods that are rival in consumption can include seats on an airplane or for a broadway performance | |
when demand is high for rival goods businesses can exert more pricing power limited availability coupled with demand gives businesses pricing power | demand for rival goods drives retail sales during holiday periods as consumers race to buy gifts before they sell out or while certain discounts are available this type of shopping behavior has been used to retailers advantage in particular during black friday sales events | |
what are club goods public goods private goods and common goods | economists define goods based on the level of excludability and potential rivalry to obtain them | |
what is the free rider problem | the free rider problem is a phenomenon of the free market system it occurs when some members of a community fail to contribute their fair share to the costs of a shared resource the free rider problem creates a burden on a shared resource as a result of its use or overuse | |
why can markets only provide private goods efficiently | the free rider problem creates an opportunity for private goods all non excludable goods suffer from the free rider problem they become economically infeasible to produce creating a market for private goods the bottom lineeconomists define products as rival goods or non rival goods as a way to analyze patterns of consumption and the workings of the law of supply and demand a rival good is restricted in its availability which can cause demand to outstrip supply and its price to increase a non rival good is relatively unaffected by demand as it can be consumed by many people at the same time | |
what is a roadshow | a roadshow is a series of presentations made in various locations leading up to an initial public offering ipo the roadshow is a sales pitch or promotion made by the underwriting firm and a company s management team to potential investors before going public roadshows generally take place in major cities and are meant to drum up interest in the upcoming offer potential investors are introduced to the company its history and its key personnel understanding roadshows | |
when a company decides to go public the members of the investment firm responsible to underwrite or issue the ipo travel around the country in a roadshow to present the investment opportunity to potential investors most roadshows include stops in major cities like boston chicago los angeles and new york city | a successful roadshow is often critical to the success of the ipo the goal of the roadshow is to generate excitement about the company and its ipo by traveling to different cities underwriters introduce the ipo to institutional investors analysts fund managers and hedge funds to interest them in the security the roadshow also provides an opportunity for the underwriters to introduce the company s management and for investors to hear management s vision and goals for the company the goal of the roadshow is to generate enthusiasm surrounding the company s upcoming ipo which means the success of the ipo depends on a successful roadshow roadshow events may attract hundreds of prospective buyers interested in learning more about the offering in a face to face setting and online events may include multimedia presentations and question and answer sessions many companies may hold smaller private meetings in the months and weeks leading up to the ipo while the majority livestream some of their events to those who can t attend some of the topics covered during a roadshow include the company s history and any future plans other information may include the roadshow is essential to the ipo since it provides a forum where the company can communicate directly with potential investors to address any concerns or highlight successes the underwriters also use information gathered from investors to complete the book building process which involves gathering prices potential investors are willing to pay for the offering once a roadshow is complete the final prospectus is created and distributed to potential investors this prospectus is also filed with the securities and exchange commission sec an initial price for the offering is set based on the information gathered during the book building process and the ipo date is solidified special considerationsnot all roadshows involve an ipo in fact there are cases where companies travel across the country to talk to investors even when they aren t going public these are called non deal roadshows ndrs these roadshows occur when executives hold discussions with current and potential investors but no equity or debt security is offered ndrs are carried out to provide public information to investors including updates on the company s existing business and vision for the future ndrs involve meeting with key investors to keep them updated on how the company is performing example of a roadshowchinese e commerce giant alibaba group baba posted the largest ipo ever by raising 25 billion in 2014 while the underwriters involved took home 300 million the ipo was so successful that the stock price surged 38 in its debut but enthusiasm for the ipo began well before the stock began trading the roadshow included the financial numbers but also a video history of the company narrated by co founder and chair jack ma the roadshow was such a success with investors that it s likely the reason why the ipo price range was increased to 66 to 68 from the earlier published 60 to 66 range although the increase in the price range may not appear to be impressive it s important to remember that the company sold over 300 million shares during its ipo | |
what is a robber baron | robber baron is term used to describe america s most successful industrialists this derogative term was primarily used during the era of the late 19th century often known as the gilded age the term robber baron is also sometimes used to describe any successful businessperson whose practices are considered unethical or unscrupulous this behavior can include employee or environmental abuse stock market manipulation or deliberately restricting output to charge higher prices understanding robber baronsthe first known uses of the phrase robber baron described feudal lords in medieval europe who robbed travelers often merchant ships along the rhine river as they passed nearby the term appeared in american newspapers in 1859 its modern use stems from matthew josephson s the robber barons 1robber barons were widely despised and considered rapacious monopolists during their lifetimes however later biographies and historical reviews about the gilded age s american robber barons cast a more complicated and favorable light robber barons and monopoliesa chief complaint against the 19th century capitalists was that they were monopolists fear over the robber barons and their monopoly practices increased public support for the sherman antitrust act of 1890 economic theory says a monopolist earns premium profits by restricting output and raising prices this only occurs after the monopolist prices out or legally restricts any competitor firms in the industry however there is no historical evidence that natural monopolies formed before the sherman antitrust act many so called robber barons james j hill andrew carnegie cornelius vanderbilt and john d rockefeller became wealthy entrepreneurs through product innovation and business efficiency of the goods and services they provided supply grew and prices fell rapidly greatly boosting americans standards of living this is the opposite of monopolistic behavior andrew carnegie gave over 350 million to charity during his lifetime including over 56 million to build 2 509 public libraries around the world 2criticism of robber baronsamong common criticisms of the early robber barons included poor working conditions for employees selfishness and greed some robber barons including robert fulton edward k collins and leland stanford earned their wealth through political entrepreneurship many wealthy railroad tycoons during the 1800s received privileged access and financing from the government via extensive use of lobbyists they received monopolistic special licenses per mile subsidies huge land grants and low interest loans special considerationsworking conditions in 19th century america were challenging to say the least while robber barons took advantage of their workers they sometimes offered better working conditions than the norm of the day rockefeller and ford for example paid higher than average wages including bonuses for innovation or exceptional production managers often received long vacations at full pay some tycoons rank among the most noted philanthropists of all time rockefeller donated around 10 of every paycheck he ever earned 3 he gave almost 550 million to charity and championed biomedical research public sanitation medical training and educational opportunities for disadvantaged minorities 4railroad tycoon james j hill publicized and provided free education about crop diversification along with free seed grain cattle and wood to local communities he would transport immigrants at reduced rates if they promised to farm near his railroads who were the original robber barons the original robber barons were feudal lords who robbed travelers and ships passing through their territory during the 1800s the term was applied to successful capitalists like andrew carnegie cornelius vanderbilt and john rockefeller who used monopolistic business practices to corner entire industries and extract great wealth from workers and consumers who are today s robber barons although the term robber baron is somewhat antiquated it is still sometimes used to compare modern entrepreneurs to the monopolistic practices of 19th century industrialists today the term is most often used for tech moguls heading companies like apple google meta and amazon not only for the enormous wealth they ve accumulated but also for their allegedly monopolistic business practices and the accusations of exploiting their workers and consumers | |
how do billionaires earn their wealth | less than half of billionaires inherit wealth with the remainder building their fortunes through shrewd investments or entrepreneurship 5 according to forbes the most common path to riches is through the finance and investments industry 15 of billionaires with the tech sector providing another 12 6the bottom line robber barons was a derisive term for the nineteenth century capitalists who built their fortunes using monopolistic and exploitative business practices today the term is sometimes applied to moguls in the tech industry who are accused of using similarly monopolistic practices to take control of their markets | |
what is the robinson patman act | the robinson patman act is a federal law passed in 1936 to outlaw price discrimination the robinson patman act is an amendment to the 1914 clayton antitrust act and is supposed to prevent unfair competition 1understanding the robinson patman actthe robinson patman act requires a business to sell its products at the same price regardless of who the buyer is it was intended to prevent large volume buyers from gaining an advantage over small volume buyers the act only applies to sales of tangible goods that are completed within a reasonably close timeframe and where the goods sold are similar in quality the act does not apply to the provision of services such as cell phone service cable television and real estate leases 2the law came about to combat unfair trade practices that allowed chain stores to purchase goods at lower prices than other retailers it was the first legislation to attempt to prevent price discrimination it required that the seller offer the same price terms to customers at a given level of trade the act instituted criminal penalties for violations but contained a specific exemption for cooperative associations 3enforcement and support for the law have faced challenges over the years because of the complexity of the act and tensions between it common business practices of price competition and other aspects of antitrust law bowing to industry pressures federal enforcement of the robinson patman act ceased for several years in the late 1960s this left enforcement of the act up to private actions of individual plaintiffs against other businesses which have always been difficult due to the complexity of understanding the law and its application 4 in the mid 1970s there was an unsuccessful attempt to repeal the act the federal trade commission temporarily revived its use in the late 1980s enforcement has again declined since the 1990s 5 | |
how the robinson patman act works | the act generally prohibits sales that discriminate in price on the sale of goods to equally situated distributors when the effect of such sales is to reduce competition and may give favored customers an advantage in the market unrelated to their actual efficiency price refers to net price and includes all compensation paid including compensation for advertising or other services the also seller may not throw in additional goods or services to lower the effective price injured parties or the us government may bring action under the act charges may be brought on sales that involve 26a hypothetical example of the robinson patman actfor example the robinson patman act requires that if wholesale company abc sells two 32 inch flat screen televisions of equal quality one to target on august 10 and one to mom and pop s shop on august 11 both stores must be charged 250 per television however the act does not require that wholesale company abc and wholesale company xyz both sell 32 inch flat screen televisions to all big box retailers for 250 per television criticisms of the robinson patman actthe robinson patman act has been widely criticized by economists and legal scholars from nearly the beginning the act was criticized as potentially anti competitive itself and in tension with other aspects of antitrust law as favoring the interests of some businesses over the interests of consumers and as a practical matter highly subject to potential abuse 7in that the act raises potential legal consequences for charging lower prices it always runs the danger of effectively punishing price competition which is otherwise generally viewed as economically beneficial furthermore because the practices outlawed by the act typically involve transactions between businesses rather than directly involving consumers and often involve business charging lower prices on larger volumes it is often argued that it tends to favor the interest of higher cost resellers who in turn charge higher prices over the interests of consumers who would benefit from lower retail prices finally because charging different prices to different business customers is such a common practice among businesses in virtually all industries and because antitrust enforcement resources are necessarily limited and small relative to the size of the economy prosecutors have to be highly selective in when and which cases to pursue or else rely on private civil actions to enforce the law either of these alternatives present a high potential for abusive suits under the law through capricious or politically motivated prosecutions or through civil actions motivated by opportunism rather than the economic welfare of society | |
a robo advisor sometimes without the hyphen as roboadvisor is a digital platform that provides automated algorithm driven financial planning and investment services with little to no human supervision a typical robo advisor asks questions about your financial situation and future goals through an online survey it then uses the data to offer advice and automatically invest for you | other common designations for robo advisors include automated investment advisor automated investment management and digital advice platforms the best robo advisors offer easy account setup robust goal planning account services and portfolio management additionally they offer security features comprehensive education and low fees robo advisors history and investing strategythe first robo advisors betterment and wealthfront launched in 2008 wealthfront began as a mutual fund company it planned to assist the tech community then realized that computer software could make investment advice more accessible betterment on the other hand began with the initial purpose of rebalancing assets within target date funds tdfs it sought to help manage passive buy and hold investments through a simple online interface 1the technology was nothing new human wealth managers have been using automated portfolio allocation software since the early 2000s but until betterment and wealthfront launched wealth managers were the only ones who could buy the technology so clients had to employ a financial advisor to benefit from the innovation today most robo advisors use passive indexing strategies that are optimized using some variant of modern portfolio theory mpt 2 typically the account holder can t choose which mutual funds or exchange traded funds etfs to invest in or purchase individual stocks or bonds in their account 3some robo advisors offer optimized portfolios for socially responsible investing sri halal investing or tactical strategies that mimic hedge funds they also can handle much more sophisticated tasks such as tax loss harvesting investment selection and retirement planning explosive growththe industry has experienced explosive growth according to polaris market research the robo advisory market size was valued at 7 39 billion in 2023 and is projected to grow from 9 50 billion in 2024 to 72 00 billion by 2032 a cagr of nearly 29 4as of december 2023 the largest robo advisor by assets under management aum was vanguard digital advisor with 289 billion 56portfolio rebalancingthe majority of robo advisors use modern portfolio theory or some variant to build passive indexed portfolios for their users once portfolios are established robo advisors continue to monitor them to ensure that the optimal asset class weightings are maintained even after market moves robo advisors achieve this by using rebalancing bands 37in rebalancing bands every asset class or individual security is given a target weight and a corresponding tolerance range for example an allocation strategy might include the requirement to hold 30 in emerging market equities 30 in domestic blue chips and 40 in government bonds with a corridor of 5 for each asset class the use of rebalancing bands means that given the 5 corridor emerging market and domestic blue chip holdings can fluctuate between 25 and 35 government bonds can fluctuate between 35 and 45 when the weight of a holding moves outside of the allowable band the entire portfolio is rebalanced to reflect the initial target composition in the past this type of subtle rebalancing was frowned upon because it was time consuming and generated transaction fees however low fee robo advisors are designed to handle rebalancing automatically another type of rebalancing commonly found with robo advisors made cost effective through algorithms is tax loss harvesting tax loss harvesting is a strategy that involves selling securities at a loss to offset a capital gains tax liability this strategy is typically employed to limit the recognition of short term capital gains robo advisors do this by maintaining two or more stable etfs for each asset class so if the s p 500 etf loses value a robo advisor will automatically sell it to lock in a capital loss simultaneously it buys a different s p 500 etf it s worth bearing in mind that the irs wash sale rule prevents investors from re purchasing the same security or a security that is substantially identical within 30 days from its sell date 8 however robo investment platforms should have algorithms in place that incorporate rules like this make sure your robo advisor is programmed to select etfs appropriately so that you avoid wash sale violations benefits of robo advisors vs traditional financial advisorsthe emergence of robo advisors has broken down some of the traditional barriers between the financial services world and average consumers because of these online platforms sound financial planning is now accessible to almost everyone not just high net worth individuals some human advisors won t take on clients with less than 25 000 50 000 or sometimes even 100 000 or more in investable assets 12limitations of robo advisorsconvenient easy accesslower cost low starting capitalinvestment experience not requiredstraightforward index investinggrowing number of valuable serviceslacks human interactionlimited investment opportunitiesinvestor must define financial situation and investment goalsone size approach not right for alluneven technology standardshiring a robo advisorrobo advisors don t all cost the same amount and offer all the same features each one may excel in particular areas so it s important to do some research first dedicating a bit of time to finding the right one could turn out to be one of your smartest investments there are also hybrid robo advisors which essentially seek to combine the benefits of automated investment with human financial advice opening a robo advisor account usually entails completing a short risk profiling questionnaire and evaluating your financial situation time horizon and personal investment goals in many cases you will have the opportunity to link your bank account directly for quick and easy funding of your robo advisory account target demographicmany digital platforms target and attract certain demographics more than others for robo advisors these include millennial and generation z investors who are technology savvy and still accumulating their investable assets this population is much more comfortable sharing personal information online and entrusting technology with essential tasks such as wealth management indeed the marketing efforts of robo advisory firms typically employ social media channels to reach these investors 1415the u s securities and exchange commission sec issued a risk alert to investors in november 2021 regarding compliance issues with many robo advisors be sure to stay informed of these and other issues by checking finra investor alerts and the sec division of examination websites for information 1617robo advisors and regulationrobo advisors hold the same legal status as human advisors accordingly they must be registered with the sec and are subject to the same securities laws and regulations as traditional broker dealers 18most robo advisors are members of the financial industry regulatory authority finra you can use brokercheck to research robo advisors in the same way that you would a human advisor assets managed by robo advisors aren t insured by the federal deposit insurance corp fdic that s because they are securities held for investment purposes not bank deposits however this doesn t necessarily mean clients are unprotected for example wealthfront is insured by the securities investor protection corp sipc meaning that if the company goes bust investors will be reimbursed up to 500 000 of their invested balance 19 as you research robo advisors don t forget to check on the kind of insurance each has to protect your investment | |
how robo advisors get paid | the primary way that most robo advisors get paid is through a wrap fee based on assets under management aum while traditional human financial advisors typically charge 1 or more of aum per year many robo advisors charge around 0 3 of aum per year 910another revenue stream is payment for order flow pfof this payment typically fractions of a penny per share results from directing trade orders to a particular market maker pfof can potentially result in better execution prices for clients typically robo advisors bundle various trade orders together into large block orders executed just one or two times a day finally robo advisors can earn money by marketing targeted financial products and services to their customers such as mortgages credit cards or insurance policies this is often done through strategic partnerships rather than advertising networks if the costs of your robo advisor outweigh returns on your investments then you may be better off not using one the best in class robo advisorsthere are hundreds of robo advisors available in the u s and worldwide more of them launch every year they all provide some combination of investment management retirement planning and general financial advice here s a look at our list of the best robo advisors see how we picked them by reading our methodology | |
what does a robo advisor do | robo advisors provide financial planning services through automated algorithms with no human intervention they start by gathering information from a client through an online survey and then automatically invest for the client based on that data robo advisors often use passive index investing strategies can robo advisors make you money yes you can make money with a robo advisor as you can with any other financial advisor can you lose money with robo advisors yes as with any investment you can lose money with robo advisors if investments lose value or costs outpace portfolio returns | |
do robo advisors beat the market | most robo advisors won t beat the market that s because their investing involves a passive index strategy that seeks only to replicate the market s return typically robo advisor investing is based on modern portfolio theory which relates to constructing a portfolio that maximizes return within an acceptable level of risk the bottom linerobo advisors leverage advances in algorithmic trading and electronic markets to automate investment strategies for ordinary investors often based on modern portfolio theory robo advisors are able to optimize investors risk return tradeoffs and automatically manage and rebalance their portfolios automation also allows for tax loss harvesting and other strategies that were once too complex or expensive for ordinary investors with low fees and small minimum balances required to get started robo advisors may be a good choice for most long term investors and may be especially attractive to younger tech forward individuals | |
what is robotic process automation rpa | robotic process automation rpa occurs when basic tasks are automated through software or hardware systems that function across a variety of applications just as human workers do this can greatly reduce labor costs and increase efficiency by speeding things up and greatly minimizing human error the software or robot can be taught a workflow with multiple steps and applications such as taking received forms sending a receipt message checking the form for completeness filing the form in a folder and updating a spreadsheet with the name of the form the date filed and so on rpa software is designed to reduce the burden for employees of completing repetitive simple tasks understanding robotic process automationrobotic process automation rpa is designed to help primarily with office type functions that often require the ability to do several types of tasks in a specific order it creates and deploys a software robot with the ability to launch and operate other software in a sense the basic concept is similar to traditional manufacturing automation which focuses on taking one portion of a workflow or even just one task and creating a robot to specialize in doing it office work often requires the same sort of repetitive effort but since it is data being manipulated across platforms and applications a physical robot is not necessary while automation is often sought by companies to streamline processes and cut labor costs there have been some instances where automation has gone awry benefits of robotic process automation rpa the software used in process automation is programmed to do the tasks in a particular workflow by the employees with minimal assistance from human workers the software doesn t learn on its own or seek to tweak out new efficiencies or new insights like big data analysis or enterprise resource management erm software instead rpa works like a digital assistant for employees by clearing the onerous simple tasks that eat up part of every office worker s day as such rpa is a simpler product than an artificial intelligence driven system or enterprise software that seeks to bring all data inside the platform this also makes it a relatively cheaper product than ai or erm software this simplicity and relative cheapness can make rpa a more attractive solution for many companies particularly if the company has legacy systems robotic process automation is designed to be compatible with most legacy applications making it easier to implement compared to other enterprise automation solutions industry research suggests that the global rpa market will grow to nearly 600 billion in 2022 1 | |
where can rpa be applied | rpa is quite common in the financial services industry with increasing compliance and regulatory filing requirements the finance industry banks insurers and investment management companies has been an early adopter of rpa many onerous back office functions such as ensuring an up to date know your client kyc form is filed or a recent credit check is included on a loan application are ideal for rpa removing this burden from employees allows them to focus on high return tasks more importantly the software can clear these basic filing and data manipulation functions faster than humans reducing the overall processing time of course rpa is not just limited to finance any industry that deals in data and filing can benefit from robotic process automation when software can reduce costs and increase efficiency without requiring an onerous and complex implementation it will find eager users and useful applications in almost any sector indeed rpa has also been found useful in the following fields challenges for rparpa does however have its drawbacks these systems can be expensive to customize and deploy and may not be suitable for more complex tasks that require some degree of human judgment or creativity rpa systems when unchecked can also go awry one example is the case of so called robo signers used in the mortgage industry these systems rubber stamped foreclosure documents on homeowners automatically even when a foreclosure was questionable or avoidable moreover this practice failed to meet government regulations for oversight of the foreclosure process in the mid 2010s leading to a scandal following the housing market bubble of the 2008 09 financial crisis 2 following the public exposure of robo signers foreclosure documents had to be manually reexamined and the companies involved faced disciplinary action | |
what is the goal of robotic process automation rpa | rpa is meant to automate and streamline certain redundant clerical processes for an organization using software or related technologies this is meant to reduce costs while also increasing efficiency | |
does robotic process automation require coding | rpa systems are often tailor made to suit the specific needs of a particular organization or firm therefore rpa must be coded in accordance with the specifications and application of an individual company or process this can make development more time consuming and expensive than other types of automation that are more turnkey | |
is robotic process automation a good career | while rpa can reduce labor costs overall those developing rpa systems remain in high demand these include roles that range from software developers to product managers and business analysts | |
what are the two main types of robotic process automation | traditional rpa relies on hard coding routine tasks for automation this is still the most common form of rpa today more and more however machine learning and ai techniques are being merged with rpa to allow it to do more sophisticated tasks such as recognizing images text or speech or to analyze unstructured data sets | |
what does robust mean | in the world of investing robust is a characteristic describing a model s test s or system s ability to perform effectively while its variables or assumptions are altered a robust concept will operate without failure and produce positive results under a variety of conditions for statistics a test is robust if it still provides insight into a problem despite having its assumptions altered or violated in economics robustness is attributed to financial markets that continue to perform despite alterations in market conditions in general a system is robust if it can handle variability and remain effective understanding robustfinancial models are an integral part of running a corporation from the corporate executives of large multinational corporations to the franchise owner of the local burger restaurant decision makers need timely information presented to them in a model form that best reflects the activities of the business investors also use financial models to analyze and forecast the value of corporations to determine if they are viable prospective investments business financial modelsbusiness financial models focus mainly on the fundamentals of a corporation or business such as revenues costs profits and other financial ratios a model is considered to be robust if its output and forecasts are consistently accurate even if one or more of the input variables or assumptions are drastically changed due to unforeseen circumstances for example a specific cost variable may sharply increase due to a severe decrease in supply resulting from a natural disaster another commonly unforeseen circumstance is when war erupts between major countries many financial variables can be impacted due to war which causes models that are not robust to function erratically a robust model will continue to provide executives and managers with effective decision making tools and investors with accurate information on which to base their investment decisions robust trading modelswhile investors analyze a corporation s fundamental data in order to find securities that are priced below market value and are therefore perceived to be a good investment traders analyze a security s price data using technical analysis to forecast price movements that result from disparities in the security s supply and demand of the moment traders that use computerized trading systems to analyze and trade markets using technical analysis do so by developing testing and optimizing statistical models based on the application of technical indicators to the price data of a security this is typically done by looking at historical or past price data along with market indicators and identifying situations that have high probabilities of success in the future a trading model is considered robust if it is consistently profitable regardless of market direction very often a trading model will function well in a specific market condition or time period however when market conditions change or the model is applied to another time period or the future the model fails horribly and losses are realized this is usually a sign that a trading model is not robust | |
what is a rogue trader | a rogue trader is a trader who acts recklessly and independently of others usually to the detriment of the institution that employs the trader and perhaps clients rogue traders typically play with high risk investments that can produce huge losses or gains rogue traders though are only labeled as such if they lose which generates incentives that create moral hazard if their trades are enormously profitable no one calls them rogue and in fact they are more likely to receive a huge bonus but if they re risky bets lose they are rogue and can cost the firm millions or even billions of dollars in losses rogue traders explainedbanks over the years have developed sophisticated value at risk var models to control the trading of instruments which desks can trade them when they can trade them and how much in a given period in particular the limit of a trade is carefully set and monitored not only to protect the bank but also to satisfy regulators internal controls however are not 100 foolproof a determined trader can find a way to circumvent the system to try to reap outsized gains often they are caught in bad trades and then forced by regulators to be publicly exposed to the embarrassment of the bank one has to wonder how many small time rogue traders are quietly fired by a bank because the bank does not want the negative publicity that comes with news that internal trading controls were not properly developed or implemented examples of rogue tradersamong the most notorious rogue traders in recent years is nick leeson a former derivatives trader at the singapore office of britain s barings bank in 1995 leeson incurred heavy losses through the unauthorized trading of large amounts of nikkei futures and options leeson took large derivative positions on the nikkei that leveraged the amount of money at stake in the trades at one point leeson had 20 000 futures contracts worth more than 3 billion on the nikkei a large chunk of the losses came from the downturn in the nikkei after a major earthquake in japan caused a broad based sell off in the nikkei within a week the total loss to the 233 year old barings bank was well over 1 billion and eventually led to its bankruptcy leeson was charged with fraud and served several years in a singapore prison more recent examples include bruno iksil the london whale who racked up 6 2 billion in losses in 2012 at jp morgan and jerome kerviel who was partly or wholly responsible for more than 7 billion in losses at soci t g n rale in 2007 jp morgan ceo jaime dimon was slow to realize the magnitude of the london whale losses first calling the incident a tempest in a teapot later to his chagrin he had to admit the truth about his bank s rogue trader | |
what is a roll back | a roll back or roll backward refers to a derivatives trading strategy that replaces an existing position with a new one that has a nearer expiration date aside from the contract s expiration date other details are often not changed for instance a trader may roll back a september at the money call position to a june position with the same strike price traders use this strategy to cut out market risk and volatility in the short or long term option roll strategies sometimes called jelly rolls can take various forms including roll back roll forward roll up and roll down | |
how a roll back works | a roll back is one of many options trading strategies available to traders and one of many that is labeled as a roll a roll back may also be called a roll backward this strategy rolls from one options position to a new one with a more near term expiration date the roll back component of the transaction requires that the expiration month be closer than the previous position other aspects of the contract primarily the strike price can change or stay the same most roll backs occur as either all puts or all calls but a trader could potentially switch from one to the other in all types of roll backs the option owner sells their options contract in the open market to close the position then uses the proceeds to roll into the new shorter term position a roll back is used to increase the long or short gamma exposure in an options position where an option s gamma is its sensitivity in its delta to changes in the underlying price a trader would want to increase a long gamma position if they believe the underlying will be quite volatile in the near term while they would prefer to increase a short gamma position if they believe that the underlying price will remain constant and stable gamma is the rate of change between an option s delta and the underlying asset s price the option s delta is the rate of change between its price and a 1 change in the underlying asset s price traders use a roll back to take advantage of changing market conditions or to revise positions that they no longer see as profitable call positions rolled back with higher strike prices are also considered a roll up or a roll back and up 1 call positions rolled back with a lower strike price are considered a roll down or a roll back and down options with the same strike are just considered a roll back and focus only on the expiration date a put roll back will roll one put to another with a closer expiration the trader can use the proceeds from the sale to buy a new put contract with a selling strike price that is higher lower or the same as the previous position changing the strike price would also incorporate a roll up or roll down with a put roll back the investor believes there will be greater profit from the contract in the near term example of a roll backhere are a couple of examples to show how the roll back process works with both a call and a put remember a call gives a trader the right but not the obligation to purchase a security by a specific date at a specific price while a put gives the owner the right but not the obligation to sell the security by a specific date at a specific price let s say a trader has an october 50 call and wants to execute a roll back they do so by swapping it out for a september 50 call this trader may believe that the former october call is no longer worth owning and the september call is a better bet if the investor is bearish on the stock they may do a roll back and down with a september 45 here s how it works with a put let s say this trader purchases the september 50 contract and decides that they d be better off selling this contract for one with a closer expiration date they use the proceeds from the sale of the contract to purchase one at the same position for the month of august advantages and disadvantages of roll backsas mentioned above options contracts are a hedge against risk and volatility traders can take advantage of rolling back on their options contracts in order to reduce market risk which can put the investor s entire investment in jeopardy by cutting back on the risks roll backs also allow traders to cut down on losses and lock in their profits that s because this strategy gives them the option to agree on a fixed price for the underlying security with the other party to be purchased or sold by a specified date traders can also save on transaction costs trading options contracts including the execution of roll backs means the trader puts down a lower cost at the onset of the contract including commissions rather than purchasing the underlying security individually and commissions are generally lower as traders may have to pay one fee to swap out contracts options trading of any kind requires a lot of experience you need to have a good understanding of all the risks involved and the potential for losses that may come your way in short this kind of trading isn t for novice investors as such the firm you work with the one that handles your accounts will need to ensure you are experienced enough to execute these trades and strategies including roll backs speculation plays a big part in options trading traders use a variety of techniques to map out which direction their investments will head toward which means it s never an exact science you do risk boosting your losses as you try to chase profits if your strategy doesn t work out your brokerage or financial firm may want you to set up a margin account in order for you to trade options contracts and there may be a minimum balance requirement in order to set this up this can increase your costs as it can add interest charges account fees not to mention increasing how much you originally intended to invest in the first place reduces market risks and volatilitylimit losses and lock in profitssave on transaction costs and feesyou need to be experienced in order to take advantage of roll back strategiesspeculation can lead to more lossesyou may need to set up a margin account which could increase your costsother option roll strategiestraders have many strategies available to them when they want to exit or enter options contracts roll backs are one of those options these strategies involve exiting one contract and entering a new one in the same class while some details of the contract may or may not change one definite is that the expiration date in the new position is always earlier rolling strategies help option traders to lock in profits limit losses and reduce risk investors typically roll contracts because the contract they seek to close is far out of the money 2using the following roll strategies can help an investor to increase their profit potential and capitalize on market changes roll back faqscan you buy back an option you sold once you sell your option you generally can t buy it back but there is a way to eliminate your short position you can do this by buying a call option with similar details for the same underlying asset including the strike price and expiry date | |
does rolling options count as a day trade | a day trade is any trade whether that s buying or selling that takes place within a single day options may count as day trades but they tend to count as single trades because they are held in one contract | |
what does it mean to roll out of an option | rolling out of an option means that you close and open a position in an options contract at the same time roll backs happen when an investor exits a contract with a long term expiration date and takes a position in one with a shorter term date | |
what is a roll down return | roll down returns come from maximizing a bond s yield by exploiting the yield curve the yield curve is a chart that illustrates the relationship between the yields of bonds and their maturities the curve typically plots the yield on the vertical axis and the time to maturity on the horizontal axis in a roll down situation if you bought a bond that is now on the steeper part of the yield curve and you hold while its maturity shortens but market yields stay relatively stable the bond s price will likely increase as it rolls down the yield curve toward its par value this contributes to your total return over and above the interest income the bond generates 1the size of the roll down return varies greatly between long and short term dated bonds roll downs are smaller for long dated bonds trading away from par than short dated bonds understanding a roll down returna bond investor may calculate the return on a bond in several ways the yield to maturity ytm is the rate of return if the bond is held until it reaches its maturity date the current yield is the total of the coupon payments owed on the bond when purchased roll down returns are a third way to assess a bond s earnings the roll down return depends on the shape of the yield curve which is a visual representation of the yields for maturities ranging from one month to 30 years assuming the yield curve is normal its slope is upward to the right the rate earned on longer term bonds will be higher than that earned from short term bonds | |
how the roll down return works | the roll down return is a bond trading strategy for selling a bond as it approaches its maturity date as time passes a bond s yield falls and its price rises bond investors perceive greater risk in lending money for a longer period thus demanding higher interest payments as compensation so the initial higher interest rate of the long term bond will decline as its maturity approaches the direction of the roll down depends on whether the bond is trading at a premium or a discount to its face or par value generally as its maturity date grows a bond s interest rate moves closer to zero since there is an inverse relationship between bond yields and prices bond prices increase as interest rates decrease pros and cons of the roll down return strategyhere are some advantages and disadvantages of employing a roll down return strategy capital appreciationpredictabilityexploiting interest rate stabilitymanaging interest rate risksinterest rate riskyield curve dependencylimited upsideopportunity costoverall a roll down strategy can offer predictable and potentially attractive returns in the right yield curve environment however it has specific risks and limitations that investors need to consider carefully understanding the current and expected future state of the yield curve while assessing market conditions is crucial for the roll down return s success example of a roll down returnsuppose you want to employ the roll down return strategy in an upward sloping yield curve environment typically characterized by short term bonds having lower yields than long term bonds you buy a five year bond with a ytm of 3 when the yield for a similar one year bond is 1 you plan to hold the bond for two years before selling it over the next two years as the bond s remaining maturity comes closer its ytm is also closer to the yields found for shorter maturities which are lower in an upwardly sloping yield curve scenario after two years the bond s yield has decreased to mirror those of bonds with a three year maturity if the yield curve remains upward sloping and interest rates are stable the bond s price increases because new investors are willing to accept a lower yield for a bond closer to maturity you would then sell the bond at this higher price realizing capital gains on top of the coupon payments from the previous two years investors would use this strategy expecting the bond price to appreciate as it rolls down the yield curve toward maturity the rationale is that in a normal yield curve scenario the yield required by the market for short dated bonds is lower as the bond approaches maturity its yield is expected to decrease to align with the market yields of bonds with shorter maturities assuming that interest rates are stable this decrease in yield increases the bond s price providing investors with capital gains in addition to the regular coupon payments | |
when a bond is trading at a premium its market price is above its par or face value typically this happens when the bond s coupon rate is higher than similar bonds current market interest rates the outcomes for a roll down return strategy might differ from those for bonds at par or at a discount | suppose you buy a bond trading at a premium as the bond approaches maturity its ytm will gradually decrease toward the current market rates for shorter dated bonds assuming a stable or declining interest rate environment this decrease in ytm can still lead to price appreciation as the bond s remaining time to maturity shortens if its yield aligns with those of similar shorter maturity bonds in an upward sloping yield curve 2however for a premium bond another factor to consider is the amortization of the premium this refers to the gradual decrease in the bond s price premium as it moves toward its par value at maturity the bond s price will converge with its par value as maturity approaches with the premium being amortized throughout the bond s life this amortization effectively reduces the bond s total return as part of the premium paid upfront is not recouped directly but is offset by receiving higher coupon payments than the market average the roll down return for a bond trading at a premium includes potential capital gains because of the bond s price appreciation as it rolls down the yield curve and the effects of premium amortization the total return for the investor will be a combination of the coupon payments the capital gains or losses from selling the bond before maturity and the results of premium amortization | |
how do you calculate roll down return | the roll down return is the percentage change in the bond price over the period plus the coupon payments divided by the initial bond price the calculation assumes the yield curve remains constant there are no significant changes in the issuer s credit risk and yields evolve as anticipated 2 | |
are there any other yield curve strategies | there are bullet barbell and laddering strategies as well as spread trades such as the butterfly spread investors employ these yield curve strategies to optimize returns and manage risks based on their expectations of interest rate changes and the economy | |
how does duration impact a roll down return strategy | duration plays a significant role in the effectiveness of a roll down return strategy by impacting the sensitivity of a bond s price to changes in interest rates duration influences the bond s price sensitivity and thus the potential for capital gains investors should ensure their duration exposure aligns with their expectations for interest rates and risk tolerance | |
how does credit quality impact a roll down return strategy | credit quality plays a role but is not as significant as the duration in a roll down return strategy higher credit quality bonds offer stability and lower risk but generally lower yields also higher credit quality bonds like investment grade bonds are more influenced by interest rate risk than credit risk while lower credit quality bonds can enhance returns they introduce higher volatility and risk of loss and are more affected by credit risk than interest rate risk the bottom lineroll down returns are a concept in investing with fixed income securities concerning the potential capital appreciation of a bond as it approaches maturity within a given yield curve environment this strategy expects the bond to roll down the yield curve transitioning from its current position to one with shorter maturity in a typical upward sloping curve this movement decreases yield which inversely increases the bond s price this price appreciation combined with the bond s coupon payments contributes to its total return over the period before maturity the effectiveness of this strategy depends on the shape of the yield curve the interest rate changes or lack thereof and the duration of the bonds held | |
roll forward refers to extending the expiration or maturity of an option futures contract or forward by closing the initial contract and opening a new longer term contract for the same underlying asset at the then current market price a roll forward enables the trader to maintain the position beyond the initial expiration of the contract since options and futures contracts have finite expiration dates it is usually carried out shortly before the expiration of the initial contract and requires that the gain or loss on the original contract be settled | basics of roll forwarda roll forward includes two steps first the initial contract is exited then a new position with a later expiry is initiated these two steps are usually executed simultaneously in order to reduce slippage or profit erosion due to a change in the price of the underlying asset the roll forward procedure or switch varies for different financial instruments optionsa roll forward can be done using the same strike price for the new contract as the old one or a new strike can be set if the new contract has a higher strike price than the initial contract the strategy is called a roll up but if the new contract has a lower strike price it is called a roll down these strategies may be used to protect profits or hedge against losses for example consider a trader who has a call option expiring in june with a 10 strike price on widget company the stock is trading at 12 as the call option nears expiration if the trader remains bullish on widget company they can choose to maintain their investment stance and protect profits by either selling the june call option or by simultaneously buying a call option expiring in september with a strike price of 12 this roll up to a higher strike price will reduce the premium paid for the second option compared to buying a new 10 strike call thereby protecting part of the profits from the first trade forwardsforward foreign exchange contracts are usually rolled forward when the maturity date becomes the spot date for example if an investor has bought euros versus the u s dollar at 1 0500 for value on june 30 the contract would be rolled on june 28 by entering into a swap if the spot rate in the market is 1 1050 the investor would sell the same number of euros at that rate and receive the profit in dollars on june 30 the euros would net to zero with no movement of funds the investor would simultaneously enter into a new forward contract to buy the same amount of euros for the new forward value date the rate would be the same 1 1050 spot rate plus or minus the forward points to the new value date futuresa futures position must be closed out either before the first notice day in the case of physically delivered contracts or before the last trading day in the case of cash settled contracts the contract is usually closed for cash and the investor simultaneously enters into the same futures contract trade with a later expiry date for example if a trader is long a crude oil future at 110 with a june expiry they would close this trade before it expires and then enter into a new crude oil contract at the current market rate that expires at a later date investopedia does not provide tax investment or financial services and advice the information is presented without consideration of the investment objectives risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors investing involves risk including the possible loss of principal | |
what is roll yield | roll yield is the amount of return generated in the futures market after an investor rolls a short term contract into a longer term contract and profits from the convergence of the futures price toward a higher spot or cash price roll yield is positive when a futures market is in backwardation which occurs when a futures contract trades at a higher price as it approaches expiration compared to when the contract is further away from expiration understanding roll yieldroll yield is a profit that can be generated when investing in the futures market due to the price difference between futures contracts with different expiration dates when investors purchase futures they have both the right and the obligation to buy the asset underlying the futures investment at a specified date in the future unless they sell their position to offset the long futures position ahead of the delivery date most futures investors do not want to take delivery of the physical asset that the futures investment represents so they close the position before expiration or roll their near term expiring futures investments into other futures contracts with expiration dates further in the future rolling the position allows the investor to maintain their investments in the assets without having to take physical delivery the number of futures contracts traded worldwide in 2022 1backwardation vs contango | |
when the market is in backwardation the future price of an asset is below the expected cash or spot price in this case an investor profits when the position is rolled to the contract with a later expiration date because the investor is effectively paying less money than expected by the spot market for the underlying asset that the futures investment represents | for example imagine that an investor holds 100 crude oil contracts and wants to buy 100 again for expiration at a later date if the contract s future price is below the spot price the investor is actually rolling into the same quantity of an asset for a lower price negative roll yield occurs when a market is in contango which is the opposite of backwardation when a market is in contango the future price of the asset is above the expected future spot price and so the investor will lose money when rolling contracts returning to the example of an investor with 100 oil contracts if the investor wants to roll into 100 oil contracts with a later expiration date as the contract nears expiration the investor will pay more money for the oil contracts compared to the spot market they would therefore have to pay more money to maintain the same number of contracts negative roll yields have sometimes led to significant losses by hedge funds and exchange traded funds that hold futures | |
what does it mean to roll a futures contract | rolling is the practice of renewing a futures contract beyond its original expiration date allowing the contract holder to benefit from anticipated changes in the market price in order to roll a contract traders must first settle the gain or loss of the original contract | |
how do you calculate roll yield for futures contracts | roll yield is essentially the opportunity to gain profits by buying long term futures contracts and selling short term ones it is calculated based on the difference in price between two futures contracts and the spot price of the underlying commodity it is calculated by the formula total change in futures prices total change in spot price roll yield | |
how much does it cost to roll futures | futures traders can roll their contracts by selling their near term contracts and buying new contracts with later expiration dates the cost is equal to the difference between the two contract prices plus trading and commission fees the bottom lineroll yield represents the potential profits from extending a futures contract to a later expiration date to take advantage of anticipated changes in the underlying commodity roll yield is positive when the future price is expected to increase and negative when the market expects future price to decrease | |
what are rolling returns | rolling returns also known as rolling period returns or rolling time periods are annualized average returns for a period ending with the listed year rolling returns are useful for examining the behavior of returns for holding periods similar to those actually experienced by investors looking at a portfolio or fund s rolling returns will give performance results that are smoothed over several periods throughout its history such information often paints a more accurate picture for an investor than a single snapshot of one period understanding rolling returnsone goal of rolling returns is to highlight the frequency and magnitude of an investment s stronger and poorer periods of performance rolling returns can offer better insight into a fund s more comprehensive return history not skewed by the most recent data month or quarter end for example the five year rolling return for 2015 covers jan 1 2011 through dec 31 2015 the five year rolling return for 2016 is the average annual return for 2012 through 2016 some investment analysts will break down a multi year period into a series of rolling 12 month periods by looking at rolling returns investors are able to understand how a fund s returns stacked up at a more particular point in time if an investment displays a 9 annualized return over a 10 year period this shows that if you invested on jan 1 in year 0 and sold your investment on dec 31 at the conclusion of year 10 you earned the equivalent of 9 a year yet during those 10 years returns could have varied drastically in year 4 the investment could have moved up 35 while in year 8 it could have dropped 17 averaged out you earned 9 per year the average annualized return yet this 9 might misrepresent the investment s performance analyzing rolling returns instead could demonstrate annual performance not simply starting jan 1 and ending dec 31 but also beginning feb 1 and ending jan 31 of the next year then march 1 through feb 28 of the next year and so on a 10 year rolling return could highlight an investment s best and worst decades in this form in the context of equity research and valuation financial results for publicly traded companies are only released on a quarterly basis in securities filings in accordance with generally accepted accounting principles gaap less frequently firms provide monthly statements with sales volumes or key performance indicators trailing 12 months ttm rolling returnsa common rolling return period is trailing 12 months ttm trailing 12 months is the term for the data from the past 12 consecutive months used for reporting financial figures a company s trailing 12 months represents its financial performance for a 12 month period it does not typically represent a fiscal year ending period using trailing 12 month ttm returns is an effective way to analyze the most recent financial data in an annualized format annualized data is important because it helps neutralize the effects of seasonality and dilutes the impact of non recurring abnormalities in financial results such as temporary changes in demand expenses or cash flow by using ttm analysts can evaluate the most recent monthly or quarterly data rather than looking at older information that contains full fiscal or calendar year information ttm charts are less useful for identifying short term changes and more useful for forecasting companies conducting internal corporate financial planning and analysis have access to detailed and very recent financial data they use the ttm format to evaluate key performance indicators kpi revenue growth margins working capital management and other metrics that may vary seasonally or show temporary volatility in the context of equity research and valuation financial results for publicly traded companies are only released on a quarterly basis in securities filings in accordance with gaap less frequently firms provide monthly statements with sales volumes or key performance indicators securities and exchange commission sec filings generally display financial results on a quarterly or year to date basis rather than ttm to get a clear picture of the last year of performance analysts and investors often must calculate their own ttm figures from current and prior financial statements consider recent financial results from general electric ge in q1 2020 ge generated 20 5 billion in revenue versus 27 billion in q1 2019 1 2 ge logged 95 billion of sales for the full year of 2019 3 by subtracting the q1 2019 figure from the full year 2019 figure and adding q1 2020 revenues you arrive at 88 5 billion in ttm revenue | |
what is a rollover | a rollover may entail a number of actions most popularly the transfer of the holdings of one retirement plan to another without creating a taxable event a rollover may also entail reinvesting funds from a mature security into a new issue of the same or similar security or moving a forex fx position to the following delivery date in which case the rollover incurs a charge in the context of retirement assets the distribution from a retirement plan is reported on irs form 1099 r and may be limited to one per annum for each individual retirement account ira the forex rollover fee arising from the difference in interest rates between the two currencies underlying a transaction is paid to the broker understanding a rolloverrollovers often occur as a way of making money for a specific purpose such as immediate income from day trading or for saving on taxes as with retirement plans a rollover ira or ira rollover is a transfer of funds from a retirement account into a traditional ira or a roth ira as shown by the following examples the benefits of rollovers vary among different types of investments rollover in retirement accountswith a direct rollover the retirement plan administrator may pay the plan s proceeds directly to another plan or to an ira the distribution may be issued as a check made payable to the new account when receiving a distribution from an ira through a trustee to trustee transfer the institution holding the ira may distribute the funds from the ira to the other ira or a retirement plan in the case of a 60 day rollover funds from a retirement plan or ira are paid directly to the investor who deposits some or all of the funds in another retirement plan or ira within 60 days taxes are typically not paid when performing a direct rollover or trustee to trustee transfer however distributions from a 60 day rollover and funds not rolled over are typically taxable another type of retirement account rollover has emerged as a financing alternative for those who are starting a business when executed properly a rollover for business startups robs allows entrepreneurs to invest their retirement savings into a new business venture without incurring taxes early withdrawal penalties or loan costs however a robs transaction can be complicated to execute so it s important to work with a competent provider rollover in forex positionslong term forex day traders can make money in the market by trading from the positive side of the rollover equation traders begin by computing swap points which is the difference between the forward rate and the spot rate of a specific currency pair as expressed in pips traders base their calculations on interest rate parity which implies that investing in varying currencies should result in hedged returns that are equal regardless of the currencies interest rates traders compute the swap points for a certain delivery date by considering the net benefit or cost of lending one currency and borrowing another against it during the time between the spot value date and the forward delivery date the trader thus makes money when he is on the positive side of the interest rollover payment | |
what is rollover risk | rollover risk is a risk associated with the refinancing of debt rollover risk is commonly faced by countries and companies when a loan or other debt obligation like a bond is about to mature and needs to be converted or rolled over into new debt if interest rates have risen in the meantime they would have to refinance their debt at a higher rate and incur more interest charges in the future or in case of a bond issue pay out more in interest it is similar to reinvestment risk rollover risk may also refer to the risk of losing money when rolling derivatives positions | |
how rollover risk works | also known as roll risk rollover risk is sometimes used interchangeably with refinancing risk however it s actually more of a sub category of that refinancing risk is a more general term referring to the possibility of a borrower being unable to replace an existing loan with a new one rollover risk deals more specifically with the adverse effect of rolling over or refinancing debt this effect has more to do with prevailing economic conditions specifically interest rate trends and the liquidity of credit than the financial condition of the borrower for example if the u s had 1 trillion dollars of debt it needed to roll over in the next year and interest rates suddenly rose 2 higher before the new debt was issued it would cost the government a lot more in new interest payments special considerationsthe state of the economy is also significant lenders are often unwilling to renew expiring loans during a financial crisis when collateral values drop especially if they are short term loans that is their remaining maturity is less than one year so along with the economy the nature of the debt can matter according to a 2012 article rollover risk and credit risk published in the journal of finance 1derivatives roll riskrollover risk also exists in derivatives where futures or options contracts must be rolled over to later maturities as near term contracts expire in order to preserve one s market position if this process will incur a cost or lose money it poses a risk in particular it refers to the possibility that a hedge position will expire at a loss necessitating a cash payment when the expiring hedge is replaced with a new one in other words if a trader wants to hold a futures contract until its maturity and then replace it with a new similar contract they run the risk of the new contract costing more than the old paying a premium to extend the position example of rollover riskat the beginning of october 2018 the world bank issued concerns about two asian nations rollover risks are potentially acute for indonesia and thailand given their sizable stocks of short term debt around 50 billion and 63 billion respectively it stated 2the world bank s concerns had reflected the fact that central banks around the world had been tightening credit and raising interest rates following the lead of the u s federal reserve which had increased the federal funds rate steadily between 2015 and december 2018 from near 0 to 2 25 resulting in billions in u s and foreign investments being pulled from both countries 3however between 2008 and 2021 interest rates fell as the fed cut the federal funds rate to a range of 0 0 to 0 25 4 the move was made to support the economy amid the 2020 economic crisis following the global covid 19 pandemic 5 however 2022 saw increased inflation and the fed was forced to raise interest rates this can result in renewed rollover risk | |
how can rollover risk be minimized | interest rate changes are out of our individual control so it is difficult to minimalize rollover risk institutional traders can use interest rate derivatives to hedge this type of exposure but this is largely unavailable to ordinary individuals | |
when is it best to refinance a mortgage | if you have a mortgage with no prepayment penalties it can make sense to refinance when interest rates fall lowering your monthly payments and reducing the overall amount of interest paid on the loan because refis are new loans they often come with fees and closing costs therefore the interest rate has to be sufficiently lower enough to also cover these costs | |
what is roll risk in derivatives trading | in derivatives trading contracts expire on regular schedules and so positions must be rolled over to longer dated contracts in order to maintain them roll risk in this context is the risk of losses resulting from this type of transaction | |
what is a roth 401 k | a roth 401 k is an employer sponsored retirement savings account that is funded using after tax dollars this means that income tax is paid immediately on the earnings that the employee deducts from each paycheck and deposits into the account as long as certain conditions are met that is you must be at least 59 and you must have had the account for at least five years withdrawals from the account are tax free upon retirement this type of plan is different from a traditional 401 k plan which is funded with pretax money in this case payroll deductions come out of the employee s gross income and taxes are due when the money is withdrawn from the account 1investopedia matthew collins | |
how roth 401 k s work | investors have many options when it comes to saving for retirement one of the most common ways to put money aside is through employer sponsored plans like the 401 k participation is voluntary and those who take part agree to automatic payroll deductions that are transferred into a special retirement account some employers even match employee contributions up to a certain amount 1there are several varieties of 401 k s the roth 401 k option became available at the beginning of 2006 while the traditional 401 k has been around since 1978 both were authorized by congress as tax advantaged retirement plans to encourage employees to save for their retirement 234their tax advantages are different 5the number of plan sponsors that offer a roth 401 k option as surveyed by the transamerica institute at the end of 2022 6roth 401 k contribution limitsa roth 401 k is subject to contribution limits based on the individual s age these limits are adjusted annually for inflation and released by the internal revenue service irs the contribution limit for individuals is 23 000 in 2024 individuals 50 and older can contribute an additional 7 500 as a catch up contribution in 2023 the contribution limit was 22 500 and the catch up contribution was 7 500 unlike other plans there is no income limit to participate 75note that you cannot contribute more than your taxable income for the year roth 401 k withdrawal ruleswithdrawals of any contributions and earnings are not taxed as long as the withdrawal is a qualified distribution which means certain criteria must be met this means that 8the irs has updated the rules for required minimum distribution rmd s for 2024 keep in mind that individuals can withdraw more than the rmd but there is a penalty if you miss an rmd or if your withdrawal is less than outlined during a calendar year previously 50 of the value of the missed withdrawal this penalty is now 25 of the missed withdrawal s value you can reduce the amount of the penalty to 10 if you fix the mistake before the date that the penalty is imposed which is known as the correction window 9advantages and disadvantages of roth 401 k sa roth 401 k may have the greatest benefit for employees currently in a low tax bracket who expect to move into a higher one after they retire contributions made to a roth 401 k are taxed at the lower tax rate distributions are tax free in retirement making them the greatest single advantage no matter how much the account grows over the years that money is still exempt from income taxes after the account holder retires the downside is a little more immediate financial pain because contributions to a traditional 401 k are not taxed immediately but effectively reduce the amount of your gross income the impact on your take home pay is reduced and your tax break for the year is maximized but there s no such deal with a roth 401 k this means that you are out of pocket for and taxed on the deposits you make in the year you make them 10helps people who believe they ll be in a higher tax bracket later in lifedistributions are tax free during retirementearnings grow tax freecontributions are made using after tax dollarscontributions don t reduce your taxable incomeroth 401 k s vs other retirement accountsa roth 401 k is an employer sponsored plan that helps people prepare for retirement but it s not the only option available to investors like its roth equivalent the traditional 401 k is an employer sponsored plan this means you can t set one up on your own money is taken out of your paycheck through automatic deductions and transferred into a special account the money is then invested in a series of mutual funds that you choose the irs sets limits on how much you can contribute to the plan each year this figure is adjusted annually for inflation 7employers can also contribute to their employees plans so long as the total contribution does not exceed the employee s annual salary the 2023 limit for employer and employee contributions together is capped at 69 000 in 2024 or 76 500 including the catch up contribution for 2023 those limits were 66 000 and 73 500 respectively 11this plan is a defined contribution plan which means your contributions determine the account balance and how well your account performs contributions are made using pretax dollars reducing the income tax you pay withdrawals made during retirement are subject to income tax 12if you don t have the option to invest in an employer sponsored plan you may want to consider an individual retirement account ira this kind of account can be set up by anyone through a financial institution or investment firm which means anyone who has earned income is entitled to one unlike a roth 401 k a roth ira is not subject to required minimum distributions you can invest in a variety of investments under an ira including stocks bonds exchange traded funds etfs mutual funds and real estate investment trusts reits just like the 401 k there are several types of ira options available 13you can also choose a simplified employee pension sep ira or a savings incentive match plan for employees simple ira if you re self employed or work for a small business these plans are just like the 401 k but are sponsored by employers for individuals who work in schools and other tax exempt organizations this includes teachers professors clergy people government employees and librarians 403 b s come with regular payroll deductions and potentially additional contributions by the employer 15these plans have the same contribution limits as 401 k plans you can contribute a maximum of 22 500 in 2023 and 23 000 in 2024 people over 50 can make an additional contribution of 7 500 in 2023 and in 2024 7 | |
how do roth 401 k plans work | roth 401 k plans are only available through an employer which means you can t set one up yourself contributions are made using after tax dollars through payroll deductions the contributions grow tax free in your account withdrawals are also tax free as long as you ve held the account for at least five years and you re at least 59 16117 | |
is a roth 401 k better than a traditional 401 k | your personal circumstances can help answer that question for many people the roth 401 k is a better deal because you only pay income taxes on your contributions this allows your earnings to grow tax free and make withdrawals without paying income taxes however if you re cash strapped now keep in mind that this option will be a heavier hit to your current annual income than a traditional 401 k contributions to a traditional 401 k are tax free but you must pay taxes on your withdrawals so if you expect to be in a lower tax bracket after retiring the immediate tax break of a traditional 401 k will likely be more useful 1 however it s difficult to predict what income tax rates will be in the future | |
what are the criteria for roth 401 k withdrawals | a withdrawal is only considered a qualified distribution as long as you ve held the account for at least five years and you re 59 unless you are disabled or the account holder dies 517can you lose money in a roth 401 k you can lose money in any investment if the market tanks that said most plans offer several funds including very low risk options like government bond funds you can mix and match choices to reach the level of risk you are comfortable taking you can also lose money in a roth 401 k if you break the rules and take early distributions if you re considering taking some money out early check with the fund administrator to find out whether you might owe a tax penalty 5the bottom lineroth 401 k plans allow a company s employees to start investing for retirement both the traditional 401 k and the roth version may offer an employer match however there is a big difference between the two whereas a traditional 401 k is funded using after tax dollars translating to a tax break up front a roth is funded using after tax dollars meaning that there are no income taxes when you take distributions during retirement 10 | |
what is a roth ira | a roth ira is a type of tax advantaged individual retirement account to which you can contribute after tax dollars toward your retirement the primary benefit of a roth ira is that your contributions and the earnings on those contributions can grow tax free and be withdrawn tax free after age 59 assuming the account has been open for at least five years in other words you pay taxes on money going into your roth ira and then all future withdrawals are tax free roth iras are similar to traditional iras with the biggest distinction being how the two are taxed roth iras are funded with after tax dollars unlike a traditional ira the contributions are not tax deductible but once you start withdrawing funds the money you take out is tax free tara anand investopediasubscribe to term of the day and learn a new financial term every day stay informed and make smart financial decisions sign up now | |
how does a roth ira work | you can put money you ve already paid taxes on into a roth ira it will then grow and when you come to withdraw once you retire you won t have to pay any further taxes a roth ira can be funded from a number of sources all regular roth ira contributions must be made in cash which includes checks and money orders they can t be in the form of securities or property 2 the internal revenue service irs limits how much can be deposited annually in any type of ira adjusting the amounts periodically the contribution limits are the same for traditional and roth iras these limits apply across all your iras so even if you have multiple accounts you can t contribute more than the maximum 3similar to other qualified retirement plan accounts the money invested within the roth ira grows tax free however a roth ira is less restrictive than other accounts the account holder can maintain the roth ira indefinitely there are no required minimum distributions rmds during their lifetime as there are with 401 k s and traditional iras 4conversely traditional ira deposits are generally made with pretax dollars you usually get a tax deduction on your contribution and pay income tax when you withdraw the money from the account during retirement 5allowable investments in a roth iraonce the funds are contributed a variety of investment options exist within a roth ira including mutual funds stocks bonds exchange traded funds etfs certificates of deposit cds and money market funds note that irs rules don t allow the contribution of cryptocurrency directly to your roth ira 6 however the recent emergence of bitcoin iras has created retirement accounts designed to let you invest in cryptocurrencies indirectly the irs also lists other assets that are not permitted within an ira such as life insurance contracts and derivative trades 7if you want the broadest range of investment options you need to open a roth self directed ira sdira a special category of roth ira in which the investor not the financial institution manages their investments these unlock a universe of possible investments including directly investing in digital assets in addition to the standard investments stocks bonds cash money market funds and mutual funds you can hold assets that aren t typically part of a retirement portfolio some of these include gold investment real estate partnerships and tax liens even a franchise business 6the maximum annual contribution that an individual can make to a roth ira in 2024 people ages 50 and older can contribute up to 8 000 the maximum is up from 6 500 in 2023 those 50 and older can contribute up to 7 500 8opening a roth iraa roth ira must be established with an institution that has received irs approval to offer iras these include banks brokerage companies federally insured credit unions and savings and loan associations generally individuals open iras with brokers 9a roth ira can be established anytime however contributions for a tax year must be made by the ira owner s tax filing deadline which is normally april 15 of the following year 1011two basic documents must be provided to the ira owner when an ira is established these provide an explanation of the rules and regulations under which the roth ira must operate and they establish an agreement between the ira owner and the ira custodian trustee 12not all financial institutions are created equal some ira providers have an expansive list of investment options while others are more restrictive almost every institution has a different fee structure for your roth ira which can have a significant impact on your investment returns your risk tolerance and investment preferences will play a role in choosing a roth ira provider if you plan on being an active investor and making lots of trades you want to find a provider that has lower trading costs 13 certain providers even charge you an account inactivity fee if you leave your investments alone for too long some providers have more diverse stock or etf offerings than others it all depends on what type of investments you want in your account pay attention to the specific account requirements as well some providers have higher minimum account balances than others if you plan on banking with the same institution see if your roth ira account comes with additional banking products if you re looking at opening a roth ira at a bank or brokerage where you already have an account see whether existing customers receive any ira fee discounts most ira providers offer only regular ira traditional or roth accounts for a self directed ira you ll need a qualified ira custodian that specializes in that type of account which allows assets beyond the typical stocks bonds etfs and mutual funds 6 | |
are roth iras insured | if your account is located at a bank be aware that iras fall under a different insurance category from conventional deposit accounts therefore coverage for ira accounts is not as robust the federal deposit insurance corp fdic still offers insurance protection up to 250 000 for traditional or roth ira accounts but account balances are combined rather than viewed individually 14for example if the same banking customer has a cd held within a traditional ira with a value of 200 000 and a roth ira held in a savings account with a value of 100 000 at the same institution then the account holder has 50 000 of vulnerable assets without fdic coverage | |
what can you contribute to a roth ira | the irs dictates not only how much money you can deposit in a roth ira but also the type of money that you can deposit basically you can only contribute earned income to a roth ira 2for individuals working for an employer compensation that is eligible to fund a roth ira includes wages salaries commissions bonuses and other amounts paid to the individual for the services that they perform it s generally any amount shown in box 1 of the individual s form w 2 for a self employed individual or a partner or member of a pass through business compensation is the individual s net earnings from their business less any deduction allowed for contributions made to retirement plans on the individual s behalf and further reduced by 50 of the individual s self employment taxes 1516money related to divorce alimony child support or in a settlement can also be contributed if it is related to taxable alimony received from a divorce settlement executed prior to dec 31 2018 16so what sort of funds aren t eligible the list includes you can never contribute more to your ira than your earned income in that tax year 8 and as previously mentioned you receive no tax deduction for the contribution although you may be able to take a saver s tax credit of 10 20 or 50 of the deposit depending on your income and life situation 18who s eligible for a roth ira anyone who has earned income can contribute to a roth ira as long as they meet certain requirements concerning filing status and modified adjusted gross income magi 2 those whose annual income is above a certain amount which the irs adjusts periodically become ineligible to contribute the chart below shows the figures for 2023 and 2024 8here s how the system works an individual who earns less than the ranges shown for their appropriate category can contribute up to 100 of their compensation or the contribution limit whichever is less 2individuals within the phaseout range must subtract their income from the maximum level and then divide that by the phaseout range to determine the percentage that they are allowed to contribute 19the spousal roth iraone way that a couple can boost their contributions is the spousal roth ira an individual may fund a roth ira on behalf of their married partner who earns little or no income spousal roth ira contributions are subject to the same rules and limits as regular roth ira contributions the spousal roth ira is held separately from the roth ira of the individual making the contribution as roth iras cannot be joint accounts for an individual to be eligible to make a spousal roth ira contribution the following requirements must be met withdrawals qualified distributionsat any time during the tax year you may withdraw contributions from your roth ira both tax and penalty free if you take out only an amount equal to the sum that you ve put in then the distribution is not considered taxable income and is not subject to penalty regardless of your age or how long it has been in the account 21however there s a catch when it comes to withdrawing account earnings any returns that the account has generated for distribution of account earnings to be considered a qualified distribution it must occur at least five years after the roth ira owner established and funded their first roth ira and the distribution must occur under at least one of the following conditions the five year rulewithdrawal of earnings may be subject to taxes and or a 10 penalty depending on your age and whether you ve met the five year rule here s a quick rundown if you meet the five year rule if you don t meet the five year rule roth ira withdrawals are made on a first in first out fifo basis so any withdrawals made come from contributions first therefore no earnings are considered touched until all contributions have been taken out 24withdrawals non qualified distributionsa withdrawal of earnings that do not meet the above requirements is considered a non qualified distribution and may be subject to income tax or a 10 early distribution penalty 24 there may be exceptions however if the funds are used note that if you withdraw only the amount of your contributions made within the current tax year including any earnings on those contributions then the contribution is reversed for example if you contribute 5 000 in the current year and those funds generate 500 in earnings you can withdraw the 5 000 principal tax and penalty free and the 500 gain will be treated as taxable income 21a special provision in the coronavirus aid relief and economic security cares act allowed taxpayers to take a coronavirus related distribution from jan 1 2020 to dec 31 2020 up to an aggregate 100 000 from all qualified plans and iras the coronavirus related distribution could be taken by a qualified individual defined by the irs as someone who was negatively affected by coronavirus either financially or through a family diagnosis retirement plan owners who qualified for coronavirus related distributions included those the special provision allowed the retirement account holder to take the distribution as a standard withdrawal with no repayment or as a loan with a repayment option the distribution was exempt from the 10 early distribution penalty but was taxed as ordinary income the cares act allowed the withdrawal to be taxed as ordinary income in full in 2020 or over a three year period in 2020 2021 and 2022 those who took advantage of this provision had until the end of the third year to pay back the funds 26for example let s assume that you withdrew 15 000 in 2020 you would need to claim 5 000 on your tax returns in 2020 and 2021 if you repaid the funds in full in 2022 then you would not have needed to pay taxes on the final 5 000 additionally you will need to file an amended return for 2020 and 2021 to recoup your taxes previously paid on the first two thirds roth ira vs traditional irawhether a roth ira is more beneficial than a traditional ira depends on the tax bracket of the filer the expected tax rate at retirement and personal preference individuals who expect to be in a higher tax bracket once they retire may find the roth ira more advantageous since the total tax avoided in retirement will be greater than the income tax paid in the present therefore younger and lower income workers may benefit the most from a roth ira 27indeed by beginning to save with an ira early in life investors make the most of the snowballing effect of compound interest your investment and its earnings are reinvested and generate more earnings which are reinvested and so on of course even if you expect to have a lower tax rate in retirement you ll still enjoy a tax free income stream from your roth ira that s not the worst idea in the world those who don t need their roth ira assets in retirement can leave the money to accrue indefinitely and pass the assets to heirs tax free upon death even better while the beneficiary must take distributions from an inherited ira they can stretch out tax deferral by taking distributions for a decade and in some specialized cases for their lifetimes traditional ira beneficiaries on the other hand do pay taxes on the distributions also a spouse can roll over an inherited ira into a new account and not have to begin taking distributions until age 73 4some open or convert to roth iras because they fear an increase in taxes in the future and this account allows them to lock in the current tax rates on the balance of their conversions executives and other highly compensated employees who are able to contribute to a roth retirement plan through their employers for example via a roth 401 k can also roll these plans into roth iras with no tax consequence and then escape having to take mandatory minimum distributions when they turn 73 | |
is it better to invest in a roth ira or a 401 k | there are many variables to consider when choosing a roth ira or a 401 k retirement account each type of account provides an opportunity for savings to grow tax free roth iras do not provide tax advantages when you make a deposit but you can withdraw tax free during retirement the reverse is true for 401 k s these types of accounts involve contributing a portion of your paycheck to a 401 k prior to income tax deductions in terms of contribution limits roth iras are typically lower than 401 k s additionally 401 k s allow employers to make matching contributions on the flip side 401k s often have higher fees minimum distributions and fewer investment options 2829 | |
how much can i put in my roth ira monthly | in 2023 the maximum annual contribution amount for a roth ira is 6 500 or 541 67 monthly for those under age 50 this amount increases to 7 500 annually or roughly 625 monthly for individuals age 50 or older note there is no monthly limit only the annual limit the limits increase for 2024 to 7 000 annually or 583 33 monthly for those 50 and older the limit is 8 000 annually or 666 67 monthly 38 | |
what are the advantages of a roth ira | while roth iras do not include an employer match they do allow for a greater diversity of investment options 6 for individuals who anticipate that they will be in a higher tax bracket when they re older roth iras also can be a beneficial option and you can withdraw your contributions but not earnings at any time tax and penalty free 21 ultimately you can manage how you want to invest your roth ira by setting up an account with a brokerage bank or qualified financial institution 9 |
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