Reviewed by Charlene Rhinehart

Home-sharing sites like Airbnb are a good source of supplemental (and even full-time) income, providing an easy way to rent out a portion of or all of your home. But before renting to temporary guests, you’ll want to review your homeowners insurance policy or speak to your insurer about whether you need additional coverage. 

Some insurers offer short-term rental coverage endorsements for an additional fee—ensuring that you’re protected in case of tenant-caused property damage, theft, or accidents. Others may require a separate, standalone policy depending on your property’s location and overall risk.

Key Takeaways

• Standard homeowners insurance generally offers limited business property coverage and no business liability coverage for Airbnb or other short-term rentals. 
• Occasionally, insurers will extend one-off coverage for a short-term rental if you notify them in advance. 
• Several other insurance options exist for home-sharing, including policy endorsements (home insurance add-ons) and separate short-term rental insurance, as well as landlord insurance tailored for short-term rentals.
• Airbnb’s free supplemental host coverage provides $1 million in liability insurance and $3 million in host damage protection. However, it only covers your property during the rental period and has other coverage gaps.

Short-Term Rental Coverages by Insurance Type
	Dwelling Coverage	Personal Belongings Coverage	Liability Coverage	Loss of Rent Coverage
Standard Home Insurance	Maybe	Maybe	Maybe	✘
Home-Share Insurance	✔	✔	✔	✔*
Airbnb AirCover for Hosts	✔**	✔**	✔**	✔***
Landlord Insurance	✔	✔****	✔	✔*

*Availability depends on the insurer or may be offered as an endorsement

**Coverage is only applicable during a guest’s stay and does not apply between stays. 

***Loss of income is only reimbursed for confirmed Airbnb bookings canceled because of guest damage

****Coverage may be limited to items needed for home-sharing

Homeowners Insurance and Short-Term Rentals

Opening your house to strangers through home-sharing is a good way to make extra money, but it also presents additional risks and liabilities that standard homeowners insurance isn’t designed to cover. Because of this, homeowners insurance may not cover paying guests staying in your home, even for one-off rentals. Some insurers may allow for occasional rentals if you provide advance notice.

Standard home insurance typically provides limited coverage or no coverage at all for business activities. So if you’re booking regular short-term rentals, your insurance company will likely consider this a business and may require additional coverage, such as a policy endorsement or separate home-sharing insurance.  

Important

Your insurer may not cover home-sharing or rentals even if it’s not explicitly excluded in your policy. Before renting out your home, consult with your insurer or your state’s department of insurance to determine what coverage is required to ensure your property is adequately protected. 

Extending Coverage with Endorsements

Some insurance companies offer riders (or endorsements) for short-term rentals that you can add to your policy for an additional fee. This is generally the easiest way to get home-sharing coverage, as you can just add it to your existing homeowners policy. However, this option may not be available for detached structures or buildings on your property that you rent out. Home-sharing endorsements may have a business activity exclusion for other separate, standalone structures. 

Note

Endorsements may only be available for your primary home, not for a secondary or vacation home that you are renting out.

Short-Term Rental Insurance

Standalone short-term rental insurance is a specialized form of coverage tailored for short-term rentals. These policies often insure your home in the same way as a standard homeowners policy, but provide additional protection for your home’s physical structure, household belongings used as part of the rental, and lost rental income while the house is under repair for covered damage. They also include liability protection in case a guest or someone else is injured during the stay and you’re deemed legally responsible.  

Short-term rental insurance may also provide additional protections, such as covering extra utility costs when a guest forgets to turn off the lights or leaves the faucet running. 

Landlord Insurance

Landlord insurance is typically used for long-term rentals, such as those lasting six months or more. Some insurers may also offer this coverage for short-term rentals like Airbnbs. 

Landlord insurance is similar to homeowners insurance in that it can offer liability protection and cover the costs to replace, repair, or rebuild your property from a covered peril, such as fire, wind, or lightning. It may also have coverage for certain belongings you keep in the home, such as appliances and furniture. Home-share specific policies can even have extended personal belongings coverage. 

The most significant difference between landlord and homeowners insurance is that it may also offer rental income protection, allowing you to receive lost income while your home is being repaired after a covered loss. These policies are also more expensive, typically costing 25% more than standard homeowners insurance. 

Which Companies Offer Short-Term Rental Coverage?

Standard homeowners insurance is much more widespread than short-term rental insurance, but you can find home-sharing insurance offered by:

• Allstate: Allstate’s HostAdvantage policy add-on is available to existing policyholders. It enhances your home insurance with $10,000 of personal property protection for damage not covered by your policy. It also covers belongings stolen by guests. 
• American Family: American Family’s homeowners insurance endorsement (available in 19 states) is for existing policyholders who rent out their home for 62 days or less. You’ll have many of the same benefits from your standard home insurance policy extended to your short-term rental. 
• Foremost: Foremost’s landlord policies are unique in that they can cover short-stay home rentals and extended rentals of 12 months or less. The company offers $1 million in liability and dwelling coverage. Its policies are customizable and can be built up or pared down based on your needs.
• Proper Insurance: Unlike other companies on this list, Proper specializes in short-term rental insurance. Its comprehensive all-risk policies cover all causes of damage except those specifically excluded in the policy, and have higher liability coverage limits than competitors. 

Airbnb Host Coverage

Airbnb includes free supplemental coverage called AirCover for Hosts, which provides $1 million in liability insurance if you are found legally responsible for a guest’s injury, damage to their property, or theft of their belongings.

This coverage also offers up to $3 million in host damage protection, covering your home and your belongings in the event of guest-caused damage. However, host damage protection isn’t a substitute for actual insurance. 

AirCover also won’t protect your home between guest stays if there are damages or liability issues.

State-Specific Requirements

Some states have minimum insurance requirements you must meet for short-term rentals. Massachusetts, for instance, mandates homeowners carry at least $1 million in liability coverage. If using home-sharing platforms like Airbnb, verify that any included host liability insurance is enough to meet your state’s laws or if additional insurance is necessary. 

The Bottom Line

Contact your insurance company before listing your home on Airbnb to understand your short-term rental coverage needs and options. Insurers may require you to add a rider to your policy or purchase a standalone policy as a condition for coverage.

While Airbnb offers its own supplemental protection, this coverage has significant limitations and isn’t a replacement for an insurance policy. When you secure the right coverage, you protect your investment and gain peace of mind as you welcome paying guests into your home.

We independently evaluate all recommended products and services. If you click on links we provide, we may receive compensation.

The best protection against bad trouble is good planning

Life is full of financial surprises—job loss, car repairs, inflation, or medical emergencies can disrupt even the most carefully laid plans. Yet only 54% of Americans say they have enough savings to cover even just three months of expenses.

To help plan for an emergency, there are several steps you can take to help build a stronger foundation through goal-setting, improved saving behaviors, and debt management. 

Key Takeaways

• Building a rainy day fund that covers three months of expenses is important for withstanding unexpected setbacks such as car repairs, a loss of job, or reduced work hours.
• Paying down debt during stable periods frees up cash flow and reduces financial strain during emergencies.
• Good health insurance plays a critical role in cushioning the blow of sudden medical expenses and income loss.

How to Build Financial Health

The best way to protect yourself from a financial shock is good planning. A financial advisor can help with this, but it is something you can get started on by yourself, if you know where to start. To help build resilience against unplanned events, consider the following strategies that will improve your financial health:

Make a Budget

In 2024, just 47% of Americans spent less than their income amid a rising cost of living. The first step to financial security is knowing where your money goes. Track your income and routine monthly expenses in order to identify where you can reduce costs and save more.

Then, develop a realistic budget that you can follow. Many budgeting calculators can help serve as a starting point, the you’ll need to gather up all your fixed expenses as well as any recurring bills and subscriptions, and you’ll need to know all of your sources of income.

“The most valuable first step in emergency proofing your finances is to have a grasp on monthly cash flow,” says David Bigelow, a wealth manager at Coldstream Wealth Management.

Set Up an Emergency Savings Fund

Set a specific savings goal—typically enough to cover at least three months of expenses—and build toward it over time. Contribute a consistent amount from each paycheck or automate transfers into a dedicated emergency fund.

Even small, regular contributions to a dedicated account can add up and provide a critical buffer when life throws a curveball. A good high-yield savings account offers more flexibility to withdraw your money when you need it, but pays more interest than your average savings account. Alternatively, a money market account offers benefits similar to those of a high-yield savings account, but you can write checks from the account.

Some experts recommend saving at least six months of expenses in your emergency fund.

Pay Down High-Interest Debt

The median average credit card rate in the U.S. is 24.2%, which eats up a significant amount of money over time. Making matters worse, 30% of Americans struggle with debt management.

By paying off high-interest debt, it will leave more funds available to save and limit your exposure to a costly cycle of debt. If tackling this debt feels overwhelming, consider using a credit counselling service.

Organize Important Legal Documents

To prepare for the worst-case scenarios, such as death, severe medical emergencies, and disasters, make sure to have documents including a power of attorney, health-care directive, and a will organized in one place.

This type of planning can ease the burden on loved ones and protect your wishes in times of crisis.

Get Health Insurance

In 2023, 8% of the American population did not have health insurance, equal to 26 million people. Given that a single night at the hospital can cost on average $2,883, having adequate health insurance can be a worthwhile investment for sheltering you from these costs.

Invest for the Future

Investing is a powerful way to grow your assets thanks to the power of compounding. It can also help offset the impact of inflation over time. Not only that, people with investments perform stronger on financial health indicators—such as those who are confident in reaching their long-term financial goals, pay all bills on time, and have a manageable amount of debt.

By making these positive financial decisions, even with a limited budget, you can protect yourself from jeopardizing your long-term goals. “Taking the necessary steps so that you’re un-sinkable from a personal finance standpoint is key to staying in the game,” says Bigelow.

Fast Fact

People who plan ahead for a significant and unexpected expense are more likely to be financially healthy by a factor of tenfold than those who don’t.

Moreover, these planning skills are the single strongest predictor for financial health—even more so than income.

The Bottom Line

Financial setbacks are almost inevitable, but their consequences don’t have to be devastating. Whether it’s a medical bill, job loss, or emergency home repair, taking proactive steps—like building savings, reducing debt, and maintaining health coverage—can provide the cushion needed to recover.

Even a modest emergency fund can make a meaningful difference, helping prevent temporary disruptions from turning into long-term setbacks.

Reviewed by Julius Mansa
Fact checked by Patrice Williams

What Is the Invesco QQQ ETF?

The Invesco QQQ ETF is an exchange-traded fund (ETF) that tracks the Nasdaq 100 Index. Because it passively follows the index, the QQQ share price goes up and down along with the tech-heavy Nasdaq 100.

Passive management keeps fees low, and investors are rewarded with the full gains of the volatile index if it rises. But they must also bear the Nasdaq 100’s full losses when it falls. In this article, we explain how the QQQ ETF works and then consider the risks and rewards associated with trading the QQQ.

Key Takeaways

• The Invesco QQQ ETF is a popular exchange-traded fund that tracks the Nasdaq 100 Index.
• QQQ holdings are dominated by big technology-related companies such as Apple, Amazon, Alphabet, and Meta.
• The QQQ ETF offers investors big rewards during bull markets, with the potential for long-term growth, ready liquidity, and low fees.
• QQQ usually declines more in bear markets, has high sector risk, often appears overvalued, and holds no small-cap stocks.
• This ETF allows traders to invest in the largest 100 non-financial companies listed on the Nasdaq.

How Invesco QQQ ETF Works

QQQ has 101 holdings and is the seventh-most popular ETF in the world by three-month average daily share volume. The index excludes financial companies and is based on market capitalization. Like the Nasdaq 100, QQQ holdings are heavily weighted toward large-cap technology companies. The assets under management (AUM) of QQQ were over $297 billion as of April 28, 2025.

The Invesco QQQ ETF was previously known as the PowerShares QQQ Trust ETF. It is also informally called the triple-Qs or the cubes. The QQQ ETF is often viewed as a snapshot of how the technology sector is trading.

The Nasdaq 100 Index that the QQQ share price follows is based on a modified capitalization methodology. This modified method uses individual weights of included items according to their market capitalization. Weighting allows constraints to limit the influence of the largest companies and balance the index with all of its members. To accomplish this, Nasdaq reviews the composition of the index each quarter and adjusts weightings if the distribution requirements are not met.

The Invesco QQQ ETF offers the public an easy way to invest in the 100 largest non-financial companies listed on the Nasdaq.

QQQ ETF Quick Facts
Ticker	QQQ
Tracked Index	Nasdaq 100
Inception Date	03/10/1999
Expense Ratio	0.20%
# Holdings	101
Brand	Invesco
Avg. 30 Daily Volume	64.69 million (April 28, 2025)

QQQ ETF Sectors

The Invesco QQQ ETF tracks many high-tech sectors, including information technology (IT), communications services, and healthcare. The QQQ is rebalanced quarterly and reconstituted annually to track the Nasdaq 100 index.

It is important to remember that some of the companies people associate with technology are generally classified in other sectors. For example, Alphabet Inc. (GOOGL, Google’s parent company) and Meta Platforms, Inc. (META, formerly known as Facebook) are under the communications services sector. Amazon.com, Inc. (AMZN) is part of the consumer discretionary sector.

Important

Trading the QQQ ETF is a good way to get the rewards of investing in technology stocks without the risks of betting on individual companies.

The sector breakdown of the Invesco QQQ ETF as of June 22, 2024, appears in the table below.

Invesco QQQ ETF Sector Breakdown
Sector	Share of QQQ
Information Technology	58.94%
Consumer Discretionary	17.90%
Health Care	6.29%
Industrials	4.64%
Telecommunications	4.41%
Consumer Staples	3.87%
Basic Materials	1.94%
Utilities	1.24%
Energy	0.50%
Real Estate	0.29%

QQQ ETF Top Holdings

The top 10 stocks in the Invesco QQQ ETF made up about 51% of all QQQ holdings as of Q2 2024. They are given in the table below.

Invesco QQQ ETF Top Holdings
Stock	Share of QQQ
Microsoft (MSFT)	8.75%
Nvidia Corp. (NVDA)	6.32%
Apple (AAPL)	7.41%
Broadcom (AVGO)	4.44%
Amazon (AMZN)	5.25%
Meta Platforms (META)	4.76%
Alphabet (GOOGL)	2.49%
Alphabet (GOOG)	2.42%
Costco (COST)	2.35%
Tesla Inc. (TSLA)	2.37%

The top holding of the QQQ ETF holding is Microsoft Corporation (MSFT), which had a market cap of more than $3.3 trillion in Q2 2024.

Meanwhile, Nvidia became one of the top-performing tech stocks in 2024. Apple Inc, Alphabet, and Amazon all have strong operating cash flows and are very popular with investors and funds. Most of these top stock holdings consistently deliver on the bottom line and are able to navigate change without harming their investors. While still offering legacy products like operating systems, Microsoft has successfully reinvented itself, transitioning to its cloud-based Azure and artificial intelligence.

QQQ Dividend History

QQQ Dividend History Since 2003
Year	1st Quarter	2nd Quarter	3rd Quarter	4th Quarter
2003	–	–	–	$0.0136
2004	–	–	–	$0.3786
2005	–	$0.0348	–	$0.1011
2006	$0.0291	$0.0257	$0.0234	$0.5445
2007	$0.0267	$0.0369	$0.0260	$0.0533
2008	$0.0325	$0.0344	$0.0281	$0.0435
2009	$0.0489	$0.0439	$0.0408	$0.0776
2010	$0.0515	$0.0893	$0.1116	$0.1083
2011	$0.0769	$0.1208	$0.1043	$0.1605
2012	$0.1128	$0.1431	$0.2002	$0.3666
2013	$0.1593	$0.2236	$0.2377	$0.2724
2014	$0.3731	$0.2061	$0.2491	$0.2378, $0.3867
2015	$0.2481	$0.2542	$0.2600	$0.3423
2016	$0.3178	$0.2866	$0.2939	$0.3549
2017	$0.2742	$0.3784	$0.3192	$0.3294
2018	$0.2766	$0.3784	$0.3296	$0.4206
2019	$0.3241	$0.4156	$0.3842	$0.4577
2020	$0.3627	$0.4243	$0.3882	$0.5613
2021	$0.3947	$0.3968	$0.4139	$0.4914
2022	$0.4337	$0.5274	$0.5186	$0.6554
2023	$0.4722	$0.5039	$0.5356	$0.8083
2024	$0.5735	$0.7615	–	–

QQQ Pros and Cons

Like most assets, the QQQ ETF has specific strengths and weaknesses that investors need to consider before putting it in their portfolios.

QQQ Pros

• Big bull market rewards: If you’re feeling bullish or want a bullish investment for an asset allocation, the QQQ ETF is a good choice. The QQQ price increases more than the S&P 500 during bull markets.
• Long-term growth potential: QQQ holdings include many companies that develop new technologies. That gives the QQQ ETF more potential for long-term growth. QQQ is also much more diversified across the growth technology sector. This means it is safer to diversify capital allocation in the tech sector through investment in QQQ than making individual investments.
• Liquidity: Frequent traders need to buy and sell quickly at a low cost. The QQQ ETF offers them this liquidity. AUM for QQQ reached more than $228 billion in 2024, providing a large market for traders.
• Low expenses: The QQQ ETF’s expense ratio was 0.2% as of Q2 2024. Reducing the expense ratio is the only guaranteed way to increase returns from fund investments because expenses can add up over time.

QQQ Cons

• High bear market risk: Just as QQQ tends to outperform the S&P 500 during bull markets, it also often underperforms it during bear markets. In particular, the QQQ share price declined significantly when the dotcom bubble collapsed.
• Volatility risk: Tech sector stocks are growth stocks and are more volatile than the rest of the market. As a result, the Nasdaq 100 also makes many more significant daily, monthly, and annual moves than other indexes, such as the S&P 500. For example, the fund had annual returns of -0.12% in 2018, 38.96% in 2019, -32.58% in 2022, and 54.85% in 2023.
• Nasdaq-only focus: The fund has a Nasdaq-only focus and excludes successful tech companies listed on other exchanges. For example, Salesforce.com, Inc. (CRM), which is listed on the New York Stock Exchange (NYSE), is not included in the index. Neither are Oracle Corporation (ORCL) nor Block, Inc. (SQ), both of which are listed on the same exchange.
• Sector risk: The root cause of the QQQ ETF’s high risks and rewards is that it places more weight on volatile technology-related sectors than the S&P 500. There is also a sector risk that Nasdaq 100 stocks will eventually become less important, much like the railroad companies that once dominated the Dow Jones Transportation Average (DJTA). Investors already talk about old tech stocks vs. mostly newer FAANG stocks within the Nasdaq.
• High valuation levels: QQQ holdings tend to be too expensive by most of the standards value investors use. For example, QQQ had a price-to-earnings ratio of 30.26 on June 22, 2024.
• No small-cap stocks: Because the QQQ ETF holds only 100 of the Nasdaq’s largest companies, it necessarily excludes small-cap stocks. Small caps outperformed larger companies in the long run, according to research by Fama and French. Furthermore, growth investing also emphasizes small companies because they have more room to grow.

Pros

• Big bull market rewards

• Long-term growth potential

• Liquidity

• Low expenses

Cons

• High bear market risk

• Sector risk

• High valuation levels

• No small-cap stocks

• Volatility risk

• Nasdaq-only focus

QQQ Performance

Being more heavily weighted toward growth stocks and high-tech sectors, the Nasdaq 100 (and, by extension, the QQQ ETF, which tracks the index) has outperformed the broader S&P 500 over the past several years.

As the chart below depicts, over the nearly seven-year period from Q3 2017 through Q2 2024, the QQQ has returned 234.71%, nearly double what SPY (an S&P 500 ETF) has returned.

18.59%

The average annual return of QQQ was 18.59% during the 10 years ended Q1 2024.

What Companies Make Up the QQQ ETF?

Stock holdings in the QQQ ETF include 100 of the biggest companies in the Nasdaq, which tend to be tech giants such as Apple, Amazon, Google, and Meta. The top 10 stocks in the portfolio make up over half of its total holdings.

Is QQQ Stock Worth Buying?

QQQ is one of the best choices for active traders who are bullish on large technology companies. It is also one of the most popular Nasdaq-tracking ETFs, although several others also exist.

What Stocks Make Up QQQ?

QQQ mirrors the Nasdaq 100, which is a tech heavy index of large cap stocks listed on the Nasdaq. Companies in Microsoft, Apple, Nvidia, Broadcom, and Alphabet.

Is QQQ the Same as Nasdaq?

QQQ is an index fund offered by Invesco that mimics the returns of the Nasdaq 100 index. Nasdaq is a stock exchange that provides a stock trading platform.

The Bottom Line

The Invesco QQQ ETF checks many of the boxes short-term traders look for in ETFs, and it also has significant advantages for long-term investors. The ETF offers liquid, cost-efficient exposure to a tech-heavy basket of large-cap, innovative companies. Furthermore, investors benefit from increases in the QQQ share price without being burdened by stock-picking issues.

But those advantages are offset by sector concentration and volatility. Stocks contained within the index also have significantly high valuation levels and P/E ratios. This makes them susceptible to steep increases or declines. There are no small-cap stocks in the index to minimize the reliance on large-cap tech stocks.

Here are three ways to make your monthly payments more affordable

Fact checked by Michael Logan
Reviewed by Pamela Rodriguez

If you have a home equity line of credit (HELOC) that’s nearing the end of its draw period and about to enter its repayment period, brace yourself: You could be in for much higher monthly payments. That’s because your new payments will consist of both principal and interest, unlike the interest-only (or interest plus a small amount of principal) payments your lender likely required during the draw period.

There are several ways to deal with this situation if the new payments prove to be a problem. This article explains your major options and their pros and cons.

Key Takeaways

• When the draw period of your HELOC ends and the repayment period begins, you could face much higher monthly payments.
• If those payments are unmanageable, you might want to consider refinancing your HELOC.
• You can refinance with a new HELOC, a home equity loan, or a new first mortgage.
• If you don’t qualify for refinancing, and can’t afford your new HELOC payments, ask your lender or loan servicing company about a loan modification.

Ways to Refinance Your HELOC

If you’re looking to refinance your HELOC, you might do so with a new HELOC, a home equity loan, or a new first mortgage. Here are the basics of each option.

1. Refinance With a New HELOC

How It Works: If a lender (either your current bank or a different one) approves your application for a new HELOC, you may be able to roll your existing HELOC’s balance into it. This essentially restarts your draw period.

Pros: Taking out a new HELOC allows you to put off those larger payments you were facing for another five or 10 years, or whatever draw period the lender agrees to. This might make sense if you are reasonably confident that you’ll be in a better financial position when the new HELOC goes into repayment mode and won’t have a problem with the new payments. You might also be able to switch from a variable-rate HELOC to one with a fixed-rate option.

Cons: All you’re really doing here is postponing the inevitable: At some point you’ll need to repay your entire balance. What’s more, since interest will be accumulating all the while, your payments will be even higher than the ones you’ve managed to avoid.

2. Refinance With a Home Equity Loan

How It Works: You take out a home equity loan and use it to pay off your HELOC in a lump sum.

Pros: A home equity loan has several potential advantages over your home equity line of credit. One is that these loans typically have fixed interest rates, while HELOCs usually come with variable rates. A fixed rate gives you predictability for budgeting purposes as well as some protection against rising rates. In addition, home equity loans often have terms (lengths) of up to 30 years, giving you a longer time to repay than a HELOC, which usually allows 20 years at most.

Cons: As with a new HELOC, taking out a home equity loan to repay your HELOC means that your debt will continue to grow. What’s more, home equity loans generally require you to make both principal and interest payments for the entire term, so you could be faced with higher payments from the outset.

3. Refinance With a New First Mortgage

How It Works: You take out a new mortgage to refinance both your existing first mortgage and the HELOC. One way to do this is through a cash-out refinance. With a cash-out refinance you take out a mortgage that’s larger than your current mortgage balance, pay off that balance, and then use the remaining cash for whatever you wish. In this case that would be paying off the HELOC.

Pros: The interest rates on primary mortgages tend to be lower than those on HELOCs or home equity loans, so you could see substantial savings right there. You can opt for a mortgage with a fixed rate if you wish, and terms of up to 30 years are common.

Cons: Depending on the prevailing rates when you apply, you might have to accept a higher interest rate on the new mortgage than you had on your old one, making it more expensive. In addition, closing costs on a mortgage can be substantial—often 2% to 5% of the total loan amount on top of your down payment. With a $300,000 mortgage, for example, that’s $6,000 to $15,000. Some lenders will cover your closing costs if you take out a HELOC.

Warning

HELOCs sometimes have prepayment penalties if you attempt to pay them off ahead of schedule. So it’s smart to read your loan contract or check with your lender first.

How to Qualify to Refinance Your HELOC

Whatever method you use to refinance, the lender will want to assure itself that you’re a good risk. For starters, any lender you apply to is likely to review your credit report and check your credit score.

As a general rule, you’ll need a FICO score in the 700s or high 600s to qualify for a good rate. You may need a score of at least 620 to qualify at all.

The lender will also want information on your income (which is not included in your credit report). So you might have to provide pay stubs, W-2 forms, and one or more recent tax returns, among other documentation.

Based on that information and a list of your current debt payments, the lender will calculate your debt-to-income (DTI) ratio. That ratio compares your gross income to your total monthly debt obligations to make sure you aren’t getting in over your head. Many lenders like to see a DTI no higher than 36%.

Of course, the home itself also comes into the picture. Lenders will typically require a new appraisal to determine its fair market value. They’ll use that to compute your combined loan-to-value (CLTV) ratio, which compares how much you owe on the home to its current value. Lenders generally prefer that your CLTV (including any new loan) not exceed 80% or 85%.

What if I Don’t Qualify to Refinance My Home Equity Line of Credit (HELOC)?

If you can’t keep up with your HELOC payments and don’t qualify for new financing, one option is to contact your current lender or loan servicer and ask about a possible loan modification. Some lenders will be willing to work with you, and some won’t. Loan modification can take a variety of forms, all with the goal of making it easier for you to pay your debt (and to ensure that the lender gets at least a portion of what you owe them). For example, the lender might agree to defer your payments for a time, reduce your payments by stretching them out over a longer period, lower your interest rate, or even cut the amount you owe. The time to apply for a loan modification is as soon as you realize you’re not going to be able to afford your payments. Putting it off only makes the situation worse.

Can I Take Out a Personal Loan to Refinance My HELOC?

Yes, a personal loan could be an option if you can get one that’s large enough to cover your HELOC balance. Personal loans are typically unsecured, so it can be difficult to obtain one with a good interest rate unless you have very strong credit, such as a FICO score in the 700s. Personal loans also have relatively short repayment terms, usually 84 months or less, so you might find that your monthly payments are even higher than with your HELOC.

What Happens if I Can’t Repay My HELOC?

Because your home serves as collateral for your HELOC, the lender could potentially seize and sell it if you can’t repay. That’s also true for first mortgages and home equity loans. As mentioned above, however, many lenders have loan modification programs that are intended to avoid that. Bear in mind that defaulting on a loan can do long-lasting damage to your credit, so it’s worth avoiding if at all possible.

The Bottom Line

If the monthly payments on your HELOC become unmanageable, refinancing it could be your best recourse. There are a number of ways to go about it, each with their own pros and cons. If you find you can’t qualify for a new HELOC or other loan for whatever reason, contact your current lender and ask if a loan modification is possible. It is often in the lender’s best interests, as well as yours, to modify your HELOC to make your monthly payments affordable.

You can use your IRA to buy a first home, without penalties

Fact checked by Hans Daniel Jasperson

Yes, you can use your individual retirement account (IRA) to buy a house, but there are rules and potential tax implications. For a first-time home purchase, both traditional and Roth IRAs allow you to withdraw up to $10,000 at any time or age—whether the money consists of earnings or contributions—without the usual 10% early withdrawal penalty. However, you may still owe taxes. If you’re thinking about using IRA funds for purchasing a home, you should take an in-depth look at the pros and cons, and consider the long-term impact it could have on your retirement savings to help you decide if it is the right move for you.

Key Takeaways

• Traditional and Roth IRAs provide exceptions to allow investors to withdraw up to $10,000 to purchase, build, or rebuild a first home.
• $10,000 is the lifetime limit for the first-time homebuyer exemption.
• Both you and your spouse can each access up to $10,000 for the first-time homebuyer exemption.
• First-time homebuyer exemption can be used to help pay for qualified acquisition costs of a home for: yourself, your spouse, your child, grandchild, or parent.

First-Time Homebuyer Exemption

A first-time homebuyer is someone who hasn’t owned a home as their primary residence in the previous two years, the IRS says. If you are married, your spouse must also meet this definition of a first-time homebuyer. The IRS allows a first-time homebuyer to withdraw up to $10,000 from an IRA without incurring the 10% early withdrawal penalty, which normally applies to distributions taken before age 59½. For a withdrawal of earnings from a Roth IRA to escape tax and penalty, the account or any other Roth IRA owned by the account holder must be at least five years old. The first-time homebuyer exemption applies to both traditional and Roth IRAs, but the tax treatment is different. To qualify, the funds must be used within 120 days to buy, build, or rebuild a first home for yourself, a spouse, a child, grandchild, or parent. The $10,000 limit is a lifetime cap per individual.

It is important to note that if you have received a first-time homebuyer distribution and the acquisition of the home is canceled or delayed, generally, you may contribute the amount of the distribution to an IRA within 120 days of the distribution to avoid paying income tax or the 10% additional tax on early distributions.

Traditional IRA

When using money from your traditional IRA to buy a home using the first-time homebuyer exemption, you can withdraw up to $10,000 without paying the 10% early withdrawal penalty if the funds are used to buy, build, or rebuild a first home. However, the amount you withdraw is still subject to ordinary income tax since traditional IRA contributions are made with pre-tax dollars.

Roth IRA

Like the traditional IRA, you are allowed to withdraw up to $10,000 of earnings from your Roth IRA without the 10% early withdrawal penalty if the funds are used to buy, build, or rebuild a first home. To qualify for a tax-free and penalty-free withdrawal, the portion of the distribution allocable to earnings must have been open for at least five years from the beginning of the year for which you first set up and contributed to your Roth IRA. Unlike traditional IRAs, Roth IRA contributions can always be withdrawn tax-free and penalty-free because these contributions are made with after-tax dollars. Only the earnings portion of your Roth IRA is subject to these rules.

Pros and Cons of Withdrawing Early From Your IRA

Withdrawing early from an IRA is a major financial decision that should not be taken lightly. Using funds from your IRA to buy a home, even under the first-time homebuyer exemption, still comes with potential tax implications and long-term financial consequences. It’s crucial to evaluate all options and consider the long-term impact on your retirement funds before proceeding.

Pros:

• Penalty-Free Withdrawal (First-Time Homebuyer Exemption): With the first-time homebuyer exemption, you can withdraw up to $10,000 from a traditional or Roth IRA without paying the 10% early withdrawal penalty.
• Jumpstart Homeownership: Using IRA funds can help you purchase a home sooner than you might otherwise be able to, allowing you to start building equity in an asset you own, rather than continuing to rent.
• Flexible Use of Funds: The withdrawn money can be used for various home-acquisition expenses, including closing costs or a downpayment. You are also able to use your lifetime limit of $10,000 toward helping a family member such as a child, grandchild, or parent, if you don’t need to use it all yourself.

Cons:

• Potential Tax Liability: Even though the early withdrawal penalty is waived, you may still owe income taxes on the amount withdrawn from a traditional IRA. This could result in a higher tax bill for the year of the withdrawal.
• Reduced Retirement Savings: Taking money out of your IRA means you’ll have less saved for retirement, potentially impacting your long-term financial goals and growth due to lost compounding interest over time.
• Lifetime Limit on Exemption: The $10,000 first-time homebuyer exemption is a lifetime limit, so once you use it, you won’t be able to get this tax-advantaged exemption again. Additionally, the amount is limited to only $10,000, which may not meet your entire need when trying to pull together a downpayment or come up with closing costs.

The Financial Impacts of an Early Withdrawal

While the first-time homebuyer exemption allows an IRA account holder to withdraw up to $10,000 without an early withdrawal penalty, doing so can still impact long-term financial growth. For instance, if a 30-year-old withdraws $10,000 from their IRA and the account would have earned an average annual return of 5%, that amount could have grown to nearly $55,000 by age 65. By using the funds now, they could miss out on around $45,000 in potential gains—significantly reducing the value of their retirement savings.

Alternatives to Using Your IRA for a House

Before tapping into your IRA to finance a home purchase, it’s important to explore other options that may better preserve your retirement savings. While the first-time homebuyer exemption offers penalty-free access of up to $10,000 of funds, there are alternative methods that could help you achieve homeownership without sacrificing your long-term financial goals. Exploring these possibilities can provide the cash or beneficial financing options you need while keeping your retirement plan on track.

401(k) Loan

A 401(k) loan allows you to borrow from your retirement savings, typically up to 50% of your vested account balance or $50,000, whichever is less. However, if 50% of your vested balance is less than $10,000, some plans may permit you to borrow up to $10,000. These loans typically are expected to be repaid with interest in five years, although if the loan is used to purchase a primary residence, repayment terms may be extended

Using a 401(k) loan for a home purchase offers several advantages. It provides quick access to funds without a credit check, and the repayment interest goes back into your retirement account—so essentially, you are paying yourself to borrow against your own retirement account. Additionally, it doesn’t affect your credit score or debt-to-income ratio, which can be beneficial when applying for a mortgage.

There are some risk factors that you should consider before borrowing against your 401(k). If you leave your job before repaying the loan, the outstanding balance may become due immediately. Failure to repay on time can result in the loan being treated as a taxable distribution, subject to income tax and possibly a 10% early withdrawal penalty. This risk factor can be mitigated, though, by rolling over the outstanding loan balance to an IRA or another eligible retirement plan by the due date. Furthermore, while the loan is outstanding, you may miss out on potential investment gains, which can impact your long-term retirement savings.

VA Home Loan

A VA loan is a mortgage option backed by the U.S. Department of Veterans Affairs. Advantages of a VA loan are that it typically requires no down payment, offers competitively low interest rates, and imposes limited closing costs. Further, a VA loan does not require the borrower to purchase private mortgage insurance (PMI), which can result in substantial savings over the life of the loan. To be eligible for a VA loan, applicants must obtain a Certificate of Eligibility (COE), which verifies their service history and duty status. Generally, this benefit is available to veterans who meet specific length-of-service requirements, active-duty service members, certain members of the National Guard and Reserves, and some surviving spouses. In addition to meeting service criteria, borrowers must also demonstrate satisfactory credit and sufficient income to qualify for the loan. The home purchased must be for a primary residence.

FHA Home Loan

An FHA loan is a government-backed mortgage insured by the Federal Housing Administration, designed to help individuals, who may not otherwise be able to buy a home, qualify for financing. Key benefits of an FHA loan are a low down payment requirement, which can be as little as 3.5% for borrowers; low closing costs; and, more flexible qualification criteria.

However, there are some drawbacks. FHA loans require borrowers to pay mortgage insurance premiums (MIP), both upfront and annually, which increases the overall cost of the loan. The loan limits may also be lower than those of conventional loans, which could restrict the ability to purchase the desired home. Still, for buyers with limited savings or credit challenges, an FHA loan can be a valuable tool toward owning a home.

The Bottom Line

Using your IRA to buy a house is possible, particularly with the first-time homebuyer exemption, which allows you to withdraw up to $10,000 without facing the typical early withdrawal penalty. However, this decision should not be made lightly. While accessing your IRA funds can help you achieve homeownership sooner, it can also significantly impact your long-term retirement savings by reducing the benefits of compounding growth. It’s crucial to weigh the immediate advantages against the long-term effects of taking retirement money out of your IRA.

Before tapping your IRA, consider alternative ways of financing a home purchase. Some alternatives might better protect your retirement nest egg. Options like FHA loans offer low down payments and flexible credit requirements, while VA loans provide eligible veterans and service members with the chance to buy a home with no down payment and favorable loan terms. Another option could be borrowing against your 401(k), which allows you to access funds without permanently removing them from your retirement account. Exploring these alternatives can help you make a more informed decision that supports both your short-term goals and long-term financial goals.

A Guide to Selecting Profitable Day Trading Stocks

Reviewed by Samantha Silberstein
Fact checked by Vikki Velasquez

While the market offers thousands of options, not all stocks are created equal for intraday trading. The most successful day traders know that being able to choose the right stocks—those with the right blend of volatility, liquidity, and market attention—means the difference between consistent profits and frustrating losses.

For some successful traders, that might mean finding a range of stocks they can trade quickly to build up tiny profits. For others, being incredibly selective about their entries is key. They might only make two to three trades per day, but each one aligns perfectly with their strategy and their criteria for risk. This guide will give you the rules successful traders use to identify and trade the stocks that align with their day trading strategies.

Key Takeaways

• Day traders seek profits by monitoring real-time market data and identifying clear trending patterns.
• Strategically selecting stocks is crucial for day trading success—focus on those with high liquidity, optimal volatility, and correlate strongly with the overall sector or market.
• Managing your risks through proper position sizing and strategic exit points is essential for sustainable day trading success.
• Understanding market psychology and sector movements can help traders spot the most promising prospects.

Rule No. 1: Understand the Basics of Intraday Trading

The digital age has vastly increased access to market data, with platforms like TD Ameritrade, E*TRADE, and Webull offering sophisticated real-time trading information that was once available only to professional traders. However, having access to data is just the beginning. Knowing how to interpret this information and select the right stocks is what separates successful day traders from the vast majority of day traders who aren’t.

Three critical factors should guide your stock selection:

1. Liquidity is paramount. High-volume stocks allow you to enter and exit positions quickly without significantly affecting the price—a crucial advantage when timing is everything.
2. Look for stocks with the right amount of volatility—enough movement to create profit opportunities, but not so much that the risks become unmanageable.
3. Finally, consider how your chosen stocks move in relation to their sectors and the broader market, as this correlation can help you spot and capitalize on emerging trends.

A strategic approach to selecting stocks combines these factors with careful analysis of market conditions and robust risk management practices. We’ll expand on some of these points below.

Rule No. 2: Master Key Day Trading Strategies

There are several strategies that day traders use to profit from their activities. The techniques include the following:

• Scalping: This entails taking advantage of small price movements by having several positions during stock market trading. The goal is to accumulate a bunch of small profits over time.
• Momentum trading: Day traders identify stocks that are trending up or down and will ride that consistent price move over the day, hour, or even minute. Day traders assume that the momentum will continue, allowing them to profit.
• Breakout trading: This involves looking at stocks that are trading within a range and entering a position when it is assumed that the range that the stock is trading in is no longer maintained.
• Trend trading: This approach entails the use of moving averages, momentum indicators, trend lines, and chart patterns to determine whether the stock will continue to go higher or lower. The day trader will trade in the same direction of the trend until the trend reverses.
• Contrarian trading: Day traders also apply contrarian investing techniques to intraday trading. This involves taking a position that is opposite to the prevailing market sentiment. For example, if the current market sentiment is bearish, the day trader will be monitoring to buy stocks. Conversely, if the current market sentiment is bullish, the day trader will be monitoring to sell stocks short.
• News trading: This involves analyzing financial and economic calendars and determining what news and events will affect a stock’s price. The day trader will then trade the respective stocks before, during, and after the news or event.

Rule No. 3: Follow Core Stock Selection Criteria

Finding the right stocks for day trading isn’t about picking “hot tips”—it’s about identifying stocks with specific characteristics that make them suitable for quick trades. You’ll want to have your strategies in place for entries and exists: Here are the key factors to consider:

Rule No. 4: Track Market Leaders and Laggards

Look for stocks that move more dramatically than the major indexes like the S&P 500 or Nasdaq. For example, if the S&P 500 rises 1%, focus on stocks climbing 2% or more. These “market leaders” typically offer better profit potential because they show more strength than the overall market.

Rule No. 5: Know When To Exit With Your Gains

Day traders have limited time to capture profits and must spend as little time as possible in trades that are losing money or moving in the wrong direction.

Here are two simple guidelines that can be used to take profits when trading with trends:

• In an uptrend or long position, take profits at or slightly above the former price high in the current trend.
• In a downtrend or short position, take profits at or slightly below the former price low in the current trend.

In the chart below, entries and exits are marked. The chart shows that, as the trend continues higher, the price pushes through past highs. This provides an exit for each respective long position taken. The same method can be applied to downtrends: profits are taken at or slightly below the prior price low in the trend.

Rule No. 6: Prioritize High-Volume Stocks

Look for stocks that trade at least 1 million shares per day. High trading volume means you can buy and sell quickly without dramatically affecting the price. As mentioned earlier, you could also get priced out of quality trading action if you choose an illiquid stock. Illiquid stocks may have sharper bid/ask spreads as quantity wanes, so focusing more on higher volume companies reduces your risk.

Rule No. 7: Master Downside Trading Techniques

When markets are falling, focus on stocks dropping faster than the overall market. These “weak” stocks tend to bounce less during brief market recoveries, making them prime candidates for short-selling. However, short-selling carries significant risks and isn’t recommended for beginners.

When entering a long position, buy after the price moves down toward the trend line and then moves back higher. To draw an upward trend line, a price low and then a higher price low is needed. The line is drawn connecting these two points and then extended out to the right. On the chart below, the price bounces off the trend line a couple of times before the price falls through it the third time. 

Rule No. 8: Capitalize on Upward Momentum

During market rallies, target stocks showing the most aggressive upward movement compared with the broader market. The best candidates are those that barely dip when the market pulls back. This resilience often indicates institutional investors are accumulating the stock, which can lead to sustained upward moves.

The stocks and exchange-traded funds (ETFs) that are stronger or weaker than the market may change daily, although specific sectors may be relatively strong or weak for weeks.

The following chart compares the SPDR S&P 500 to the Technology Select Sector SPDR Fund (XLK). The blue line, XLK, was relatively strong compared with SPY. Both ETFs moved higher throughout the day, but because XLK had such large gains on rallies and slightly smaller declines on pullbacks, it was a market leader and outperformed SPY on a relative basis.

Rule #9: Act on the Best Volatility Levels

You want stocks that move enough to create profit opportunities but not so wildly that they become unpredictable. Stocks with more volatility can offer bigger profits but also carry more risk. A good rule of thumb is to look for stocks that typically move 3% to 5% per day.

It can be hard for many traders to alternate between trend trading and range trading. Therefore, many traders opt to do one or the other. If trend trading, step aside when markets are ranging and focus on trading stocks or ETFs that tend to trend. When range trading, avoid trading during trends and focus on trading stocks or ETFs that tend to range.

Rule No. 10: Know Trend-Following Techniques

Many successful day traders focus on stocks that move in tandem with their sector or the broader market. This means that, when the index or the sector ticks upward, the individual stock’s price also increases. This is important if the trader wants to be trading the strongest or weakest stocks every day. If a trader opts to trade the same stock every day, it is wise to focus on that one stock; there is no need to worry about whether it is correlated with anything else.

Below is a table that helps you with the correlations among different sectors and assets:

In addition, some look at the trend and then focus on specific sectors. For example, when tech stocks are rising, you might look for individual securities in the sector moving even higher than their peers. This makes it easier to spot and capitalize on trends.

Intraday trends don’t continue indefinitely, but one or two trades (or sometimes more) can be made before a reversal occurs. When the dominant trend shifts, begin trading with the new trend.

Isolating the trend can be the difficult part. Trend lines provide a simple and useful entry and stop-loss strategy. The following historical chart of the SPDR S&P 500 (SPY) shows several short-term trends during a typical day.

Warning

When volatility spikes, you can generate above-average profits, but you also face a greater risk of losing more capital in a relatively shorter period of time.

Rule No. 11: Know When To Take a Pause

Markets don’t always trend. Sometimes, intraday trends reverse so often that an overriding direction is hard to show. If major highs and lows aren’t being made, ensure the intraday movements are large enough for the potential reward to exceed the risk. For example, if risking 10 cents per share, the stock or ETF should be moving enough to give you at least 15 cents to 20 cents in profit using the guidelines above.

If the price is moving in a range (not trending), switch to a range-bound trading strategy. During a range, our drawn lines will be horizontal, not angled. However, the same general concepts apply: Buy when the price moves to the lower horizontal area, support, and then start moving higher. Short sell when the price reaches the upper horizontal line, resistance, and moves lower again.

When buying as a day trader, look to exit near the top of the range but not right at the top. When shorting, look to exit in the lower portion of the range but not right at the bottom. The potential reward should always be greater than the risk.

Place a stop-loss just below the most recent low before entry on a buy signal or just above the most recent high before entry on a short signal.

Rule No. 12: Know How To Assess Stock Liquidity

The depth and liquidity of a stock are essential for day traders. There are several techniques to determine stock depth and liquidity:

• Trading volume: Day traders use the amounts of shares traded to determine a stock’s depth and liquidity. A higher trading volume shows that there are more market participants, which increases the likelihood of entering and exiting a stock position. Below are some metrics for assessing the depth of trading volume.

• Bid-ask spread: This is simply the difference between the price that market participants are willing to buy and sell a stock. A tighter or narrower bid-ask spread signifies that the stock is more liquid. Meanwhile, a wider bid-ask spread indicates that the stock is less liquid.
• Order book: This tool provides all the buy and sell orders for a particular stock. By analyzing the order book, the day trader can learn more about the stock’s liquidity, depth, and overall supply and demand.
• Time and sales: This tool shows the price and volume of every trade executed for a stock. Like the order book, the time and sales tool gives the day trader extra insights into the stock’s liquidity, depth, and overall supply and demand.

• Market depth: The phrase “market depth” refers to a market’s ability to absorb large amounts of orders. In the case of a stock market, a market depth report shows the number of shares available at each price level in the order book. A high level of market depth indicates that the stock is very liquid.

How Do Day Traders Determine the Correlation of a Stock?

The correlation of a stock estimates the proportion at which a stock moves in line with another stock or even a stock market index. A stock’s correlation is determined by the following: correlation coefficient, scatter plot, rolling correlation, and regression analysis.

How Do Day Traders Figure Out Where to Exit Winning and Losing Positions?

Day traders think it critical to determine when to exit winning and losing positions. This is done through deciding the stop-loss and profit-taking levels. Day traders use various techniques for figuring out these levels, including: technical analysis, volatility, the risk-reward ratio, and the average true range.

How Can I Get Better at Day Trading?

When picking stocks for intraday trading, select highly liquid stocks with substantial trading volumes to ensure easy entry and exit, and look for stocks exhibiting volatility to capitalize on short-term price movements. Additionally, use technical analysis to identify clear patterns and trends, and stay updated on relevant news that might influence stock prices.

What Is the Biggest Risk When Intraday Trading?

The biggest risk in intraday trading is the potential for significant financial losses. You may be stuck with a security you don’t want or at least stuck with it at a price you don’t want. In addition, high transaction costs from frequent trading will eat into your profits.

The Bottom Line

Identifying the right stocks for intraday trading involves isolating the current market trend from the surrounding noise. Then, a trader’s task is to capitalize on that trend. Specific characteristics of a stock—liquidity, volatility, and correlation—characterize the best prospects. But it’s also important to have the right entry and exit strategies—not just the right asset.

Studying trend lines and charting price waves can aid in this endeavor. There are many ways to trade, but none of them works all the time. If the conditions don’t provide a suitable environment for deploying your strategies, save your money and wait for when they are.

Reviewed by JeFreda R. Brown
Fact checked by Pete Rathburn

Bitcoin has value because it can be exchanged for and used in place of fiat currency, but it maintains a high exchange rate primarily because it is in demand by investors interested in the possibility of returns. Of course, many other factors influence Bitcoin’s value. Read on to learn more about why Bitcoin has value.

Key Takeaways

• Bitcoin has value because it can function as a store of value and a unit of exchange.
• Bitcoin demonstrates six key attributes that enable its use in an economy.
• The definition of value in a currency has changed over centuries from physical attributes to the velocity of its use in an economy.
• Bitcoin demonstrates the attributes of a currency, but its primary source of value lies in its restricted supply and increasing demand.

Why Traditional Currencies Have Value

Many items have been used to exchange value, such as shells, beads, animal skins, and precious metals. In this context, these items are regarded as money. Money doesn’t have to be the printed currency we are all familiar with—all it needs is to act as a store of value, be recognizable as a unit of account, and be accepted as a medium of exchange.

So, if an item meets those criteria, it is money. However, to be successful and long-lasting, it must have:

• Scarcity: It must not be a widely available resource
• Divisibility: Currency should have many denominations
• Acceptability: The intended audience must accept it
• Portability: It must be able to be carried around and exchanged
• Durability: Currency should have a long life span time
• Uniformity: All denominations should be identical and not easily reproduced

Value is then assigned by the users based on its supply, demand for the currency, how much it is worth to them, and how much of a good or service it can purchase.

The image below compares many different value attributes of gold, fiat, and cryptocurrency.

Note

Traditional money, as we know it, is backed by the full faith and credit of the issuing government. For instance, the U.S. dollar is backed by the U.S. government while the British pound is backed by the government of the United Kingdom.

Why Does Bitcoin Have Value?

Unlike fiat currency, cryptocurrencies like Bitcoin aren’t backed by the full faith of the government. But, they do display the same attributes a fiat currency system does. Here’s how it meets them:

• Scarcity: As the supply of unrewarded coins diminishes, demand increases. There will only ever be 21 million Bitcoins in existence.
• Divisibility: Bitcoin is much more divisible than fiat currencies. One coin can be divided into up to eight decimal places, with constituent units called satoshis.
• Acceptability: More people are becoming familiar with cryptocurrencies, and citizens of many countries are adopting them because their financial systems are failing them. Businesses are accepting them in greater numbers, and more consumers are using them.
• Portability: Bitcoin can be used across borders, allowing any consumer with an internet connection to participate in the global economy and access financial services.
• Durability: As it occupies a digital space, a Bitcoin can last as long as there is a digital area for its storage.
• Uniformity: Bitcoins cannot be counterfeited and don’t have a physical appearance, although there are renditions of coins that represent them.

Bitcoin is considered money because it is accepted as a medium of exchange, stores value, and is recognized as a unit of account.

Important

Two of the most influential factors behind Bitcoin’s price volatility are greed and the fear of missing out on large returns. Greed is generally considered a negative trait, but in these modern (and expensive) times, it is natural for people to want more money. In fact, society and the businesses operating within it even encourage the desire for more.

But its exchange rate, the value most often associated with the coin, isn’t so much a factor that the people who use Bitcoins in transactions. Rather, it’s investors buying the cryptocurrency hoping for profits and traders buying and selling it to make money on price movements.

Because it is in demand by investors (realistically, they are speculators because they want returns), Bitcoin commands a very high price, as demonstrated by the exchange rates it has experienced in the past. At one point, 1 BTC was valued at less than $1. As of April 2025, that same Bitcoin is worth more than $95,000. Prices have varied wildly since Bitcoin was introduced, but this volatility has many hoping that the market will continue to feed an increasing value.

Why Is Bitcoin So Precious?

Like any asset or thing of value, the price people will pay for Bitcoins is a socially agreed-upon level based on supply and demand. As long as Bitcoin is highly valued by some, it will maintain its demand.

What Is the Point of Bitcoin?

Bitcoin’s original design was to be a replacement for traditional money systems and take control of money away from centralized governments and third-parties.

What Drives the Price of Bitcoin?

Bitcoin’s price is primarily driven by supply, demand, fear, and greed. Some people argue that its price is correlated to its cost of production, its utility as a store of value, or its intrinsic value—but if these were true, it would not be as volatile and reactive as it is.

Who Created Bitcoin?

Bitcoin was created in 2009 by an individual who used the pseudonym Satoshi Nakamoto. Their identity has never been revealed.

Bitcoin is a digital asset and has no central bank or authority. There are no physical coins, which means it is distributed by individuals over digital platforms, exchanges, and through peer-to-peer transactions.

The Bottom Line

Like all forms of currency, Bitcoin is given value by its users, supply, and demand. As long as it maintains the attributes associated with money and there is demand for it, it will remain a means of exchange, a store of value, and another way for investors to speculate, regardless of its monetary value.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. Read our warranty and liability disclaimer for more info. As of the date this article was written, the author does not own cryptocurrency.

Fact checked by Vikki Velasquez
Reviewed by Eric Estevez

Want to strengthen your portfolio’s risk-return profile? Adding bonds can create a more balanced portfolio by adding diversification and calming volatility. But the bond market may seem unfamiliar even to the most experienced investors.

Many investors make only passing ventures into bonds because they are confused by the apparent complexity of the bond market and the terminology. In reality, bonds are very simple debt instruments.

So how do you get into this part of the market? How do bonds work? Get your start in bond investing by learning these basic bond market terms.

Key Takeaways

• The bond market can help investors diversify beyond stocks.
• Some of the characteristics of bonds include their maturity, their coupon (interest) rate, their tax status, and their callability.
• Several types of risks associated with bonds include interest rate risk, credit/default risk, and prepayment risk.
• Most bonds come with ratings that describe their investment grade.

How Do Bonds Work?

A bond is simply a loan taken out by a company. Instead of going to a bank, the company gets the money from investors who buy its bonds. In exchange for the capital, the company pays an interest coupon, which is the annual interest rate paid on a bond expressed as a percentage of the face value. The company pays the interest at predetermined intervals (usually annually or semiannually) and returns the principal on the maturity date, ending the loan.

Unlike stocks, bonds can vary significantly based on the terms of their indenture, a legal document outlining the characteristics of the bond. Because each bond issue is different, it is important to understand the precise terms before investing. In particular, there are six important features to look for when considering a bond.

Important

Bonds are a form of IOU between the lender and the borrower.

Types of Bonds

Corporate Bonds

Corporate bonds refer to the debt securities that companies issue to pay their expenses and raise capital. The yield of these bonds depends on the creditworthiness of the company that issues them. The riskiest bonds are known as “junk bonds,” but they also offer the highest returns. Interest from corporate bonds is subject to both federal and local income taxes.

Sovereign Bonds

Sovereign bonds, or sovereign debt, are debt securities issued by national governments to defray their expenses. Because the issuing governments are very unlikely to default, these bonds typically have a very high credit rating and a relatively low yield.

In the United States, bonds issued by the federal government are called Treasuries, while those issued by the United Kingdom are called gilts. Treasuries are exempt from state and local tax, although they are still subject to federal income tax.

Municipal Bonds

Municipal bonds, or munis, are bonds issued by local governments. Contrary to what the name suggests, this can refer to state and county debt, not just municipal debt. Municipal bond income is not subject to most taxes, making them an attractive investment for investors in higher tax brackets.

Read about Investopedia’s 10 Rules of Investing by picking up a copy of our special-issue print edition.

Key Terms

Maturity

This is the date when the principal or par amount of the bond is paid to investors and the company’s bond obligation ends. Therefore, it defines the lifetime of the bond.

A bond’s maturity is one of the primary considerations that an investor weighs against their investment goals and horizon. Maturity is often classified in three ways:

• Short-term: Bonds that fall into this category tend to mature in one to three years.
• Medium-term: Maturity dates for these types of bonds are normally four to 10 years.
• Long-term: These bonds generally mature over more than 10 years.

Secured/Unsecured

A bond can be secured or unsecured. A secured bond pledges specific assets to bondholders if the company cannot repay the obligation. This asset is also called collateral on the loan. If the bond issuer defaults, the asset is then transferred to the investor. A mortgage-backed security (MBS) is one type of secured bond backed by titles to the homes of the borrowers.

Unsecured bonds, on the other hand, are not backed by any collateral. This means that the interest and principal are only guaranteed by the issuing company. Also called debentures, these bonds return little of your investment if the company fails. As such, they are much riskier than secured bonds.

Liquidation Preference

When a firm goes bankrupt, it repays investors in a particular order as it liquidates. After a firm sells off all its assets, it begins to pay out its investors. Senior debt is debt that must be paid first, followed by junior (subordinated) debt. Stockholders get whatever is left.

Coupon

The coupon amount represents interest paid to bondholders, normally annually or semiannually. The coupon is also called the coupon rate or nominal yield. To calculate the coupon rate, divide the annual payments by the face value of the bond.

Tax Status

While the majority of corporate bonds are taxable investments, some government and municipal bonds are tax-exempt, so income and capital gains are not subject to taxation. Tax-exempt bonds normally have lower interest than equivalent taxable bonds. An investor must calculate the tax-equivalent yield to compare the return with that of taxable instruments.

Callability

Some bonds can be paid off by an issuer before maturity. If a bond has a call provision, it may be paid off at earlier dates, at the option of the company, usually at a slight premium to par. A company may choose to call its bonds if interest rates allow them to borrow at a better rate. Callable bonds also appeal to investors, as they offer better coupon rates.

Risks of Bonds

Bonds are a great way to earn income because they tend to be relatively safe investments. But, just like any other investment, they do come with certain risks. Here are some of the most common risks with these investments.

Interest Rate Risk

Interest rates share an inverse relationship with bonds, so when rates rise, bonds tend to fall, and vice versa. Interest rate risk comes when rates change significantly from what the investor expected.

If interest rates decline significantly, the investor faces the possibility of prepayment. If interest rates rise, the investor will be stuck with an instrument yielding below market rates. The greater the time to maturity, the greater the interest rate risk an investor bears, because it is harder to predict market developments further into the future.

Credit/Default Risk

Credit or default risk is the risk that interest and principal payments due on the obligation will not be made as required. When an investor buys a bond, they expect that the issuer will make good on the interest and principal payments—just like any other creditor.

When an investor looks into corporate bonds, they should weigh out the possibility that the company may default on the debt. Safety usually means the company has greater operating income and cash flow compared to its debt. If the inverse is true and the debt outweighs available cash, the investor may want to stay away.

Prepayment Risk

Prepayment risk is the risk that a given bond issue will be paid off earlier than expected, normally through a call provision. This can be bad news for investors because the company only has an incentive to repay the obligation early when interest rates have declined substantially. Instead of continuing to hold a high-interest investment, investors are left to reinvest funds in a lower-interest-rate environment.

Bond Ratings

Most bonds come with a rating that outlines their quality of credit—that is, how strong the bond is and its ability to pay its principal and interest. Ratings are published and used by investors and professionals to judge their worthiness.

Agencies

The most commonly cited bond rating agencies are Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings. They rate a company’s ability to repay its obligations. Each rating agency has a different scale. For S&P, investment grade ranges from AAA to BBB. These are the safest bonds with the lowest risk. This means they are unlikely to default and tend to remain stable investments.

Bonds rated BB or below are speculative bonds, also known as junk bonds—default is more likely, and they are more speculative and subject to price volatility.

Firms will not have their bonds rated, in which case it is solely up to the investor to judge a firm’s repayment ability. Because the rating systems differ for each agency and change from time to time, research the rating definition for the bond issue you are considering.

Bond Yields

Bond yields are all measures of return. Yield to maturity is the measurement most often used, but it is important to understand several other yield measurements that are used in certain situations.

Yield to Maturity (YTM)

As noted above, yield to maturity (YTM) is the most commonly cited yield measurement. It measures what the return on a bond is if it is held to maturity and all coupons are reinvested at the YTM rate. Because it is unlikely that coupons will be reinvested at the same rate, an investor’s actual return will differ slightly.

Calculating YTM by hand is a lengthy procedure, so it is best to use Excel’s RATE or YIELDMAT functions (starting with Excel 2007). A simple function is also available on a financial calculator. 

Current Yield

The current yield can be used to compare the interest income provided by a bond to the dividend income provided by a stock. This is calculated by dividing the bond’s annual coupon by the bond’s current price.

Keep in mind, this yield incorporates only the income portion of the return, ignoring possible capital gains or losses. As such, this yield is most useful for investors concerned with current income only.

Nominal Yield

The nominal yield on a bond is simply the percentage of interest to be paid on the bond periodically. It is calculated by dividing the annual coupon payment by the par or face value of the bond.

It is important to note that the nominal yield does not estimate return accurately unless the current bond price is the same as its par value. Therefore, nominal yield is used only for calculating other measures of return.

Yield to Call (YTC)

A callable bond always bears some probability of being called before the maturity date. Investors will realize a slightly higher yield if the called bonds are paid off at a premium.

An investor in such a bond may wish to know what yield will be realized if the bond is called at a particular call date, to determine whether the prepayment risk is worthwhile. It is easiest to calculate the yield to call using Excel’s YIELD or IRR functions, or with a financial calculator. 

Realized Yield

The realized yield of a bond should be calculated if an investor plans to hold a bond only for a certain period of time, rather than to maturity. In this case, the investor will sell the bond, and this projected future bond price must be estimated for the calculation.

Because future prices are hard to predict, this yield measurement is only an estimation of return. This yield calculation is best performed using Excel’s YIELD or IRR functions, or by using a financial calculator.

How Bonds Pay Interest

There are two ways that bondholders receive payment for their investment. Coupon payments are the periodic interest payments over the lifetime of a bond before the bond can be redeemed for par value at maturity.

Some bonds are structured differently. Zero-coupon bonds are bonds with no coupon—the only payment is the face-value redemption at maturity. Zeros are usually sold at a discount from face value, so the difference between the purchase price and the par value can be computed as interest.

Convertible bonds are a type of hybrid security that combines the properties of bonds and stocks. These are ordinary, fixed-income bonds, but they can also be converted into stock of the issuing company. This adds an extra opportunity for profit if the issuing company shows large gains in its share price.

Which Is Larger, the Stock Market or the Bond Market?

The bond market is actually much larger than the stock market, in terms of aggregate market value.

What Is the Relationship Between a Bond’s Price and Interest Rates?

Bond prices are inversely related to interest rate moves. So if interest rates go up, bond prices fall, and vice versa.

Are Bonds Risky Investments?

Bonds have historically been more conservative and less volatile than stocks, but there are still risks. For instance, there is a credit risk that the bond issuer will default. There is also interest rate risk, where bond prices can fall if interest rates increase.

The Bottom Line

Although the bond market appears complex, it is really driven by the same risk-return tradeoffs as the stock market. Once an investor masters these few basic terms and measurements to unmask the familiar market dynamics, they can become a competent bond investor. Once you have a hang of the lingo, the rest is easy.

Correction—Jan. 18, 2024: This article has been corrected to state that medium-term bonds tend to mature in four to 10 years.

Reviewed by David Kindness
Fact checked by Vikki Velasquez

Are your retirement savings a little low? You’re not alone. In fact, about one in five (21%) of Baby Boomer workers has less than $50,000 saved for retirement, according to the Transamerica Center for Retirement Studies 2023 survey. If you’re in that low-to-no camp, here are the things you can do to help shore up your finances for retirement.

Key Takeaways

• Save any extra money you get, such as an inheritance, a raise, or tax refunds, for your retirement. 
• Delay Social Security, downsize your home, get aggressive with budgeting, and freshen up your skills to boost your earnings capability.
• Give up expensive habits and hobbies or, better yet, monetize a hobby.

1. Save Your Raise

If you’re still working and get a raise, bonus, or some other form of extra compensation, commit to saving it for your retirement. Unless you absolutely need that extra money to live on, your retirement funds are a great place to stow it. Do this by upping the amount that is deducted from your paycheck for retirement if it’s deducted on a pretax basis. Remember, even if you’re retired, you can still save for retirement.

2. Save Your Tax Refund

We all want to use our tax refunds as play money, but if you’re behind on your retirement savings, that’s not a wise idea. You can deposit the money directly into an individual retirement account (IRA) using IRS Form 8888.

3. Save Your Inheritance

See the pattern? Any time you come into extra money, don’t spend it. Instead, put it toward your retirement. It’s not nearly as fun, but you’ll thank yourself later.

4. Invest in Your 401(k)

If your company is matching your contributions, you should probably invest in your 401(k). It’s free money. Your company is paying you to be involved.

“Save as much as you can in there until it hurts,” says Cassandra Toroian, founder and chief investment officer (CIO) of Bell Rock Capital in Rehoboth Beach, Delaware. “Build this nest egg as fast as you can and also get a slight tax benefit since it’s pretax dollars you are contributing.”

Note: A traditional 401(k) uses pretax dollars for contributions, whereas a Roth 401(k) uses after-tax dollars for contributions. To choose between them, decide when you want your tax break: upfront (as with a traditional account) or during retirement (as with a Roth, as long as it’s been at least five years since you first contributed to the account).

If you have access to a 401(k) with matching contributions from your employer, at the very least, contribute enough to get them.

5. Delay Social Security

If you don’t need to collect Social Security when you’re first eligible at age 62, then don’t. If you can wait until you reach age 70, your benefits will be significantly higher. That will likely mean working longer, but it might be worth it.

“This will give you an automatic increase in benefit amount and cost-of-living adjustment and avoid unnecessary taxes on Social Security while you’re working and drawing the benefits,” says Chris Hardy, CFP®, EA, ChFC®, CLU®, founder and chief executive officer (CEO) of Paramount Investment Advisors in Buford, Georgia.

6. Re-Evaluate Your Investments

In the investing world, little things add up fast. For example, if you’re invested in high-fee mutual funds or other investment products, consider some different choices. Fees can eat away at your savings. And higher fees do not equate to better performance. 

“It is crucial for every investor—especially those retirees with a modest-sized nest egg—to keep the investment costs as low as possible,” says Craig L. Israelsen, Ph.D., founder of the 7Twelve Portfolio in Springville, Utah. “[An annual expense ratio] below 25 basis points (BPS) is definitely the target; 10 BPS is achievable with Vanguard funds.”

7. Get a Cheaper Vehicle

A vehicle is just one example, but what are you spending money on that you could cut? The lawn service? A rarely used gym membership? Expensive subscriptions?

8. Downsize Your Home

Maybe the kids are gone, but you’re still living in that big house. How much could you bank for retirement if you sold your home and found something smaller? There are a lot of financial variables involved in this decision, so talk to a financial planner to see if it’s right for you.

9. Learn a New Skill

How about something like consulting work? Or maybe you’re good with computers and could learn a computer language. Learning something that can earn you extra money as you age means you can continue working well into retirement.

10. Give Up Expensive Habits

For example, if you can give up smoking a pack of cigarettes a day, that could be an extra $2,300 annually for retirement. How about cutting out drinking? Water is a lot cheaper than alcohol, and the savings can add up fast.

11. Give Up Expensive Hobbies

How much is your golf game costing you? What about your boat? Whatever your expensive hobby, either give it up or, even better, find a way to monetize it. For example, become a golf instructor or start a charter service with the boat.

12. Get Aggressive With Your Budget

First, if you don’t have a budget, start one.

“A budget is like a roadmap or game plan. It clearly lays out your sources of income and expenses and the difference. By having it clearly in front of you, you can see how you can adjust your income or expenses to reach the overall savings goal you desire or need,” says Mark T. Hebner, founder and president of Index Fund Advisors, headquartered in Irvine, California, and author of Index Funds: The 12-Step Recovery Program for Active Investors.

If you’re already budgeting, it’s time to get more aggressive. Cut more expenses. Maybe eat out only once per month, use more coupons, look for deals, and don’t go on that expensive vacation this year.

How Much Do Baby Boomers Have Saved for Retirement?

Baby Boomer workers have a median of $289,000 saved for retirement, according to the Transamerica Center for Retirement Studies 2023 survey. This means that half of Baby Boomer workers saved more than this amount, and half saved less.

What Is the Full Retirement Age for Social Security?

The full retirement age for Social Security is the age at which you’re eligible to collect your full retirement benefits. It varies depending on your birth year. If you were born in 1960 or later, for example, your full retirement age for Social Security is 67.

How Many People Are Satisfied With Their Retirement Savings?

According to the Federal Reserve Board, only about a third (34%) of people who aren’t retired think their retirement savings are on track.

The Bottom Line

You’re probably not going to make a massive change to your retirement savings unless you get an inheritance or another large-scale blessing, but little changes add up fast. Just because you’re low on savings doesn’t mean it has to stay that way. Work longer, save more, and spend less—however that looks in your life.

Fact checked by Ryan Eichler
Reviewed by Thomas Brock

The yield curve shows the difference in the short- and long-term interest rates of bonds and other fixed-income securities issued by the U.S. Treasury. An inverted yield curve occurs when short-term interest rates exceed long-term rates.

An inverted yield curve is a noteworthy and uncommon event. Under normal circumstances, the yield curve is not inverted. Debts with longer maturities typically pay higher interest rates than shorter-term ones.

From an economic perspective, an inverted yield curve suggests that the near term is riskier than the long term.

Key Takeaways

• A yield curve illustrates the interest rates on bonds of increasing maturities.
• An inverted yield curve occurs when short-term debt instruments carry higher yields than long-term instruments of the same credit risk profile.
• Inverted yield curves are unusual since longer-term debt should carry greater risk and higher interest rates, so they have implications for consumers and investors alike.
• An inverted Treasury yield curve is one of the most reliable leading indicators of an impending recession.

Interest Rates and Yield Curves

Typically, short-term interest rates are lower than long-term rates. The yield curve slopes upwards, reflecting higher yields for longer-term investments. This is referred to as a normal yield curve.

When the spread between short-term and long-term interest rates narrows, the yield curve begins to flatten. A flat yield curve can be a transition from a normal yield curve to an inverted one.

What Does an Inverted Yield Curve Suggest?

Historically, an inverted yield curve has been viewed as an indicator of a pending economic recession. When short-term interest rates exceed long-term rates, market sentiment suggests that the long-term outlook is poor and that the yields offered by long-term fixed income will continue to fall.

More recently, this viewpoint has been called into question, as foreign purchases of securities issued by the U.S. Treasury have created a high and sustained level of demand for products backed by U.S. government debt.

When investors are aggressively seeking debt instruments, the debtor can offer lower interest rates. When this occurs, many argue that it is the law of supply and demand, rather than impending economic doom that allows lenders to attract borrowers without paying higher interest rates.

Inverted yield curves have been relatively rare, due in large part to longer-than-average periods between recessions since the early 1990s. For example, the economic expansions that began in March 1991, November 2001, and June 2009 were three of the four longest economic expansions since World War II.

During these long periods, the question often arises as to whether an inverted yield curve can happen again.

Economic cycles, regardless of their length, have historically transitioned from growth to recession and back again. Inverted yield curves are an essential element of these cycles, preceding every recession since 1956.

Upward-sloping yield curves are a natural extension of the higher risks associated with long maturities. In a growing economy, investors demand higher yields at the long end of the curve to compensate for the opportunity cost of investing in bonds versus other asset classes like stocks, and to maintain an acceptable level over inflation rates.

As an economic cycle begins to slow, the upward slope of the yield curve tends to flatten as short-term rates increase and longer-term yields stay stable or decline slightly. In this environment, investors see long-term yields as an acceptable substitute for the likelihood of lower returns in stocks and other asset classes, which tend to increase bond prices and reduce yields.

784 Days

The longest-ever yield curve inversion lasted for 784 days, from July 5, 2022, until August 27, 2024.

The Formation of an Inverted Yield Curve

As concerns of an impending recession increase, investors tend to buy long Treasury bonds as a safe harbor from falling equities markets. As a result of this rotation to long maturities, yields can fall below short-term rates, forming an inverted yield curve.

Between 1955 and 2018, equities have consistently peaked six times after the start of an inversion, and the economy fell into recession within six to 24 months.

An inverted yield curve appeared in August 2006, as the Fed raised short-term interest rates in response to overheating equity, real estate, and mortgage markets. The inversion of the yield curve preceded the peak of the Standard & Poor’s 500 in October 2007 by 14 months and the official start of the recession in December 2007 by 16 months.

In 2019, the yield curve again inverted, worrying economists about another downturn. In early 2020, the COVID-19 pandemic did indeed trigger a global recession. No one thought it was likely that the yield curve was able to predict the pandemic. In any case, the COVID-19 downturn quickly rebounded to new record highs.

Inverted Yield Curve Impact on Consumers

An inverted yield curve has an impact on consumers.

Homebuyers financing their properties with adjustable-rate mortgages (ARMs) have interest-rate schedules that are periodically updated based on short-term interest rates. When short-term rates are higher than long-term rates, payments on ARMs rise. When this occurs, fixed-rate loans can be more attractive than adjustable-rate loans.

Lines of credit are also affected. Consumers must dedicate a larger portion of their incomes toward servicing existing debt. This reduces expendable income and has a negative effect on the economy as a whole.

Important

While a yield curve can be constructed between any bonds of different maturities, most investors look to the yields of the 10-year and two-year Treasury bonds. Some academic studies also compare the 10-year Treasury bond to the three-month note.

Inverted Yield Curve Impact on Fixed-Income Investors

A yield curve inversion has the greatest impact on fixed-income investors.

In normal circumstances, long-term investments have higher yields. Because investors are risking their money for longer periods of time, they are rewarded with higher payouts. An inverted curve eliminates the risk premium for long-term investments, giving investors better returns with short-term investments.

When the spread between U.S. Treasuries (a risk-free investment) and higher-risk corporate alternatives is at historical lows, it is often an easy decision to invest in lower-risk vehicles. In such cases, purchasing a Treasury-backed security provides a yield similar to the yield on junk bonds, corporate bonds, real estate investment trusts (REITs), and other debt instruments, but without the risk inherent in these vehicles.

Money market funds and certificates of deposit (CDs) may also be attractive, particularly when a one-year CD is paying yields comparable to those on a 10-year Treasury bond.

Inverted Yield Curve Impact on Stock Investors

When the yield curve becomes inverted, profit margins fall for companies that borrow cash at short-term rates and lend at long-term rates, such as community banks. Likewise, hedge funds are often forced to take on increased risk to achieve their desired level of returns.

In fact, a bad bet on Russian interest rates is largely credited for the demise of Long-Term Capital Management, a well-known hedge fund run by bond trader John Meriwether.

Despite their consequences for some parties, yield-curve inversions tend to have less impact on consumer staples and healthcare companies, which are not interest-rate dependent.

This relationship becomes clear when an inverted yield curve precedes a recession. When this occurs, investors tend to turn to defensive stocks, such as those in the food, oil, and tobacco industries, which are often less affected by downturns in the economy.

• In 2019, the yield curve briefly inverted. Signals of inflationary pressure from a tight labor market and a series of interest rate hikes by the Federal Reserve from 2017 to 2019 raised expectations of a recession. Those expectations eventually led the Fed to walk back the interest rate increases. The start of the COVID-19 pandemic, in the Spring of 2020, did lead to a brief recession.
• In 2006, the yield curve was inverted during much of the year. Long-term Treasury bonds went on to outperform stocks during 2007. In 2008, long-term Treasuries soared as the stock market crashed. In this case, the Great Recession arrived and turned out to be worse than expected.
• In 1998, the yield curve briefly inverted. For a few weeks, Treasury bond prices surged after the Russian debt default. Quick interest rate cuts by the Federal Reserve helped to prevent a recession in the United States. However, the Fed’s actions may have contributed to the subsequent dotcom bubble.

Explain Like I’m Five

An inverted yield curve happens when short-term Treasury bonds pay a higher interest rate than long-term bonds. That usually means that investors are putting their money into bonds because they don’t see better prospects in the near future.

Economists watch out for an inverted yield curve because a recession usually follows. Many loans and credit products are tied to Treasury rates, so an inverted yield curve can have rippling effects throughout the economy.

What Economic Theories Describe the Yield Curve?

Two economic theories have been used to explain the shape of the yield curve; the pure expectations theory and the liquidity preference theory.

• Pure expectations theory posits that long-term rates are simply an aggregated average of expected short-term rates over time.
• Liquidity preference theory suggests that longer-term bonds tie up money for a longer time and investors must be compensated for this lack of liquidity with higher yields.

When Was the Last time the Yield Curve Was Inverted?

The yield curve inverted on June 5, 2022, when the two-year yield rose above the 10-year yield. The curve remained inverted until August 27, 2024, the longest inversion in history.

The inversion followed shortly after the Federal Open Markets Committee began raising the target federal funds rate to control inflation. The trend peaked in July 2023 after a series of interest rate hikes by the Federal Reserve.

How Well Do Inverted Yield Curves Predict a Recession?

An inverted yield curve in U.S. Treasuries has predicted every recession since 1955, with only one false signal during that time.

 It even “predicted” the economic downturn that followed the COVID-19 pandemic (although most economists attribute this to luck, and not the fact that it can predict natural disasters).

The Bottom Line

An inverted yield curve means that short-term Treasurys are paying higher interest rates than long-term bonds. Since Treasury rates are a major factor in the cost of borrowing money, an inversion can impact corporate profits and the prices of other assets.

The yield curve has a solid history of predicting a recession, but it’s not foolproof. Like many other economic indicators, yield curves can become self-fulfilling. If enough investors start worrying about a slowdown whenever the yield curve inverts, they could make a recession more likely.