Reviewed by Samantha Silberstein

Foreign exchange (FX) traders are always looking for trends and economic outlooks that may help them to predict the potential movement of currencies.

Some examine economic reports, the gross domestic product (GDP), trade relations, and more. Some watch the equity markets.

Equity markets involve thousands of firms around the world that produce hundreds of reports every day.

That’s why equities may be a useful source of insight for currency traders who want to understand where the FX market is going.

Key Takeaways

• Currencies fluctuate relative to one another based on supply and demand; when investors demand more of a currency, it strengthens relative to other currencies.
• When there is an excess supply of a currency, it weakens relative to other currencies.
• Focusing on certain equity stocks can provide insight into the foreign exchange market because such companies are large, deal on a global scale, and transact in various currencies.
• The hedging strategies used by companies are an indicator of their outlook on future currency fluctuations.
• Equities alone are not a prudent way to predict the direction of currencies; government balance sheets, monetary policy, and interest rates play a major role in forex markets.

Supply and Demand Move Currencies

Ultimately, a currency fluctuates based on supply and demand characteristics. When more investors demand a currency, it will likely strengthen relative to other currencies. When there is less demand and excess supply, the opposite is true.

Supply and demand, however, are influenced by many factors that lead to constant currency fluctuations. Equities are one of these factors.

Global Companies Can Influence FX

The foreign exchange markets are a global market and bigger than any other securities market. So when thinking about equities and their influence on forex markets, you have to think globally.

The best companies to study are those with international operations and that conduct transactions in various currencies. For example, as the biggest retailer on the planet, Walmart deals with foreign exchange issues all the time. Another great name is Coca-Cola.

These global consumer companies transact with buyers all over the world and thus can impact the forex market.

A useful observation that can relate to forex may be about a global company’s products and how necessary they are to consumers.

Things like food, gasoline, and medicine could be more useful, and in demand, than haute couture clothing or jewelry.

Consequently, a company like Kraft, which sells food all over the world, would be more useful to study for an impact on the forex market than Tiffany’s, the iconic jewelry store retailer.

Strong Stock Markets, Greater Capital Inflow

In addition, when companies, global or not, have successful financial results, the stock market reflects this. That can affect investor interest, which in turn may influence a demand for currency.

Furthermore, a strong stock market usually reflects a strong economy. That can attract investors and foreign capital, and, again, impact the domestic currency relative to others.

Weak Currencies Boost Exports

Equities can also influence forex markets in another way. A country’s weak currency favors its exporters because exports are cheaper for buyers abroad. That helps fuel the growth, profits, and earnings of those exporters. When earnings grow, equity markets tend to do well, and attract interest that can affect forex.

Such a situation is most likely to occur in equity markets backed by the major global currencies such as the U.S. dollar, the yen, the euro, and the British pound, among others.

Emerging Markets

Where global companies invest is often a leading sign that those companies see strong economic growth. Where there is strong economic growth, there is usually greater demand for the currency.

More importantly, a strong economy often suggests a solid government balance sheet that helps support currency prices.

The best growth opportunities are considered by many to be in emerging and developing markets. As a result, nearly all global companies have focused significant growth efforts in those parts of the world.

Commodities

The commodities market can also shed light on the performance of forex. Consider the main global commodity, crude oil. Global oil prices are denominated in U.S. dollars.

The price of oil can spike when the value of the U.S. dollar declines relative to major global currencies. So the oil price has to go up in order to equalize the price that other foreign countries pay in their home currencies.

While other global commodities—sugar, corn, and wheat—offer similar insights, oil is the most significant commodity relating to the foreign exchange markets.

Note

The U.S. dollar has benefited when crude oil’s price declines. Even when the price of oil shot up after Russia’s invasion of Ukraine, the USD strengthened against many global currencies because of the demand for USD in troubled times and increasing inflation.

Financial Statements Can Reveal FX Views

It’s not until a company reports its earnings that one can see whether there could be an effect on currency movement.

At that point, investors can analyze management statements for an outlook on currency fluctuations. Look for hedging strategies that a company may implement going forward.

And, perhaps it’s not the type of products a company sells that best identify forex movements, but how necessary or essential they are to consumers.

Things like food, gasoline, and medicine would be more useful, and in demand, than haute couture clothing or jewelry.

A company like Kraft, which sells food all over the world, may be more useful to study for an impact on the forex market than Tiffany’s, the iconic jewelry store retailer.

Investors should not rely on companies and the equity markets alone for insight into currency market movements. Activities of governments have a more direct impact.

Governments Drive FX Markets

As outlined above, companies, equities, and stock markets may influence forex. But the direction of changes in value of currencies is influenced most by the policies of governments.

The reality is that equities alone are not a prudent way to predict the direction of currencies. Government balance sheets, monetary policy, and interest rates play a more major role in forex markets.

The value of money is determined by its supply and demand, which is generally determined by the government via interest rate changes or other policy movements.

Unfortunately, using equities as a sole leading indicator is unwise when governments can influence movements at will.

Strong Economies Make Strong Currencies?

It’s far from 100% accurate to say that a strong economy means a strong currency.

During the 2007-2008 financial crisis in the U.S., the Japanese yen continued to strengthen relative to the U.S. dollar, even though Japan’s economy had been in a funk for decades.

But the U.S. economy at the time was weakening faster than Japan’s economy.

Should Investors Worry About FX Movements?

Those investing for the long term probably shouldn’t be concerned, especially if their portfolios are well diversified. What they should understand is that short-term forex fluctuations are the rule, not the exception.

How Are Equities and Forex Different?

A fundamental difference is that equities are shares of stock issued by companies and sold on a stock market. Forex is foreign exchange—currencies of countries around the world—and trades on the foreign exchange markets. The forex market is the largest financial market in the world. And it’s far more liquid than the stock market.

Who Controls the Forex Market?

The forex market is controlled by no specific company or organization. It’s a decentralized market operating in various countries.

The Bottom Line

Forex markets are vast, complex, and dynamic markets. Using one data point, such as equities, to forecast future forex directions isn’t advised.

While equities can be useful indicators, investors should be aware that using equities alone to forecast forex market behavior most likely will fail to provide an accurate projection.

Reviewed by Thomas Brock
Fact checked by Suzanne Kvilhaug

The price-to-earnings (P/E) ratio is one of the most popular and widely used financial metrics, but it has a number of inherent flaws. Another metric, the enterprise value to EBITDA (EV/EBITDA) ratio can help compensate for some of these flaws.

Investors who understand how both ratios work and how to evaluate their results have an advantage when trying to determine which stocks offer the best wealth-building opportunities.

Key Takeaways

• The price-to-earnings (P/E) ratio is a popular valuation metric that indicates a company’s future growth potential by comparing its current market price to its earnings per share (EPS).
• Using the P/E ratio to evaluate a stock has its drawbacks, including the potential for management to manipulate the earnings portion of the metric and the potential for overly optimistic investors to run up the stock price, causing an inflated P/E ratio.
• One advantage of the EV/EBITDA ratio is that it strips out debt costs, taxes, depreciation, and amortization, thereby providing a clearer picture of the company’s financial performance.
• One drawback of the EV/EBITDA ratio is that it can produce an overly favorable number because it doesn’t include capital expenditures, which can be a huge expense for some companies.

Understanding How the P/E Ratio Works

The P/E ratio is a valuation metric that compares a company’s stock earnings per share (EPS) to its current market price. This metric is widely known and used as an indicator of a company’s future growth potential. The P/E ratio does not reveal a full picture, and it is most useful when comparing only companies within the same industry or comparing companies against the general market.

A high P/E ratio typically means that the market is willing to pay a higher price relative to earnings because there is an expectation of future growth in the company. Tech stocks, for example, usually carry high P/E ratios. A low P/E ratio indicates that the market is expecting lower growth in the company or perhaps less favorable macroeconomic conditions that might hurt the company. As a result, despite its earnings, the stock typically sells off somewhat if it has a low P/E since investors don’t think the current price justifies the earnings outlook.

P/E Ratio Shortfalls

There are problems that arise for investors with the use of the P/E ratio. The stock price can get run up if investors are overly optimistic, causing an overvalued P/E ratio. Also, the earnings portion of the metric can be manipulated somewhat if, for example, a company’s earnings are flat, but the company’s management reduces their outstanding shares, thus boosting the company’s earnings on a per-share basis.

Understanding the EV/EBITDA Multiple 

The EV/EBITDA ratio helps to allay some of the P/E ratio’s downfalls and is a financial metric that measures the return a company makes on its capital investments. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. In other words, EBITDA provides a clearer picture of the financial performance of a company since it strips out debt costs, taxes, and accounting measures like depreciation, which spreads the costs of fixed assets out for many years.

Important

One of the most effective ways to use EV/EBITDA is in a comparison valuation where the metric is used to evaluate similar companies in the same industry.

The other component is enterprise value (EV) and is the sum of a company’s equity value or market capitalization plus its debt less cash. EV is typically used in buyouts. The EV/EBITDA ratio is calculated by dividing EV by EBITDA to achieve an earnings multiple that is more comprehensive than the P/E ratio.

EV/EBITDA Shortfalls

However, the EV/EBITDA ratio has its drawbacks, such as the fact that it doesn’t include capital expenditures, which for some industries can be significant. As a result, it may produce a more favorable multiple by not including those expenditures.

Though the calculation of this ratio can be complex, EV and EBITDA for publicly traded companies are widely available on most financial websites. The ratio is often preferred to other return metrics because it evens out differences in taxation, capital structure (debt), and asset counting.

P/E Ratio vs. EV/EBITDA

The P/E ratio has been established as a prime market valuation metric, and the sheer volume of current and historical data gives the metric weight in regard to stock analysis. Some analysts contend that using the EV/EBITDA ratio vs. the P/E ratio as a valuation method produces better investment returns.

Both metrics have inherent advantages and disadvantages. As with any financial metric, it’s important to consider several financial ratios—including the P/E ratio and the EV/EBITDA ratio—in determining whether a company is fairly valued, overvalued, or undervalued.

EPS vs. EBITDA

EBITDA is used to calculate the actual earning potential of a given company—that is, how much a company earns before accounting for non-core-business expenses. For public companies, you use net income to calculate the actual earnings per share, or EPS.

EPS measures a company’s profitability by indicating how much profit each outstanding share of common stock has earned. It’s calculated by dividing a company’s net income by the total number of outstanding shares.

EBITDA is an alternate measure of profitability to net income. It’s used to assess a company’s profitability and financial performance.

How Does the P/E Ratio Work?

The P/E ratio, a valuation metric, compares a company’s stock earnings per share (EPS) to its current market price. This metric is widely known and used as an indicator of a company’s future growth potential.

How Does the EV/EBITDA Ratio Work?

The EV/EBITDA ratio, a financial metric, measures the return a company makes on its capital investments. EBITDA provides a clearer picture of the financial performance of a company since it strips out debt costs, taxes, and accounting measures like depreciation, which spreads the costs of fixed assets out for many years.

How Should the P/E Ratio and the EV/EBITDA Ratio Be Used?

Some analysts say using the EV/EBITDA ratio vs. the P/E ratio as a valuation method produces better investment returns. It’s important to consider several financial ratios—including the P/E ratio and the EV/EBITDA ratio—in determining whether a company is fairly valued, overvalued, or undervalued.

The Bottom Line

The price-to-earnings (P/E) ratio, a popular valuation metric, indicates a company’s future growth potential by comparing its current market price to its earnings per share (EPS). But using the P/E ratio to evaluate a stock has its drawbacks, including the potential for management to manipulate the earnings portion of the metric and the potential for overly optimistic investors to run up the stock price, causing an inflated P/E ratio.

The EV/EBITDA ratio compensates by stripping out debt costs, taxes, depreciation, and amortization, thereby providing a clearer picture of the company’s financial performance. But it has its own drawbacks, including that it can produce an overly favorable number because it doesn’t include capital expenditures, which can be a huge expense for some companies.

Investors who understand how both ratios work and how to evaluate their results give themselves an advantage when trying to determine which stocks offer the best wealth-building opportunities.

Reviewed by Thomas Brock

Robert G. Hagstrom wrote a book about the legendary investor Warren Buffett entitled “The Warren Buffett Portfolio” back in 1999. What’s so great about the book and what makes it different from the countless other books and articles written about the “Oracle of Omaha” is that it offers readers valuable insight into how Buffett thinks about investments. It delves into the psychological mindset that has made Buffett so fabulously wealthy.

We’ve selected a sampling of the tips and suggestions regarding the investor mindset and ways to improve stock selection that will help you get inside Buffett’s head.

Key Takeaways

• Warren Buffett has a unique way of thinking about and approaching his investments.
• Diversification is a lauded approach but Buffett states that overly diversifying can be harmful as well.
• He analyzes and pores over the underlying economics of a given business or group of businesses.
• Buffett believes that overcoming emotion can be key when investing.

1. Stocks Are a Business

Many investors think of stocks and the stock market as nothing more than little pieces of paper being traded back and forth among investors. This might help prevent investors from becoming too emotional over a given position but it doesn’t necessarily allow them to make the best possible investment decisions.

Buffett has stated that he believes stockholders should think of themselves as “part owners” of the business in which they’re investing. Both Hagstrom and Buffett argue that investors will tend to avoid making off-the-cuff investment decisions and become more focused on the longer term by thinking that way.

Longer-term “owners” tend to analyze situations in greater detail and then put a great deal of thought into buy and sell decisions.

Important

Hagstrom says this increased thought and analysis tends to lead to improved investment returns.

2. Increase Your Investment

It rarely if ever makes sense for investors to “put all of their eggs in one basket” but putting all your eggs into too many baskets may not be a good thing either. Buffett contends that over-diversification can hamper returns as much as a lack of diversification. He doesn’t invest in mutual funds for this reason. It’s why he prefers to make significant investments in just a handful of companies.

Buffett is a firm believer that investors must first do their homework before investing in any security. Investors should feel comfortable enough to dedicate a sizable portion of assets to that stock, however, after the due diligence process is completed. They should also feel comfortable in winnowing down their overall investment portfolio to a handful of good companies with excellent growth prospects.

Buffett’s stance on taking time to properly allocate your funds is furthered by his comment that it’s not just about the best company but how you feel about the company. Why would you put money into your 20th favorite business instead of adding money to the top choices if the best business you own presents the least financial risk and has the most favorable long-term prospects?

3. Reduce Portfolio Turnover

Rapidly trading in and out of stocks can potentially make an individual a lot of money but this trader is actually hampering their investment returns, according to Buffett. Portfolio turnover increases the amount of taxes that must be paid on capital gains and it boosts the total amount of commission dollars that must be paid in a given year.

The “Oracle” contends that what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.

Investors must think long-term. They can avoid paying huge commission fees and lofty short-term capital gains taxes by having that mindset. They’ll also be more apt to ride out any short-term fluctuations in the business and ultimately reap the rewards of increased earnings and/or dividends over time.

4. Have Alternative Benchmarks

Stock prices may be the ultimate barometer of the success or failure of a given investment choice but Buffett doesn’t focus on this metric. He instead analyzes and pores over the underlying economics of a given business or group of businesses. The share price will ultimately take care of itself if a company is doing what it takes to grow itself on a profitable basis.

Successful investors must look at the companies they own and study their true earnings potential. The share price should reflect it in the long term if the fundamentals are solid and the company is enhancing shareholder value by generating consistent bottom-line growth.

5. Think in Probabilities

Bridge is a card game in which the most successful players can judge mathematical probabilities to beat their opponents. Perhaps not surprisingly, Buffett loves and actively plays bridge and he takes the strategies beyond the game into the investing world.

Buffett suggests that investors focus on the economics of the companies they own and then try to weigh the probability that certain events will or will not transpire. This is much like a bridge player checking the probabilities of his opponents’ hands. He adds that an investor will be more accurate in their ability to judge probability by focusing on the economic aspect of the equation and not the stock price.

Thinking in probabilities has its advantages. An investor who ponders the probability that a company will report a certain earnings growth rate over a five- or 10-year period is much more apt to ride out short-term fluctuations in the share price. Their investment returns are likely to be superior by extension and they will also realize fewer transaction and/or capital gains costs.

6. Understand the Psychology 

Investors tend to have a psychological mindset. A successful investor will focus on probabilities and economic issues while letting decisions be ruled by rational thought rather than emotional thinking.

Investors’ emotions can be their worst enemy. Buffett contends that the key to overcoming emotions is being able to retain your belief in the real fundamentals of the business and not get too concerned about the stock market.

Investors should realize that there’s a certain psychological mindset that they should have if they want to be successful and try to implement that mindset.

7. Ignore Market Forecasts

There’s an old saying that the Dow “climbs a wall of worry.” The markets have fared quite well over time despite the negativity in the marketplace and those who perpetually contend that a recession is “just around the corner.” Doomsayers should be ignored.

Just as many eternal optimists argue that the stock market is headed perpetually higher. They should be ignored as well.

Buffett suggests that investors should focus their efforts on isolating and investing in shares that aren’t currently being accurately valued by the market. The logic here is that the investor will stand to make a lot of money as the stock market begins to realize the company’s intrinsic value through higher prices and greater demand.

8. Wait for the Fat Pitch

Hagstrom’s book uses the model of legendary baseball player Ted Williams as an example of a wise investor. Williams would wait for a specific pitch in an area of the plate where he knew he had a high probability of making contact with the ball before swinging. It’s said that this discipline enabled Williams to have a higher lifetime batting average than the typical player.

Buffett suggests that all investors should act as if they owned a lifetime decision card with only 20 investment choice punches in it. This should prevent them from making mediocre investment choices and hopefully enhance the overall returns of their respective portfolios.

How Did Warren Buffett Get Started?

Buffett bought his first three shares of stock in an oil company at the age of 11. He had a little money on hand with which to do so because he’d begun selling chewing gum and Coca-Cola around his Omaha neighborhood by the age of six. He reportedly sold the shares for a profit of $2 each.

What Is Diversification in Investing?

Diversification involves spreading the assets in your portfolio across different classes. They’re not all the same or even very similar so you’re reasonably protected if one tanks. It’s not a sure thing that the others will perform poorly also. The four classes are typically considered to be domestic stocks, international stocks, bonds, and short-term investments.

What Are the Capital Gains Tax Rates?

The federal capital gains tax is divided into two categories: short-term and long-term. Short-term gains are those that derive from an investment that you’ve held for one year or less. They’re taxed along with your ordinary income at a rate of up to 37% depending on your overall taxable income.

Most long-term capital gains tax rates are 0%, 15%, or 20% but there are a few exceptions for certain business stock, real property, and collectibles. Even these rates peak at only 28%, however. You must hold the asset in question for more than a year to qualify for long-term capital gains tax rates.

The Bottom Line

“The Warren Buffett Portfolio” is a timeless book that offers valuable insight into the psychological mindset of the legendary investor, Warren Buffett. Of course, everyone would be rich if learning how to invest like Warren Buffett was as easy as reading a book! But you could be on your way to better stock selection and greater returns if you take the time and effort to implement some of Buffett’s proven strategies.

Disclosure: This article is not intended to provide investment advice. Investing in securities entails varying degrees of risk and can result in partial or total loss of principal. The trading strategies discussed in this article are complex and should not be undertaken by novice investors. Readers seeking to engage in such trading strategies should seek extensive education on the topic.

Reviewed by Gordon Scott

Investors, especially short-term traders, are usually better off waiting for a price movement to confirm a trend or reversal rather than trying to predict what will happen next. Here’s a look at the reasons why predicting prices is problematic, then some ways you can rework your thinking to gain a better edge.

Key Takeaways

• No one can predict what the market will do because there are too many variables.
• Short-term traders are typically better served by waiting for confirmation of a reversal rather than making an assumption or predicting it.
• Viewing price action as a series of waves is an alternative to predicting future price moves.
• You should establish significant points to buy and sell based on what a price is actually doing rather than what you expect it to do.

Problems with Predicting the Market

Why is predicting problematic? There are a variety of reasons—here are a few.

Change Is Certain

No matter how good an analysis is, it is only as good as the information that is available right now. You cannot know for certain what will happen tomorrow or even an hour from now. Analysis regarding likely movement in the future is done with the idea of “ceteris paribus” or “all else being equal.” This means an analyst assumes a stock will go up based on a trend if everything else but one or two variables remain constant. In the short term (minutes, hours, days, maybe weeks), macro-level changes like Federal Reserve interest rates can remain the same. However, micro-level changes, like investor choices, cannot be anticipated.

For example, predicting that an asset’s price will rise when others are falling is risky, especially since it can’t be known how the market will react to further news or information that is released. When prices are falling, even good news may not push prices substantially higher, and when prices are rising, even bad news won’t necessarily have a long-term adverse effect on prices.

Individual Stocks Don’t Always Follow the Overall Market

Individual security analysis is often based on the sentiment of the overall market. This can mean a trader expects one stock to rise because benchmarks indicate that the market is rising or that it will fall because the market has declined.

Stocks do not always mimic the market, especially in shorter time frames. Traders must be aware of market dynamics as well as individual stock dynamics. Either way, the end result is that you want to be trading in the direction of current cash flows, not against them, whether it be in the overall market or individual securities.

Predictions Are Vague

Predicting that a particular stock will move higher is vague because most predictions are based on historical trends and assumptions that, again, all else will remain the same.

Investment decisions then rarely include a profit or stop-loss exit point due to the expectation of a continued trend. Inexperienced traders often predict that their equity positions will rise and assume that they will be able to exit near the top if they are correct. In reality, such a vague plan rarely works. Therefore, all traders must have a plan for entering and exiting a trade based on how much they are willing to lose and gain.

Market Volatility Has Increased

Stock market volatility has increased over the years, while the holding period for securities has fallen. Buying and holding is still a viable strategy if the method is well-devised (as with any trading method), but due to limited capital, buy-and-hold investors must be aware that volatility can reach very high levels and must be prepared to wait out such periods.

Active traders trading on shorter time frames should trade in the direction of price movements, given that volatility has increased, and even short-term moves can sustain overbought or oversold levels for extended periods of time.

Prices Rarely Move in Straight Lines for Long

Predictions are often based on strong emotional feelings—the stronger the feeling, the stronger the trader may expect the price reaction to be. Thus, the trader assumes that the stock will fly in the anticipated direction in a straight movement, leading to large profits. When you look at all the securities in the world and then factor in time variables, having a position right before a major move is very unlikely, statistically speaking.

Traders are far better off trading the averages and trading in the direction of price movements to gain profits than looking for one trade or stock that rises aggressively in their favor in a short period.

Important

Whether attempting to predict the market or not, generating consistent profits from short-term trading is exceedingly difficult, even for the most experienced investor.

Alternatives to Prediction

Given an understanding that trying to predict a turning point in the market can be very costly, one might ask, “If I can’t predict the market, how do I make money in it?”

The answer is to follow the price, which you can do using a couple of mantras. They are hardly an exhaustive list of market dynamics, but they are key: “Prices fluctuate in waves” and “Don’t assume support or resistance will hold.”

Prices Fluctuate in Waves

Looking at any chart after understanding the points above, all traders must understand that prices move in waves in all time frames. This means that, even though prices may fall, traders don’t need to panic and jump out of positions as long as the longer trend is still up. However, they still should have an exit point in case prices are no longer in an upward trend in their time frame.

Short-term traders can participate in each of these waves but must remain nimble and not be tied to one direction. Predicting that prices will move in only one direction disregards the fact that prices tend to move in waves.

Don’t Assume Support or Resistance Will Hold

A widespread misconception is that support or resistance will hold, or that a break of these levels will cause a substantial breakout. The position traders have is often the result of what they predict will occur. Traders need to realize that support and resistance levels are important price areas. Making assumptions that a breakout will occur or that a level will hold off a further move is an attempt to predict the market.

Instead, traders should watch what occurs around these levels and then enter as momentum moves in one direction or the other. If resistance holds and prices retreat, then a short position could be entered, for example. If a breakout occurs, then trade in the direction of the breakout. Keep in mind that false breakouts occur, and (to repeat) prices move in waves. Don’t be tied to a position simply because a position showed a profit for a time.

It is better to think of support and resistance as pivot points for price and areas to look for entries and exits. By doing so, you’re not predicting that something will occur or go against the prevailing price movement. Instead, you enter into the current price flow. This makes trading “matter of fact” as opposed to emotional. You have picked out important levels that will help you isolate the price waves a market is moving in. Then, you can take a corresponding position as prices react at these levels.

Is it Possible to Predict the Market?

It is very difficult to predict what the market will do, but as the saying goes, every dog has its day. Some predictions will be accurate, but for the most part, they are not—there are too many variables, and change occurs too often.

Can You Mathematically Predict the Stock Market?

You can use probability theory, statistics, and historical data to attempt to predict what the market will do and conclude that it might do something, but this is more of a gauge of risk.

How to Predict the Market Movement?

There is no way to accurately predict how the market will move, but there are methods that can help you mitigate the trading risks, such as setting limits for your positions and your trading amounts and trading the ebb and flow of prices.

The Bottom Line

Traders benefit by remaining nimble in their positions and not being tied to a particular direction because of a prediction. Predicting the markets can be dangerous, and ultimately, predictions are not needed to make money in trading.

By realizing that prices move in waves and that you should never assume that important levels will hold or break, you can enter and exit trades at significant points—but in reaction to what the price is actually doing and not what you expect it to do. Understanding that should help traders find themselves more on the right side of the trade than on the wrong side.

Fact checked by Timothy Li
Reviewed by Doretha Clemon

Although home equity gains have slowed, Americans are sitting on record-high level of home equity: $311,000 on average at the end of Q3 2024, according to research firm Core Logic. With all that equity, many are considering tapping into it with a home equity loan. After all, you can use the funds for anything you need. However, home equity loans are subject to higher interest rates, so payments can cost more. Plus, if you fail to make payments, you risk losing your home. Before you submit a home equity loan application, consider your personal finances to decide if it’s the best move for you.

Key Takeaways

• Home equity loans allow you to access cash at a cheaper rate than many alternatives.
• They are quick to obtain, which can be both good and bad for borrowers.
• With higher interest rates, home equity loans come with higher payments. 
• If you can’t afford to repay your home equity loan, you could lose your home.

What Is a Home Equity Loan?

A home equity loan is exactly what it sounds like: a loan that allows you to borrow against the equity that you have in your home. While loan products vary across lenders, most home equity loans pay out an agreed-upon lump sum, and you pay back that loan with fixed, equal monthly payments over a set period of time until the loan is paid off.

By using your equity as collateral, home equity loans allow you to access larger sums of cash at a much lower interest rate than other unsecured forms of debt, like credit cards and personal loans, as long as you have enough equity in your home.

Calculating Your Home’s Equity

You can calculate your home’s equity by taking the current value of your home and subtracting the balance of any loans that you have on it. Then, divide that figure by the current value of your home. Let’s say you have a home valued at $400,000 with a $200,000 mortgage balance and no other loans against the home: $400,000 – $200,000 = $200,000. Then, $200,000 divided by $400,000 (your home’s value) is 50%. Congrats, you have 50% equity in your hypothetical home!

Pros of a Home Equity Loan

Home equity loans have some definite benefits, including:

• A fixed interest rate with set monthly payments for a fixed period of time. Having stable payments can make it easier to budget for repayment.
• Lower interest rates than many other common forms of debt. For instance, home equity loan interest rates are usually lower than those for credit cards or personal loans.
• Easy to obtain large sums of money that you may not qualify for through other avenues. You might find it easier to get a home equity loan if you have significant equity in your home compared to other loan products.
• The potential for tax deductions. If you use the home equity loan funds for home improvements, you might be able to deduct the interest from your personal property taxes.

Cons of a Home Equity Loan

Home equity loans aren’t without their risks. Before you take out a loan, consider the following drawbacks:

• You might borrow more than you need. A lump sum payment means that you may take out more than you need, spending the excess money frivolously and eroding your home’s value in the process. 
• You might struggle with repayments in the future. If you have other debt payments, you might find it hard to meet all of your financial obligations.
• You risk your home if you fail to make payments. You might face foreclosure if the loan becomes due and you can’t pay it back.
• There’s the risk of negative equity. If your home value drops, you might find yourself underwater on the loan.

Interest Rates Rising

Interest rates were incredibly low for much of the last decade, but this era appears to have ended. The Federal Reserve (Fed) has increased interest rates multiple times over the last several years, so borrowing against your home’s equity results in larger payments that may be harder to accommodate if your income decreases.

Do All Home Equity Loans Have Fees?

No, not all home equity loans have fees. Some lenders charge different fees depending on the amount of the home equity loan, and some have zero fees for any home equity loan. As with any loan product, shop around to make sure that you’re getting the best deal.

What Are Alternatives to a Home Equity Loan?

Alternatives to a home equity loan depend on the amount needed and the purpose of the loan. The greatest alternative to a home equity loan is either an emergency fund or delaying an expense and budgeting to save for it in advance, but neither is always possible. For a small amount, a 0% annual percentage rate (APR) credit card is a great alternative, but make sure that you pay it off before the promotional interest period is up. For a larger amount, a cash-out refinance may be a better option.

Can You Get a Home Equity Loan Without a Mortgage?

Yes, you can get a home equity loan whether or not you have a mortgage. If your home is mortgage free, then you definitely have enough equity in your home for a home equity loan as long as you meet the other lending requirements.

What Are the Requirements To Be Approved for a Home Equity Loan?

Individual lending requirements will vary, but in general, you’ll need a minimum of 10% equity in your home, with most lenders requiring 15% to 20%. In addition to having sufficient equity, you’ll also need all of the normal things that come with applying for a loan: proof of income, decent credit, and a good debt-to-income (DTI) ratio. The credit score and DTI requirements for a home equity loan generally are slightly more lenient than for unsecured debt like a credit card, as the loan is backed by an asset.

The Bottom Line

Home equity loans have long been used as a way for borrowers to access large sums of cash for relatively low interest payments. As interest rates rise, home equity loans are still a cheaper option than other forms of debt, but they carry the risk of losing your home if you can’t keep up with payments. Make sure that what you’re taking out the home equity loan for is worth the risk.

Reviewed by Colleen Ramos

Passing the Series 63 exam allows the holder to sell and solicit orders for any type of financial security in a particular state after they’ve passed it. Most states but not all require that an individual pass the Series 63 exam to become a licensed securities agent. Series 63 is also the name of the license awarded after passing the exam.

The Series 63 exam can be taken an unlimited number of times as long as applicable waiting period requirements have been met, according to the North American Securities Administrators Association (NASAA) which oversees the test. The same applies to the Series 65 and 66 exams.

Key Takeaways

• Passing the Series 63 exam allows an individual to sell and solicit orders for any type of financial security in a particular state.
• The exam can be taken an unlimited number of times subject to some waiting periods.
• NASAA periodically revises exam questions to reflect recent regulatory changes.
• The ee to take the Series 63 exam is $147 as of 2025.

Retaking the Series 63 Exam

There’s a waiting period of at least 30 days before the second taking of that exam can be scheduled after a person fails the Series 63 exam the first time. There’s another waiting period of at least 30 days after a second failed attempt. There’s a waiting period of at least 180 days for scheduling each subsequent retaking of the test if the exam is failed three times or more.

Waivers of the 180-day waiting period are only rarely granted. The test questions are selected at random from an existing database of queries so the same questions will recur if a test is taken enough times. The exam then becomes a test of memorization rather than competency.

Note

NASAA periodically revises exam questions to reflect recent regulatory changes. Series 63 65, and 66 exam questions were updated in 2021 to reflect the SECURE Act changes to retirement plan rules along with alterations in the accredited investor definition.

The waiting periods are exclusive to each of the NASAA exams. There’s no waiting period for taking either the Series 65 test (NASAA Investment Law Examination) or the Series 66 test (NASAA Uniform Combined State Law Examination if an individual fails the Series 63 exam, formally known as the Unified Securities State Law Examination. The time frames for re-dos are the same for the Series 65 and 66 tests but the waiting period applies only to the specific exam the candidate didn’t pass.

Background of the Series 63 Exam

The Series 63, 65, and 66 exams are administered on behalf of NASAA by the Financial Industry Regulatory Authority (FINRA), a regulatory body created after the National Association of Securities Dealers merged with the regulation committee of the New York Stock Exchange. FINRA is vested with responsibility for governing business between brokers, dealers, and investors.

Important

The fee to take the Series 63 exam is $147 as of 2025.

Series 63 is considered an entry-level exam. There are 60 multiple-choice questions on the exam. The passing score is 72% or 43 of the 60 questions.

The exam covers the principles of state securities regulations. It was developed to qualify candidates who want to work in the securities industry within a state and to sell investment products such as mutual funds, variable annuities, and unit investment trusts.

Most states and U.S. territories require that broker-dealer representatives pass the Series 63 exam.

What Changes Did the SECURE Act 2.0 Make to Investing?

The SECURE Act 2.0 tweaked the 2019 SECURE Act three years later in 2022. The changes largely addressed retirement savings. The age for taking required minimum distributions increased and the penalty for not doing so decreased. Catch-up contributions also increased.

Which States Don’t Require Passing the Series 63 Exam?

Colorado, Florida, Louisiana, Maryland, the District of Columbia, and Puerto Rico don’t require passing the exam to perform as a broker-dealer representative in their jurisdictions.

What Jobs in Finance Require Passing the Series 63 Exam?

Passing the Series 63 exam is mandatory in most states for acquiring securities registration and working for a FINRA-member firm or self-regulatory organization as a licensed securities agent. Not passing the exam can narrow your employment horizons if you want to work in finance and investing.

The Bottom Line

Obtaining a well-paying and critical job in securities and investment services requires passing the Series 63 exam in most states but it’s not a one-attempt-and-done deal. You can retake the test subject to waiting periods and some other rules.

Reviewed by Khadija Khartit

For investors, things are great when the prices of their investments are moving in an upward direction. Inevitably, though, the value of those investments will dip at one point or another. This is the nature of the market: ups and downs. A sell-off, however, is different. It is the accelerated selling of securities, including stocks, bonds, commodities, and currencies beyond the daily ebb and flow of market prices.

The ability to identify a sell-off can be an extremely reliable resource to have in a time of market uncertainty. These signals can present themselves in various forms, so be prepared to analyze a number of indicators.

Key Takeaways

• A sell-off occurs when the price of an asset or security suddenly experiences a sharp decline.
• A sell-off can occur unexpectedly and interrupt a bull market trend.
• Economic headwinds, unexpected news events, or missed estimates can all precipitate a sell-off.
• Some technical indicators may be able to predict a sell-off, making them valuable to traders and investors.

Unexpected Events

The unexpected has and will always be a key contributor to market sell-offs. When a company releases its quarterly earnings report, there is a possibility it can fall short of analysts’ expectations. If it’s one or multiple companies with substantially negative results, the news can trigger mass selling for that specific company or the broad market. Black swans are another unpredictable occurrence that can upset the direction of the market significantly.

Their sudden nature can eat away at the value of investment holdings extremely fast, so beware, as they are impossible to predict. If either of the preceding occurs, you can be sure that the downward movement will not be over in a day’s time, so be prepared.

Economic Activity

The overall economy doesn’t come up short when it comes to information about its progress or lack thereof. Economic reports, such as initial claims, retail sales, and gross domestic product (GDP), to name a few, will have a considerable effect on the performance of the market. Any substantial, negative developments will most certainly provide an indication that the markets are headed down for the foreseeable future.

Commodity and currency fluctuations also have the strength to wreak havoc on investment portfolios. Rising commodity prices can be an early signal of higher costs being passed down to consumers while simultaneously diminishing companies’ profits. For instance, a spike in oil prices will affect what consumers pay at the pump and what it costs for a company to ship goods. As far as currency is concerned, an upward trend in the value of the U.S. dollar can inversely devalue stock prices because it will be more expensive to buy American stocks with a higher-priced dollar. Sharp spikes in commodity and currency values should be monitored carefully, as they have a trickle-down effect on investment positions.

Technical Indication

As if the previous factors weren’t enough, technical indicators may also reveal the direction of a stock, a currency, or even a market index. For example, the moving average convergence/divergence is a momentum indicator that can convey which direction a security or market is headed beforehand. Another commonly used indicator is the Relative Strength Index, which can determine whether a security is overbought or oversold. If overvalued, this could be a sure sign that a sell-off is imminent.

The head and shoulders pattern is also said to be one of the most reliable indicators in determining a trend reversal pattern, which should be employed for those using technical analysis on a frequent basis.

What Is a Sell-Off?

A sell-off refers to downward pressure on the price of a security, accompanied by increasing trading volume and falling prices. It occurs when a large volume of securities is sold in a short period. A sell-off causes the price of a security to fall in rapid succession.

What Are Unexpected Events That Trigger Sell-Offs?

Unexpected events that trigger market sell-offs include:

• Quarterly earnings reports, a document that summarizes and highlights a company’s earnings and other financial information for a three-month period
• Black swans, extremely rare and unpredictable events that go outside of normal expectations and are characterized by their potentially severe impact and the widespread insistence that they were obvious in hindsight

What Is Economic Activity That Triggers Sell-Offs?

Economic activity that triggers market sell-offs includes:

• Substantial and negative developments in economic reports
• Commodity and currency fluctuations

What Are Technical Indicators That Might Reveal Sell-Offs?

Technical indicators that may reveal market sell-offs include:

• The moving average convergence/divergence, which helps investors identify price trends, measure trend momentum, and identify entry points for buying or selling
• The Relative Strength Index, which measures the speed and magnitude of a security’s recent price changes to detect overbought or oversold conditions in the price of that security
• The head and shoulders pattern, which is a chart formation that predicts a bullish-to-bearish trend reversal

The Bottom Line

Being able to spot a sell-off before it happens is an important skill to have as an investor. Adverse earnings and catastrophic events can be difficult to predict, but knowing how to handle them when they do occur is invaluable.

The overall economy can throw signals from different angles without warning, so being able to interpret their underlying messages may preserve portfolio value in a pinch. Technical indicators are plentiful, so understanding which ones can support your directional predictions may equip you for a potential downturn.

While it’s impossible to consistently predict when a sell-off might occur, it is feasible to have a thorough understanding of how to analyze certain events if and when they transpire, allowing you to better protect your investment portfolio.

Reviewed by Chip Stapleton
Fact checked by Suzanne Kvilhaug

A master limited partnership (MLP) is an unusual investment that combines the tax benefits of a limited partnership (LP) with the liquidity of a common stock. It is organized as a publicly traded partnership (PTP), a type of LP where the limited partners’ shares are freely traded on securities exchanges. Thus, while an MLP has a partnership structure, it issues shares that trade on an exchange like common stock.

Today’s MLPs are defined by the Tax Reform Act of 1986 and the Revenue Act of 1987, which outline how companies can structure their operations to realize certain tax benefits and define which companies are eligible. To qualify, a firm must earn 90% of its income through activities or interest and dividend payments relating to natural resources, energy, commodities, or real estate. If a company does qualify, an MLP can provide it with a variety of benefits.

Key Takeaways

• A master limited partnership (MLP) is a company organized as a publicly traded partnership (PTP).
• MLPs combine a private partnership’s tax advantages with a stock’s liquidity.
• MLPs have two types of partners; a general partner, who manages the MLP and oversees its operations, and limited partners, who are investors in the MLP.
• Investors receive tax-sheltered distributions from the MLP.
• MLPs are considered relatively low-risk, long-term investments, providing a slow but steady income stream.
• MLPs are usually found in the natural resources, energy, and real estate sectors.

Tax Benefits

Tax implications for MLPs differ significantly from those for corporations for both the company and its investors. Like other LPs, there is no tax at the company level. This essentially lowers an MLP’s cost of capital, as it does not suffer the problem of double taxation on dividends. Companies that are eligible to become MLPs have a strong incentive to do so because it provides a cost advantage over their incorporated peers.

In an MLP, instead of paying a corporate income tax, the tax liability of the entity is passed on to its unitholders. Once a year each investor receives a K-1 statement (similar to a 1099-DIV form) detailing their share of the partnership’s net income, which is then taxed at the investor’s individual tax rate.

One important distinction must be made here: While the MLP’s income is passed through to its investors for tax purposes, the actual cash distributions made to unitholders have little to do with the firm’s income. Instead, cash distributions are based on the MLP’s distributable cash flow (DCF), which is similar to free cash flow (FCF). Unlike dividends, these distributions are not taxed when they are received. Instead, they are considered reductions in the investment’s cost basis and create a tax liability that is deferred until the MLP is sold.

Fortunately for investors, MLPs generally have much higher distributable cash flow than they have taxable income. This is a result of significant depreciation and other tax deductions and is especially true of natural gas and oil pipeline and storage companies, which are the most common businesses to choose an MLP structure.

Investors then receive higher cash payments than the amount upon which they are taxed, creating an efficient means of tax deferral. The taxable income passed on to investors often is only 10% to 20% of the cash distribution, while the other 80% to 90% is deemed a return of capital and subtracted from the original cost basis of the initial investment.

The first MLP was organized in 1981. However, by 1987 Congress effectively limited the use of them to the real estate and natural resources sectors. These limitations were put into place out of a concern over too much lost corporate tax revenue; MLPs do not pay federal income taxes.

MLP Cash Flows and Taxes

Let’s look at an example of the mechanics of cash flows and taxes that occur when holding and selling MLPs. Assume that an MLP is purchased for $25 per share, held for three years, makes cash distributions of $1.50 per unit per year, and passes through $0.30 of taxable income to each unit per year.

First, calculate the change in cost basis caused by the net return of capital—cash distributions minus allocation of taxable income—over the life of the investment. For simplicity, assume taxable income and cash distribution remain constant through the life of the investment, although in reality these probably would fluctuate each year.

If the MLP is sold at the end of the third year for $26 per unit, the investor would show a gain of $4.60. One dollar of this would be a normal capital gain—having bought at $25 and sold at $26—and would be taxed at the long-term capital gains tax rate. The remaining $3.60 gain results from the $1.20 return of capital each year, and this amount would be taxed at the investor’s personal income tax rate. The table below shows cash flows, including those related to taxes, during the life of the investment. We assume a 35% income tax rate and a 15% capital gains rate.

An important side note on the concept of reducing cost basis: If and when the investment’s cost basis falls to zero, any cash distribution becomes immediately taxable, rather than being deferred until the sale of the security. This is because the investment cannot fall into a negative cost basis. This can occur if an MLP is held for many years.

MLPs can be used to gain current income while deferring taxes, as seen in the above example. This can be taken one step further when an MLP investment is used as a vehicle for estate planning. When an MLP unitholder dies and the investment is transferred to an heir, the cost basis is reset to the market price on the transfer date, eliminating any accrued tax liability caused by a return of capital.

Diversification Benefits

Investors can benefit by investing in MLPs, as they are not highly correlated with other asset classes, including stocks, bonds, and commodities. Additionally, they have a correlation coefficient of less than 0.5 to both real estate investment trusts (REITs) and the S&P 500. This makes them good diversifiers.

Diversification is a widely used investment strategy to smooth out unsystematic risk events in a portfolio without sacrificing expected returns. It is intended to allow the positive performance of some investments to neutralize the negative performance of others. Diversification is only successful if the securities in the portfolio are not perfectly correlated. That is, they respond differently, often in opposing ways, to market influences.

Moreover, an investor interested in buying MLPs could consider investing in a portfolio of MLPs that is itself diversified across sectors to further reduce risk. For example, one could look to MLPs in the real estate, infrastructure, and renewable energy sectors.

Higher Yields

MLPs are known for offering relatively slow investment returns that stem from the fact that they are often established in capital-intensive and slow-growing industries, such as pipeline construction. This slow but steady growth means MLPs generate a stable income based on long-term service contracts and consistent cash distributions to investors.

The cash distributions of MLPs usually grow slightly faster than inflation. For limited partners, 80% to 90% of the distributions are often tax deferred. Overall, this lets MLPs offer attractive income yields that are often substantially higher than the average dividend yield of equities. Also, with the flow-through entity status (and avoiding double taxation), more capital is available for future projects. The availability of capital keeps the MLP firm competitive in its industry. 

29.2%

The level of potential yields from MLPs.

MLP Partnership Structure

MLPs contain two business entities: the limited partners and the general partner. The former invests capital into the venture and obtain periodic cash distributions, while the latter oversees the MLP’s operations and receives incentive distributions rights (IDRs). IDRs are structured when the partnership is formed and provide the general partner with performance-based pay for successfully managing the MLP, as measured by cash distributions to the limited partners.

The general partner usually receives a minimum of 2% of the LP distribution. However, as payment to LP unitholders increases, so does the percentage take of the general partner through IDRs, often to a maximum of 50%. The table below shows a hypothetical IDR structure outlining the payment split between limited partners and the general partner at different distribution levels.

For each incremental dollar distributed to limited partners, the general partner realizes higher marginal IDR payments. For example, assuming 1,000 LP units outstanding, if $1,000 is distributed to limited partners ($1.00 per unit), then the general partner will receive $20 (2% of $1,000). However, if $5,000 is distributed to limited partners ($5.00 per unit), then the general partner will receive $2,810, as outlined below.

Note

The calculation for the general partner’s payment for each tier is not a straight multiplication of the general partner’s IDR by the LP’s distribution. The calculation is as follows: (LP distribution ÷ limited partner’s IDR) x general partner’s IDR. Thus, at the third tier, the general partner’s payment would be ($1 ÷ 0.65) x 0.35 = 0.538 (rounded to $0.54).

Here we see that the general partner has a significant financial incentive to increase cash distributions to limited partner unitholders; while distribution to limited partners increases by 500%, from $1,000 to $5,000, distribution to the general partner increases by more than 14,000%, rising from $20 to $2,820. Note in the calculations in the above table that the IDR payment is not a percentage of the incremental limited partners distribution amount, but rather a percentage of the total amount distributed at the marginal level. For example, in the third tier, $1.54 is distributed per LP unit; $1.00 (65%) of that amount is paid to limited partners and $0.54 (35%) is paid to the general partner.

The corporate structure of MLPs can be more complex than a simple split between limited and general partnership interests. In some cases, the general partner may own LP shares. In other cases, the general partnership of an MLP may be publicly traded, and have its own limited partner/general partner split. The MLP may have other relationships with additional entities due to financing arrangements. However, the most important relationship for the MLP investor to keep in mind is the cash distribution split between limited partners and the general partner and how this will change over time as distributions fluctuate.

Should You Own MLPs?

MLPs have remained relatively unknown in part because of their low level of institutional ownership and a consequent lack of sell-side attention. Mutual funds were largely restricted from owning MLPs until 2004, but even now MLPs present a cumbersome investment. This is because funds must send out 1099 forms to their investors detailing income and capital gains in November but may not receive K-1 statements from MLPs until February. This leads to the potential for costly mistakes in estimation.

Tax-exempt institutional investment funds, such as pensions, endowments, and 401(k) plans, are restricted from owning MLPs, because the cash distributions received are considered unrelated business taxable income (UBTI)—income that is unrelated to the activity that gives the fund tax-exempt status. This could create a tax liability on any distribution of more than $1,000. This is also true for individuals when holding MLPs in an individual retirement account (IRA); therefore, the best way to hold them is in a regular brokerage account.

Individual investors are the principal owners of MLPs. Because few individuals know much about their structure and complex tax implications, they are often purchased for individuals by private-client wealth managers, although this need not be the case. As long as the individual or their accountant understands how to manage the K-1 statement and cash distributions, this investment can be perfect for an investor seeking current income and tax deferral.

What Is the Difference Between a Limited Partnership (LP) and a Master Limited Partnership (MLP)?

A publicly traded partnership (PTP) is a type of limited partnership (LP) that is similar to a master limited partnership (MLP), and many MLPs are structured as PTPs. However, there can be some minor differences. PTPs, mostly in energy-related businesses, can offer investors quarterly income that receives more-favorable tax treatment. Additionally, not all MLPs are PTPs, because some are not publicly traded (although most are). And not all PTPs are MLPs; some could be publicly traded limited liability companies (LLC) that have decided to be taxed as a partnership.

What Happens When You Sell a Master Limited Partnership?

Just as with ordinary shares, when investors sell shares in MLPs for a profit they will face capital gains taxes. Holding periods of less than one year are treated as short-term capital gains, which are taxed as ordinary income. Holding periods of more than one year are taxed at the long-term capital gains rate, which is more favorable. Those sold for a loss will be treated similarly and can be used to offset capital gains elsewhere.

Are REITS Tax Exempt?

By law, REITs are required to pay out at least 90% of their taxable profits to shareholders as dividends. In return, REIT companies are exempt from most corporate income tax. Many REITs reinvest shareholder dividends, which offers deferred taxation and the compounding of gains.

The Bottom Line

Master limited partnerships (MLP) combine the tax benefits of a limited partnership with the liquidity of a common stock. To qualify to be an MLP, a firm has to earn 90% of its income through activities or interest and dividend payments related to natural resources, energy, commodities, or real estate.

Although these unusual investments are not well known, they can be attractive for individuals who are looking for current income and tax deferral.

How the savvy bond investor can beat Wall Street at its own game

Reviewed by Somer Anderson

Outperforming your average bond fund on a risk-adjusted basis is not a particularly difficult task for the savvy retail investor. For investors, learning how to create a successful bond portfolio starts with learning some simple allocation methods. The advantages of doing so can be immediate, such as avoiding the high management fees that some fund managers charge.

It’s also important for individual investors to understand that fixed-income fund managers aren’t necessarily interested in portfolio optimization, but tend to strive for performance that tracks a respective index. For example, the overall market capitalization of the U.S. fixed-income market is the basis for the popular fixed-income index followed by many fund managers: the Bloomberg U.S. Aggregate Bond Index, also known as “the Agg.”

How can it be so easy to beat Wall Street’s best at their game? Let’s take a look at how diversifying across the different classes is the basis of successful fixed-income investing, and how the individual investor can use simple bond allocation strategies to gain an advantage over fund managers.

Key Takeaways

• There are five asset classes for fixed-income investments: 1) government-issued securities, 2) corporate-issued securities, 3) inflation-protected securities (IPS), 4) mortgage-backed securities (MBS), and 5) asset-backed securities (ABS).
• Each of the fixed-income asset classes comes with investment risks, such as interest rate risk, credit risk, or liquidity risk.
• Diversification among the fixed-income asset classes is key to building a well-allocated bond portfolio.
• Building a bond ladder is a strategy fixed-income investors can implement to minimize risks and boost cash flows.

Types of Asset Classes

An enormous amount of innovation continues within the world of fixed income. Fixed income can be broken down into five asset classes:

• Government-issued securities
• Corporate-issued securities
• Inflation-protected securities (IPS)
• Mortgage-backed securities (MBS)
• Asset-backed securities (ABS)

For the retail investor, IPS, MBS, and ABS are all relatively new additions. The United States leads the world in the range and depth of fixed-income offerings—particularly with MBS and ABS. Other countries are developing their MBS and ABS markets. Government bonds, corporate bonds, IPSs, and MBSs tend to be readily available to retail investors. An ABS is not as liquid and tends to be more of an institutional asset class.

Interest Rate and Credit Risks

The key issue is that each of these asset classes has different interest rate and credit risks; therefore, these asset classes do not share the same correlation. As a result, combining these different asset classes into a fixed-income portfolio will increase its risk/return profile. All too often, investors only consider credit risk or interest rate risk when evaluating a fixed-income offering. In fact, there are other types of risk to consider.

For example, interest rate volatility greatly affects MBS pricing. Investing in different asset classes helps offset these other risks. Asset classes like IPS, MBS, and ABS tend to give you yield pickup without degradation in credit quality—many of these securities come with a AAA credit rating.

Government and Corporate Securities

Many investors are familiar with government and corporate bonds and their correlation during economic cycles. Some investors do not invest in government bonds because of their low yields, choosing corporate bonds instead. But the economic and political environments determine the correlation between government and corporate bonds. Pressure in either of these environments is positive for government bonds. “Flight to quality” is a phrase you will hear frequently in the financial press.

Inflation-Protected Securities (IPS)

Sovereign governments are the largest issuer of these bonds, and they guarantee a real rate of return when held to maturity. In contrast, normal bonds guarantee only a total return. Because inflation can quickly erode the gains that investors make on their investments, the real rate of return should be an investor’s focus.

Inflation-protected securities are often indexed to the rate of inflation in the issuing country, thus providing investors with protection from the negative effects of rising prices. In the United States, Treasury Inflation-Protected Securities (TIPS) are backed by the U.S. government and are considered a low-risk investment.

Mortgage-Backed Securities (MBS)

When considering the allocation of mortgage-backed securities in your bond portfolio, it’s important to understand the risks associated with these securities. In the U.S., institutions such as Fannie Mae and Freddie Mac buy residential mortgages from banks and pool them into mortgage-backed securities for resale to the investment community.

The risks of these securities became clear during the 2007–2008 mortgage meltdown, when the MBS market collapsed due to the high default rate of subprime mortgages. When banks and other lending institutions reduce their lending standards, the mortgages that comprise the MBS are riskier, thus placing the MBS investor at a higher risk of loss as well.

Interest Rate Risks

Another risk for the MBS market lies in interest rate fluctuation. Maturity is a moving target with these securities. Depending on what happens to interest rates after issuing the MBS, the maturity of the bond could shorten or lengthen dramatically. This is because the U.S. allows homeowners the ability to refinance their mortgages.

For example, a decline in interest rates encourages many homeowners to refinance their mortgages. Conversely, a rise in interest rates causes homeowners to hold on to their mortgages longer. This will extend the originally estimated maturity dates of MBSs. When purchasing an MBS, investors usually calculate some degree of prepayment into their pricing.

This ability to refinance mortgages in the U.S. creates an embedded option in MBSs, which gives them a much higher yield than other asset classes of equivalent credit risk. This option, however, means MBS prices are highly influenced by interest rate volatility.

Asset-Backed Securities (ABS)

The concept of an asset-backed security is similar to that of an MBS, but ABSs deal with other types of consumer debt, the largest of which are credit cards, student loans, and auto loans. An ABS, however, can be created from almost anything that has material and predictable future cash flows. For example, in the 1990s, royalties from David Bowie’s song collection were used to create an ABS.

The big difference between an ABS and an MBS is that an ABS tends to have little or no prepayment risk. The structure of most ABSs is at AAA, the highest credit rating. The liquidity of this asset class tends to be the lowest of the five.

Retail investors sometimes have difficulty understanding the ABS, which can make determining the appropriate allocation a challenge when creating a bond portfolio for the first time. However, as we discuss in the next section, there’s a simple strategy that any investor can use to resolve this problem.

Optimizing Your Bond Portfolio Allocation

When building a fixed-income portfolio, investors should look at diversification the same way as in equity investing—diversification within the asset class is just as important. Equity investors tend to diversify across different sectors (finance, energy, etc.) of the market. Creating a portfolio with material representation from all five fixed-income asset classes we’ve discussed here is one of the pillars of good fixed-income investing.

Mutual fund managers, however, generally don’t adhere to this rule of thumb because they fear they will deviate too far from their respective benchmarks. Savvy retail investors can bypass this weakness, though, and therefore gain an advantage in constructing their own portfolios. It’s a matter of carefully combining at least five high-quality bonds with representation from all fixed-income asset classes into a laddered, buy-and-hold portfolio.

Learning how to build a bond ladder is key to boosting returns. Obtaining yield pickup with no loss of credit quality gives an investor the ability to focus on a limited number of bonds.

Once again, with a little bit of work, the savvy retail investor can beat Wall Street at its own game.

What Are Retail Investors?

Retail investors are individuals who invest in the stock market for their personal accounts. At first, the influence of retail traders may seem small, but as time passes, more people are taking control of their portfolios and, as a result, the influence of this group is increasing.

What Is Fixed Income?

Fixed income refers to those types of investment securities that pay investors fixed interest or dividend payments until they mature. At maturity, investors are repaid the principal amount that they originally invested.

What Is a Bond Portfolio?

A bond portfolio is a collection of bonds that an investor owns. Bonds are fixed-income instruments and investment products where individuals lend money to a government or company at a certain interest rate for an amount of time. The entity repays individuals with interest in addition to the original face value of the bond.

The Bottom Line

For retail investors, learning some simple allocation methods is the start to learning how to create a successful bond portfolio that can beat fixed-income fund managers at their own game. Doing so can yield immediate advantages, such as avoiding the high management fees charged by some fund managers.

Reviewed by Thomas Brock

“Billions,” which premiered on Showtime in 2016, stars Paul Giamatti as a high-profile U.S. attorney with an 81-consecutive conviction streak, while Damien Lewis plays Bobby “Axe” Axelrod, a revered hedge fund manager and sole survivor of his firm after the terrorist attacks on Sept. 11, 2001. The show explores themes of wealth, ambition, loyalty, and betrayal, blending sharp dialogue with complex character dynamics.

Key Takeaways

• Paul Giamatti and Damien Lewis star in this drama set in the world of hedge fund managers and the New York City lawmen who pursue them.
• The show seems to have resonated with viewers newly attuned to Wall Street excesses.
• The show concluded in 2023.

How the Show Got Made

“Billions” is a fictional jaunt into the dynamic world of hedge funds. It was created by financial journalist Andrew Ross Sorkin and the writers of “Rounders,” Brian Koppelman and David Levien.

If the name Andrew Ross Sorkin sounds familiar, it’s because he is the author of “Too Big to Fail,” the definitive tell-all book about the 2008 financial crisis. Koppelman and Levien wrote “Rounders,” a novel about New York’s underground high-stakes poker scene that was later made into a movie starring Matt Damon. Sorkin’s “Too Big to Fail” was adapted into a film of the same name that aired on HBO in 2011.

Billions Cast

Here’s a quick rundown of the characters (along with the actor/actress who played each main part):

• Bobby “Axe” Axelrod (played by Damian Lewis): A billionaire hedge fund manager and co-founder of Axe Capital, known for his ruthless tactics, charm, and ambition.
• Chuck Rhoades (played by Paul Giamatti): A powerful U.S. Attorney with a deep commitment to justice, who becomes consumed by his personal vendetta against Bobby Axelrod.
• Wendy Rhoades (played by Maggie Siff): A brilliant performance coach and psychiatrist at Axe Capital, and Chuck’s wife, often caught between her professional and personal loyalties.
• Taylor Mason (played by Asia Kate Dillon): A highly intelligent, non-binary financial analyst who rises to prominence at Axe Capital and later establishes their firm.
• Mike Prince (played by Corey Stoll): A wealthy entrepreneur and hedge fund manager who becomes a rival to Axe, advocating for more ethical approaches to wealth and power.
• Lara Axelrod (played by Malin Åkerman): Bobby’s resourceful and strong-willed wife, who plays a key role in supporting his empire and protecting their family.
• Kate Sacker (played by Condola Rashad): An ambitious Assistant U.S. Attorney working closely with Chuck, navigating her career with sharp political instincts and determination.
• Bryan Connerty (played by Toby Leonard Moore): A principled yet conflicted prosecutor under Chuck, who struggles with loyalty and morality in high-stakes legal battles.
• Wags (Mike Wagner) (played by David Costabile): Bobby’s loyal and eccentric COO, known for his sharp wit, unapologetic lifestyle, and unwavering dedication to Axe Capital.

A Battle Between Power and Wealth

The show centers on a power struggle between two sharply defined characters.

Giamatti’s character, Chuck Rhoades, is a conflicted, moral man. While he is in service to his wife’s dominatrix tendencies, he is also serving the public as a successful Wall Street sheriff. With 81 straight convictions under his belt, he picks his battles against financial titans carefully but offers no leniency, even to those he has known his entire life.

At one point, Rhoades is confronted by his father and asked to step in on behalf of a family friend who has been convicted of insider trading. The decision leads to fatal consequences for the convicted, as Rhoades must confront the weight of his power on Wall Street.

Sorkin told “Modern Trader” that Chuck Rhoades is based on a number of attorneys that he witnessed over the years as a journalist covering white-collar crime.

Potential Inspirations

A viewer can see elements of former New York Attorney General Elliot Spitzer, who prosecuted many white-collar cases in the wake of the dot-com crash, and former U.S. Attorney for the Southern District of New York Preet Bharara, who won 85 straight convictions on insider trading cases.

Hedge fund manager Bobby Axelrod, though, is not based on any single Wall Street hedge fund manager.

Damien Lewis said that he read hedge fund manager David Einhorn’s book, “Fooling Some of the People All of the Time,” to prepare for the role. And it is merely a coincidence that Bobby Axelrod shares the same initials as activist investor and Pershing Square Capital founder Bill Ackman.

“Bobby Axelrod is his own character,” Sorkin said in the same interview. “He isn’t based on any one individual, but he shares a lot of qualities of lots of people in the hedge fund world.”

Better Understanding Axelrod

Axelrod is also a complex character. Perhaps most striking about him is that despite all of his wealth, his marriage, and two sons, Axelrod seems alone. He’s able to discuss his personal issues and motivations only with his company’s trading psychologist, a woman who happens to be Chuck Rhoades’ wife.

He has always tried to be careful in his work and life, but his decision to purchase a $63 million mansion marks a serious break from that cautious approach. When Rhoades advises him to not purchase the mansion, it simply makes Axelrod want it even more.

The final push comes when Axelrod sees his family pet whimpering on the ground after it has been neutered and forced to wear a protective cone. (There’s a pretty obvious metaphor here.) He allows his ego to overtake him. But it soon appears that the decision to make such a high-profile purchase may set him up for failure later in the season.

That purchase is the launching point of an investigation of his firm’s activities and the conclusion of the first episode.

Important

It should go without saying that the following section contains spoilers about the show.

Conclusion of Billions

As Billions builds toward its conclusion, the long-standing rivalry between Axelrod and Rhoades comes to a climactic head. With Bobby having retreated to Europe after his legal troubles and Mike Prince now in control of Axe Capital, the dynamics shift dramatically. The final season pivots from Axe’s dominance to the power struggle between Chuck and Prince, with Bobby eventually re-emerging as a wildcard.

Mike Prince’s downfall is a significant focus in the closing episodes. While he initially presents himself as a reformer aiming to redefine capitalism, his methods and ego ultimately reveal him to be no better than his predecessors. His presidential ambitions become his Achilles’ heel, as both Axe and Chuck exploit his weaknesses, unraveling his carefully curated public image.

The show also ties up key personal relationships, particularly those involving Wendy Rhoades. Her journey of self-discovery leads her to question her loyalties to both Chuck and Axe, eventually choosing her own path. The relationship between Chuck and Wendy reaches a bittersweet resolution, with mutual respect but an acknowledgment that their marriage has irreparably changed.

In the end, Billions emphasizes the cyclical nature of power struggles in finance and law. While the players may change, the game remains the same, with new rivalries and alliances forming. However, the characters evolve, reflecting on the costs of their ambitions and the limits of their morality.

Similar Shows to Billions

If you just finished watching Billions, here are five other shows you might find interesting:

1. Succession is a drama about the power struggles within a wealthy and dysfunctional family running a global media empire, filled with sharp dialogue and cutthroat maneuvers.
2. House of Cards is a political thriller exploring the ruthless rise to power of Frank Underwood and his wife Claire, featuring intricate scheming and high-stakes drama.
3. Industry is a series following ambitious young graduates navigating the intense and competitive world of international banking and finance in London.
4. Mad Men is a critically acclaimed drama set in the 1960s advertising industry, delving into power dynamics, ambition, and personal struggles in a high-pressure corporate environment.
5. Suits is a legal drama revolving around a brilliant college dropout who becomes a lawyer at a top Manhattan firm, blending courtroom drama with office politics and personal rivalries.

The Bottom Line

Showtime’s “Billions” is a unique character study that pits political power against extreme wealth in the world of hedge fund finance and government oversight. The show ran from 2016 to 2023.