investment

Reviewed by Somer Anderson

Absolute P/E Ratio vs. Relative P/E Ratio: An Overview

The absolute and relative P/E ratios are metrics to determine if a company is over or undervalued. The simple answer to this question is that absolute P/E is the price of a stock divided by the company’s earnings per share (EPS). This is the more common measure, and it indicates how much investors are willing to pay per dollar of earnings.

The relative P/E ratio, on the other hand, is a measure that compares the current P/E ratio to the past P/E ratios of the company or to the current P/E ratio of a benchmark. Let’s look at both absolute and relative P/E in more detail.

Key Takeaways

• The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.
• Analysts may make a distinction between absolute P/E and relative P/E ratios in their analysis.
• Absolute P/E is the current price-to-earnings calculated as usual. Relative P/E compares that to some benchmark or a range of past P/Es, say over the past 10 years. 

Absolute P/E Ratio

The numerator of this ratio is usually the current stock price, and the denominator may be the trailing EPS (from the trailing 12 months [TTM]), the estimated EPS for the next 12 months (forward P/E) or a mix of the trailing EPS of the last two quarters and the forward P/E for the next two quarters.

When distinguishing absolute P/E from relative P/E, it is important to remember that absolute P/E represents the P/E of the current time period. For example, if the price of the stock today is $100, and the TTM earnings are $2 per share, the P/E is 50 ($100/$2).

Relative P/E Ratio

Relative P/E compares the current absolute P/E to a benchmark or a range of past P/Es over a relevant time period, such as the last 10 years. Relative P/E shows what portion or percentage of the past P/Es the current P/E has reached. Relative P/E usually compares the current P/E value to the highest value of the range, but investors might also compare the current P/E to the bottom side of the range, measuring how close the current P/E is to the historic low.

The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the past is high or low). If the relative P/E measure is 100% or more, this tells investors that the current P/E has reached or surpassed the past value.

Important

When calculating a company’s earnings per share, it is important to use the diluted EPS, not the basic EPS.

Example of Absolute vs. Relative P/E Ratio

Suppose that a company’s shares are currently trading for $100, and the company reports $4 of earnings per share. The company’s absolute P/E ratio is 25, meaning that shareholders pay $25 for every $1 of earnings. This is the P/E ratio that is usually reported on stock screeners or company summaries.

But stock analysts may wish to examine how the company’s absolute P/E ratio has changed over time, or how it compares with the industry at large. Suppose that the company’s P/E ratio has ranged from 15 to 40 over the past ten years. If the current (absolute) P/E ratio is 25, the relative P/E comparing the current P/E to the highest value of this past range is 0.625 (25/40), and the current P/E relative to the low end of the range is 1.67 (25/15).

These values tell investors that the company’s current P/E is 62.5% of the 10-year high, and 67% higher than the 10-year low.

Special Considerations

If all is equal over a given time period, a P/E ratio that is close to its historical high could be a sign that the stock is overvalued. However, there is a lot of discretion that goes into interpreting relative P/E. Fundamental shifts in the company, such as a major acquisition, can justifiably raise the P/E above the historic high.

Relative P/E may also compare the current P/E to the average P/E of a benchmark such as the S&P 500. Continuing with the example above, suppose the average P/E ratio in the S&P 500 is 20. The relative P/E of the company to the index is therefore 1.25 (25/20).

This shows investors that the company has a higher P/E relative to the benchmmark, indicating that the company’s earnings are more expensive than those of other companies in the index.

A higher P/E, however, does not necessarily mean it is a bad investment. On the contrary, it may mean the company’s earnings are growing faster than those of other companies in the index. If there is a large discrepancy between the company’s P/E ratio and the P/E of the index, investors may want to do additional research into the discrepancy.

What Does the P/E Ratio Tell You?

The price-to-earnings ratio, or P/E, reflects the share price of a company relative to its actual profits, reflected in the company’s reported earnings. This tells investors whether the share price is relatively high or low, compared with other companies. A low P/E ratio indicates that a company could be a bargain investment, while a high P/E ratio suggests that the company may be overvalued. Different industries have different profit margins, so investors should be careful to compare P/E ratios across similar companies.

Is It Better for a P/E Ratio to Be Higher or Lower?

Value investors typically look for stocks with a low P/E ratio, as that indicates that the share price is low relative to the company’s earnings. That could be because that stock is undervalued in the market; however, it is also possible for a company to have a low share price due to news events or unfavorable market conditions.

What Does a Negative P/E Ratio Mean?

A negative price-to-earnings (P/E) ratio means that the stock has reported negative earnings—in other words, it is losing money. Although that’s generally a bad sign, it’s not uncommon for otherwise-successful companies to lose money if they go through a temporary rough patch, or if they focus on reinvesting their revenue for future growth.

The Bottom Line

Absolute P/E, compared to relative P/E, is the most often used measure and is useful in investment decision-making. However, it is often wise to expand the application of that measure with the relative P/E measure to gain further information.

Fact checked by Katrina Munichiello
Reviewed by Andy Smith

Apple Business Model vs. Microsoft Business Model: An Overview

More than any other American companies, Apple, Inc. (NASDAQ: AAPL) and Microsoft Corporation (NASDAQ: MSFT) dominate the intersection of technology and consumer access. Even though they compete across a huge range of sub-industries, such as computing software, hardware, operating systems, mobile devices, advertising, applications, and web browsing, each firm primarily targets different markets.

On Feb. 15, 2025, AAPL had a market cap of around $3.6 trillion. Microsoft lagged behind it at $3.04 trillion.

Key Takeaways

• As of 2025, Apple and Microsoft are two of the biggest companies in the world, alternating the title of the world’s most valuable company.
• Both companies have market caps of over $3 trillion.
• Apple’s business model targets small and medium sized businesses, and consumers with devices targeted toward them. They are able to keep their base due to easy-to-use designs and data migration to new product lines.
• Microsoft is an innovative leader in cloud computing, professional and business solutions, with a lower focus on personal computing than it used to have.

The Apple Business Model

It is difficult to recall a modern American business so thoroughly dominated by the ideas and personality of one individual as Apple was under Steve Jobs. Jobs’ remarkable innovations propelled Apple to unprecedented heights until his passing in 2011.

During Steve Jobs’ second reign—he was fired in 1985 and returned in 1997—Apple returned to relevancy and revolutionized multiple subindustries. In 2001, the company released the iPod, a pocket-sized device that could hold 1,000 songs, which soon took over the Sony Walkman. In 2007, Apple completely redefined mobile phones when the iPhone was released.

Apple easily bests its competitors in terms of hardware sales and high-end gadgets. Thanks to the company’s early 2000s reputation as a nonconformist response to Microsoft, millennials grew up using Macs in large numbers. This is buoyed by the company’s brilliant insistence on integrating its products, making it easier to keep using new Apple products and thus more difficult to switch to a competitor’s interface; this is sometimes referred to as the “Apple Ecosystem Lock.”

The weakness in the Apple’s business model lies in the historic success of the company’s golden invention: the iPhone. Nearly half of all Apple revenue comes from iPhone sales, and no comparable innovation has taken off since its former CEO died.

However, CEO Tim Cook continued driving improvements and innovations to existing products and services. In 2023, new iOS 18, MacBook Pro and Air Models, iPad Air and Pro models, the iPhone 16 variants, the Apple Watch series, and AirPods 4 were all launched.

The iPhone remained Apple’s key revenue generator in 2024, with sales of $201.18 billion out of $391.04 billion over the year (51%). Apple’s services generated $96.2 billion in sales.

The Microsoft Business Model

For years, Microsoft dominated the computer industry with its Windows software; Apple was an afterthought for more than a generation of operating products. Before Google Web browsing began to dominate the market, Microsoft gave away Internet Explorer for free, driving Netscape and other similar companies out of business.

The Microsoft revenue model historically relied on just a few key strengths. The first, and most important, was the licensing fees charged for use of the Windows operating system and the Microsoft Office suite.

However, technological developments have made its operating system less of a revenue generator. Microsoft has moved its Office suite to an online subscription service to generate recurring revenue, acquired LinkedIn and its subscription and sales solutions, and developed cloud-based solutions for businesses and developers that generate recurring revenues. Its primary revenue generator was server products and cloud services, which generated $97.7 billion in FY 2024. This was followed by office products and cloud services, with $54.9 billion generated. Windows was third, generating $23.24 billion.

Microsoft has a popular gaming console and associated services that Apple does not—the Xbox and its subscription services. Gaming and gaming services accounted for the fourth largest revenue stream for Microsoft in 2024, $21.5 billion.

Is Microsoft Doing Better Than Apple?

Each company has transitioned to focus on different products and services, so they each rank well. However, Apple generated more returns for investors as of February 2025 (33.23% year-over-year), while Microsoft lagged at 0.07%. Microsoft generated $245.12 billion in revenue in 2024, while Apple generated 391.04 billion. Microsoft earned $88.14 billion in net income to Apple’s $93.74 billion. It seems Apple did slightly better (as far as finances go) than Microsoft in 2024.

Which Is Best, Microsoft or Apple?

That depends on what you’re evaluating. They each have different products and services and are very successful.

Who Won the Apple vs. Microsoft Lawsuit?

The copyright infringement lawsuit between Apple and Microsoft ended in 1992 in favor of Microsoft. Apple sued Microsoft for violating a copyright it held on certain elements of graphic user interfaces.

The Bottom Line

Apple and Microsoft are two tech giants that have dominated their industry for many years. Each began with similar business models but eventually went in different directions, with Microsoft catering more to productivity, business solutions, and cloud computing while keeping many of its consumer-facing products and services. Apple continues to market mostly to consumers and small- and mid-sized businesses.

Fact checked by Suzanne Kvilhaug
Reviewed by Chip Stapleton

You can use the trading activity of corporate insiders and large institutional investors to learn more about a stock. Insider or institutional activity should not be considered a buy or sell signal, but it gives you another tool to add to your stock evaluation toolbox.

Here is how to access insider and institutional ownership information and evaluate what it might mean for a stock you’re considering.

Key Takeaways

• A company’s officers, directors, relatives, or anyone else with access to key company information are considered insiders.
• A company’s proxy statement, Form DEF 14A, is the statement that lists directors and officers and the number of shares they each own.
• Schedules 13D and 13G are filed by companies to disclose beneficial ownership information, which is defined as more than 5% of a company’s stock issue.
• Forms 3, 4, and 5 are filed by stockholders to disclose insider beneficial ownership when they have more than 10% of voting power.

Insider Ownership

Insiders are a company’s officers, directors, relatives, or anyone with access to key company information before it’s made available to the public. If you pay attention to what insiders do with company shares, you might catch them making decisions because they have a better picture of the company’s future than those outside of it. You’ll be able to make reasonable assumptions about the company when comparing published information with share sales or purchases.

Since insider ownership and trading can impact share prices, the Securities and Exchange Commission (SEC) requires companies to file reports on these matters, allowing you to take advantage of any changes.

Important

An insider trade can be legal or illegal depending on when it is made—it becomes illegal if information behind the trade is not public.

Where to Find Insider Trading Information

You can retrieve forms from the SEC’s EDGAR database or the SEC Insider Transaction Data Sets. The most relevant forms that help you see what insiders are doing are Forms 3, 4, 5, Form DEF 14A, Form 13D, and 13G.

Form DEF 14A

This form is also known as the Definitive Proxy Statement. An SEC requirement for publicly traded companies, Form DEF 14A, must be filed ahead of shareholders’ meetings or whenever a shareholder vote is required. This statement includes a list of items being put to a vote as well as a list of directors and officers, along with the number of shares they each own.

This form also lists beneficial owners—people or entities owning more than 5% of a company’s stock—along with other pertinent information like board member nominations, as well as executive compensation.

Schedules 13D and 13G

Schedule 13D and Schedule 13G are also relevant forms that disclose beneficial ownership information. Here is a brief description of each form:

• Schedule 13D: This form is also known as the Beneficial Ownership Report. Anyone who owns more than 5% of a company’s stock must file Form 13D with the SEC within 10 days of a stock acquisition. The form must also include the reason behind the stock acquisition—whether it’s a merger, company acquisition, or takeover. Other information on this form includes the owner’s identity and the source of the funds for the transaction. Owners who acquire more than 20% of a company’s share must automatically file a Form 13D.
• Schedule 13G: Just like Schedule 13D, this form lets the public know about anyone who owns more than 5% of a company’s total stock. However, it’s shorter than the 13D because it requires much less information.

Forms 3, 4, and 5

Forms 3, 4, and 5 are filed to disclose insider beneficial ownership when shareholders have more than 10% of voting power. Forms are filed at different stages of stock acquisition.

Individuals file Form 3 when they first acquire shares. This form is also known as the Initial Statement of Beneficial Ownership of Securities. Form 3 helps the SEC track initial ownership along with whether there is any suspicious activity going on.

Form 4 is also referred to as the Statement of Changes in Beneficial Ownership. This form is used to report any changes of ownership of insiders who hold more than 10% of a company’s stock. Part of the reporting includes the shareholder’s relationship to the company.

Also known as the Annual Statement of Changes in Beneficial Ownership, Form 5 is an annual snapshot of holdings. Insider trading must be filed electronically through the EDGAR system within two days of the transaction, giving outside investors reasonably up-to-date ownership information.

Interpreting Insider Reports

High insider ownership typically signals confidence in a company’s prospects and ownership in its shares. This, in turn, gives the company’s management an incentive to make the company profitable and maximize shareholder value.

However, a company can have too much insider ownership. When insiders gain corporate control, management may not feel responsible to shareholders and, instead, to themselves. This frequently occurs in companies that issue multiple classes of stock, which means one class carries more voting power than another.

For example, Google’s much-publicized initial public offering (IPO) in the fall of 2004 was criticized for issuing a special class of super-voting shares to certain company executives. Critics of the dual-class share structure contend that, should managers yield less than satisfactory results, they are less likely to be replaced because they possess 10 times the voting power of normal shareholders.

While insider buying is usually a good sign, don’t be alarmed by insider selling, unless there is a lot of it. Insiders tend to buy because they have positive expectations, but they may sell for reasons independent of their expectations for the company.

Which Insiders to Watch

It’s important to know which insiders to watch. Clusters of activity by several insiders might indicate something is up. If a company has more than one instance of similar insider trading over a short period, there’s a sign of a consensus of insider opinion. Large transactions also mean more than small trades.

Insiders with track records of Form 4 activity should be watched more closely than those with little or poor records—there is something going on within the company. The most telling trading activity comes from top executives with the best insights into the company, so look for transactions by CEOs and CFOs.

Finally, be careful about placing too much stake in insider trading since the documents reporting them can be hard to interpret. Additionally, the activity might not mean much. Many Form 4 trades do not represent buying and selling that relate to future stock performance. The exercise of stock options, for instance, shows up as both a buy and a sell on Form 4 documents, so it is a dubious signal to follow.

Automatic trading is another activity that is hard to interpret. To protect themselves from lawsuits, insiders set up guidelines for buying and selling, leaving the execution to someone else. SEC Form 4 documents disclose these hands-off insider transactions, but they don’t always state that the sales were scheduled far ahead of time.

Institutional Ownership

Organizations that control a lot of money—mutual funds, pension funds, or insurance companies—and which buy securities are referred to as institutional investors. These entities own shares on behalf of their clients and are generally believed to be the force behind supply and demand in the market.

The Debate Over the Implications

Whether institutional ownership in a stock is a good thing remains a matter of debate. Peter Lynch, in his best-seller One Up on Wall Street, lists the 13 characteristics of the perfect stock. One of them is this: “Institutions don’t own it and the analysts don’t follow it.” Lynch favors stocks that the big investment groups overlook because they have more of a chance of being undervalued. Lynch argues that companies whose stock is owned by institutional investors are fairly valued, if not overvalued.

William O’Neil, founder of Investor’s Business Daily, on the other hand, argues that it takes a significant amount of demand to move a share price up, and the largest source of demand for stocks is institutional investors. O’Neil reckons that if a stock has no institutional owners, it’s because they have already seen it and rejected it. In his book How to Make Money in Stocks, O’Neil has institutional sponsorship as the sixth characteristic to look for in stocks worth buying.

O’Neil and Lynch both agree that institutional ownership can be dangerous. These big institutions move in and out of positions in very large blocks, so they cannot buy or sell holdings gracefully. If something is perceived as going wrong with a company and all its big owners sell en masse, the stock’s value will plunge.

Although there are mutual funds that operate with longer-term horizons, and pension funds tend to be long-term stockholders, institutional investors tend to react to short-term events. The high correlation between high institutional ownership and stock price volatility is a fact of life in investing, and so it pays to know what the institutions are up to and whether a stock you are interested in already has a large institutional interest.

Where to Find Holdings Information

Institutional investment managers who exercise investment discretion of more than $100 million in securities must report their holdings on Form 13F with the SEC. This form is filed quarterly by institutional investment managers who have a minimum of $100 million in assets under management (AUM) within 45 days of the end of a quarter. Again, you can search for and retrieve Form 13F filings using the SEC’s EDGAR database. Yahoo Finance also provides a very useful site that details stock ownership. To view this, search Yahoo Finance for a particular company and click the section labeled “Holders” to receive details on the company’s institutional holders.

Is Institutional Ownership Good for a Stock?

Institutional ownership is believed to be essential for stock values. Institutions own most of the stocks on the market, provide liquidity, and influence retail investing. They also make it easier for retail investors to access the markets. However, institutions do pose a danger to investors if they transact in large blocks, which can unduly influence prices.

Is Insider Ownership Good for a Stock?

Generally, insider ownership is good because it indicates that those working in the company believe in its prospects.

How to Check Institutional Ownership of a Stock?

The easiest way is to visit Yahoo Finance, select the company you want to research, and click “Holders” on the left. The resulting page will tell you what percentage of shares are held by institutions and insiders and give you a list of the top institutional holders.

The Bottom Line

Institutions tend to be smart, diligent, and sophisticated investors, and insiders have the best understanding of a company’s prospects, so their ownership is a good criterion for a first screen in your research or a reliable confirmation of your analysis of a stock. However, as with all fundamental analysis considerations, insider and institutional trading should be used in conjunction with several other factors.

Fact checked by Katrina Munichiello
Reviewed by Khadija Khartit

Financial risk is inherent in any business enterprise, and good risk management is an essential aspect of running a successful business.

There are different ways to categorize a company’s financial risks. For example, managers can separate financial risk into four broad categories: market risk, credit risk, liquidity risk, and operational risk.

A company’s management can control risk with varying levels of success. Some risks can be directly managed; other risks are largely beyond the control of management.

Sometimes, the best a company can do is to try to anticipate possible risks, assess the potential impact on the company’s business, and be prepared with a plan to react to adverse events.

Key Takeaways

• There are four broad categories of financial risk that companies can address with proper risk management measures.
• Market risk is the risk that there could be a substantial change in the particular marketplace in which a company competes.
• Credit risk arises when companies extend their customers a line of credit, or, when a company can’t pay for services provided on credit by a vendor.
• Liquidity risk refers to how easily a company can convert its assets into cash if it needs funds; it also refers to its daily cash flow.
• Operational risks emerge as a result of a company’s regular business activities and include fraud, lawsuits, and personnel issues.

1. Market Risk

For businesses, market risk can relate to changing conditions in the specific marketplace in which it competes.

Changing Consumer Preferences

One example of market risk is the increase in consumers who prefer shopping online. This aspect of market risk has presented significant challenges to traditional retail businesses.

Many companies that have adapted to serving an online shopping public have thrived and seen substantial revenue growth, while other companies that couldn’t adapt, have been slow to adapt, or have made bad decisions relating to the changing marketplace have fallen by the wayside.

Another trend is ESG (environmental, social, and governance business practices). Some companies are now pressured by customers to move from polluting industries to cleaner ones. Or from seeking profits for profits’ sake only to seeking profits while doing good in communities.

Companies who lag behind this trend could be at risk for being poor in capital, short in talent, and unfortunate in branding.

Agility of Competitors

Another element of market risk is the risk of being outmaneuvered by competitors.

The global marketplace is increasingly competitive, often with narrowing profit margins. The most financially successful companies are those that offer a unique value proposition that makes them stand out from the crowd with a solid marketplace identity.

Note

Market risk can also relate to the risk of loss due to changing product prices, stock prices, currency rates, and interest rates.

2. Credit Risk

Businesses face credit risk when they extend credit to customers, essentially allowing them to make purchases without immediate payment.

As long as customers who buy on credit pay their bills, the company avoids loss. If they default on payments, then the company has a problem.

Credit risk can also refer to the company’s credit line with suppliers. A company must ensure that it always has sufficient cash flow to pay its accounts payable bills in a timely fashion.

Otherwise, suppliers may either stop extending credit to the company or even stop doing business with the company altogether.

Important

While managing risk is an important part of running a business effectively, a company’s management only has so much control. In some cases, the best thing management can do is to anticipate and prepare for potential risks.

3. Liquidity Risk

Liquidity risk involves asset liquidity and operational funding liquidity.

Asset liquidity refers to the ease and speed with which a company can convert its assets into cash should there be a sudden, substantial need for additional cash flow.

Operational funding liquidity refers to the amount of daily cash flow being enough to meet short-term liabilities and obligations, and keep the business running smoothly.

General or seasonal downturns in revenue can present a substantial risk if the company suddenly finds itself without enough cash on hand to pay the basic expenses—salaries, vendor bills—necessary to continue to function.

This is why cash flow management is critical to business success—and why analysts and investors look at metrics such as free cash flow when evaluating companies as an equity investment.

4. Operational Risk

Operational risks are the various risks that can arise from a company’s ordinary business activities. The operational risk category includes lawsuits, fraud, and personnel problems.

It also involves business model risk, which is the risk that a company’s models of marketing and growth plans may prove to be inaccurate or inadequate.

With All the Inherent Risks, Why Do People Start Businesses?

People start businesses when they fervently believe in their core ideas, their potential to meet unmet demand, their potential for success, profits, and wealth, and their ability to overcome risks. Many businesses believe that their products or services will contribute to the good of their community or society at large. Ultimately (and even though many businesses fail), starting a business is worth the risks for some people.

What Is Financial Risk?

Broadly speaking, financial risk is the risk that a business could lose money on an investment it makes or due to its decisions about its operations, its borrowing, or its market (including competitors).

Is Managing Risk a Big Part of Business?

Yes, it’s a crucial and essential effort that businesses make so that they may prevent financial loss. Many businesses employ individuals whose sole job is identifying and mitigating risk. Large companies in particular staff entire departments devoted to risk management.

The Bottom Line

All businesses face different forms of risk. Risk is built in when starting and running a business, and as a company makes moves to achieve lasting success.

Normally, businesses can’t avoid risk but they can manage and reduce it.

Four broad categories of financial risk for businesses are market risk, credit risk, liquidity risk, and operational risk.

The labor market’s recovery since the pandemic changed the dynamics of the American workforce

At the height of the COVID-19 crisis, the U.S. labor market’s employment losses topped 14% below pre-recession totals—more than eight points higher than the worst month of the Great Recession. Yet despite the unprecedented spike in unemployment, it would only take 29 months to recover the jobs lost, beating the recoveries of both the dot-com bubble and the summer recession of 1990.

2020’s surge in job losses, and subsequent return to “normal,” were the fastest recovery to pre-recession employment levels in over 40 years.

Key Takeaways

• The surge in job losses in 2020 because of COVID-19, and subsequent return to “normal” in just 29 months, were the fastest recovery to pre-recession employment levels in over 40 years.
• The pandemic affected certain labor market sectors, mainly because some could work from home and others couldn’t.
• Leisure and hospitality took some of the largest hits, but have recovered to pre-pandemic levels.
• Local messenger and delivery and private postal service jobs have surged, as have general warehousing and storage jobs.
• Black and Latino workers suffered more job losses than White or Asian workers, but current employment levels now exceed pre-pandemic levels.
• Wage growth has been strong since the spring of 2020, but was no match at first for inflation, which surged to 40-year highs. Wages finally started outpacing inflation in March 2023, and have remained ahead since.

The Shifting U.S. Labor Market

The pandemic leveled certain sectors of the labor market more than others, in no small part thanks to the unequal effect of industries that could work from home and those that couldn’t. Leisure and hospitality took some of the largest hits, as millions of Americans canceled vacation, dining, and entertainment plans for months on end. Conversely, professional and business services, some of the most likely to continue their jobs by working from home, recovered more quickly, and job gains have now surpassed pre-pandemic levels.

As of January 2025, there were slightly more workers on leisure and hospitality payrolls (16.978 million) than there were in February 2020 (16.889 million), just before the pandemic caused payrolls to plummet.

The Warehouse and Messenger Sectors Surge

If you’ve been on the highway lately, you may have noticed a lot more 18-wheelers on the roads. The explosion of ecommerce and home delivery is responsible for that, as well as the growth of jobs in the local messenger and warehousing industries.

There’s been a surge in employment in local messenger and delivery and private postal services, in addition to general warehousing and storage jobs. There are now an estimated 75% more delivery drivers and other related workers and 58% more warehousing and storage workers than there were before the spring of 2020, according to the U.S. Bureau of Labor Statistics (BLS).

On the other hand, some of the biggest outliers in job losses from pre-pandemic until now are convention and trade show organizers and workers in children/infant clothing retail.

Uneven Recovery Across Race and Sex

While the job losses in 2020 impacted Black and Latino workers more than White or Asian workers, the job gains for those groups has been robust, and current employment levels now exceed pre-pandemic levels. Employment levels for Black workers are 10.6% higher in January 2025 compared to their pandemic-level worst in May 2020. Employment is 12.8% higher for Latino workers and 11.1% higher for Asian workers for the same time period.

Strong Wage Gains, but Not Strong Enough at First

While wage growth has been strong since the spring of 2020, it was no match at first for inflation, which surged to 40-year highs.

Nominal compensation, including wages and other earnings and benefits, increased 8.6% from Q1 2020 to Q2 2022. But, as of mid-2021, inflation began rising at a higher rate than overall compensation, contributing to real compensation declines since early 2021.

In a reversal of job loss numbers, higher inflation led to real compensation declines for workers in every industry except for leisure and hospitality, the industry that had the largest declines in employment. Meanwhile, workers in the professional and business services industry experienced the second largest real wage decline at 4.4%, eclipsed only by construction workers.

Wages finally started outpacing inflation in March 2023, and have remained ahead since.

What Was the COVID-19 Pandemic?

The COVID-19 pandemic began with an outbreak in Wuhan, China, in December 2019 that soon spread to other areas of Asia, then worldwide in early 2020. The World Health Organization (WHO) declared a pandemic in March 2020. The WHO and the U.S. Department of Health and Human Services (HHS) both declared an end to the public health emergency in May 2023.

What Is the Labor Market?

The labor market refers to the supply of and demand for labor. Also known as the job market, it’s based on employees providing the supply and employers providing the demand. It’s a major component of any economy and is intricately linked to markets for capital, goods, and services.

What Is the Most Recent U.S. Unemployment Rate?

The unemployment rate is 4.0% as of January 2025, down 0.1% from the previous month, according to the U.S. Bureau of Labor Statistics (BLS). That corresponds to 6.8 million people out of work. The U.S. added 143,000 jobs in January 2025, the BLS reported.

The Bottom Line

As of December 2024, U.S. employers have added 2.2 million jobs for the year. There are now 7.2 million more jobs on U.S. payrolls than there were pre-pandemic. Still, jobs remain in high demand with 7.6 million openings, as of the BLS’s latest Job Openings and Labor Turnover Survey (JOLTS) report. That’s nearly 1.1 jobs for every unemployed person, and yet another sign of how peculiar this employment recovery has been.

Reviewed by Erika Rasure

According to the U.S. Bureau of Economic Analysis (BEA), total production in the U.S. economy grew at a 2% clip in the third quarter of 2015. In the second quarter, real gross domestic product (real GDP) was revised up to 3.7% growth. There are some problems with relying on GDP to gauge economic health, but these were still encouraging signs for a country fighting through the slowest post-recession recovery in its history.

Positive economic numbers only added to expectations about a potential interest rate hike by the Federal Reserve heading into 2016. The Fed had not raised interest rates since before the Great Recession.

A momentous 0.25% federal funds rate hike is only one challenge that the U.S. economy faced in 2016. Labor force participation was still historically low. Politicians continued to rack up enormous deficits and finance them with cheap credit. And the entire global financial system teetered because China’s economy finally slowed after years of ravenous growth.

The following are three challenges that American businesses and policymakers confronted in 2016.

Key Takeaways

• U.S. businesses and policymakers confronted three significant economic challenges in 2016.
• The Federal Open Market Committee (FOMC) raised the federal funds rate by 0.25% in December 2016, after holding steady as inflation remained below target.
• The struggles of the two largest foreign markets, Europe and China, affected the U.S. economy.
• The U.S. economy added jobs, but very few were full-time, productive jobs in the private economy.

The Fed’s Difficult Balancing Act

The Federal Open Market Committee (FOMC) openly toyed with the idea of raising interest rates beginning in at least 2012. The Fed likely did not raise them for much of 2016 because it was caught between a rock and several hard places.

There is ample historical evidence to suggest low interest rates fuel bond, equity, and housing prices. The opposite tends to occur when rates increase. The 2015 recovery was likely built on higher asset prices and lower energy costs. There were concerns that raising interest rates would not cause oil prices to jump, but would also drive down assets, turning the small recovery into a contraction.

Then again, interest rates couldn’t stay at zero forever. The economy had already suffered the terrible results of unchecked housing and stock market growth in 2007–2008, and the Fed did not want to double down on that mistake. Additionally, savers and retirees had been crippled by record-low payments on traditional income devices such as certificates of deposit (CDs) and bonds.

Just as critically, the federal government did not want rates to rise. First, the illusory growth from low interest rate policies was politically popular. Second, the United States had an enormous interest payment on the debt. These interest payments suddenly get much larger when the government has to issue new bonds with higher coupons.

In December 2016, the FOMC finally raised the fed funds rate by 0.25%.

Weakness in Europe and China

The U.S. is not immune to the ebbs and flows of a complex global economy, and the two largest foreign markets, Europe and China, struggled in 2016. When the Shanghai Stock Exchange Composite more than doubled from October 2014 to August 2015, many pronounced China as the economic superpower of the future. That optimism all but disappeared in a flash after Chinese equities fell by nearly 40% over the next two months, despite massive purchases of failing companies by the Chinese Security Finance Corp.

It turns out China had a real estate and stock market bubble that felt disturbingly similar to the American experience in 2007–2008. The “red economy,” seemingly impervious to a slowdown the year prior, seemed on the brink of a multiyear struggle.

News out of Europe was not much better. Recorded growth in the eurozone was just 0.5% in Q1 2015, and numbers were even worse for Q2 and Q3. Germany and the United Kingdom had been reluctantly dragging the rest of the continent out of the red for years, but economic and political concerns were numerous in the new year.

Sluggish Jobs Market

The U.S. economy added jobs each month in 2015. This is the good news. The bad news was that very few of those jobs were full-time, productive jobs in the private economy. The middle class was still struggling, and the economy did not seem well equipped to provide new, lasting, and high-paying opportunities.

Total government employment increased by more than 1.1 million from November 2014 to November 2015. Over the same time frame, over 500,000 jobs were added to an increasingly bureaucratic healthcare sector. And, as the November 2015 jobs report from the U.S. Bureau of Labor Statistics pointed out, “the number of persons employed part-time for economic reasons (sometimes referred to as involuntary part-time workers) increased by 319,000 to 6.1 million.”

The labor force participation rate was near decade-long lows all year, standing at under 63%. And, even though 211,000 jobs were added in November 2015, there were 2.3 million workers only “marginally attached to the labor force” or who were discouraged and not believing there were jobs out there for them. This means that, by a factor of eight-to-one, more people gave up looking for jobs than found them.

U.S. unemployment held steady for much of 2016 before falling 0.3% in Q4.

How Much Did the Economy Factor into the 2016 Presidential Election?

The economy was a top issue for voters in the 2016 U.S. presidential election, which Donald Trump won. According to a Pew Research Center survey in June 2016, 84% of registered voters said that the issue of the economy would be very important to them in deciding who to vote for.

What Was the Final Result for the U.S. Economy in 2016?

The U.S. economy grew by 1.6% in 2016, according to real GDP figures from the Bureau of Economic Analysis. This was a decline from a 2.6% increase in 2015.

What Challenges Will the U.S. Economy Face in 2025?

Challenges facing the U.S. economy in 2025 include:

• A shrinking trend of more job openings than people searching for work
• Two possible cuts to the federal funds rate, reflecting Federal Reserve recognition that the inflation rate is falling slower than expected and a possible hedge against new tariffs from the second Trump presidential administration
• Tax cuts, as promised by the Trump administration, that would keep the federal budget deficit high

The Bottom Line

American businesses and policymakers confronted three significant economic challenges in 2016. One was the Federal Open Market Committee (FOMC) toying with raising interest rates, before finally doing so in December 2016. The second was the struggles of the two largest foreign markets: Europe and China. The third was a sluggish jobs market in which very few of the jobs being added represented full-time, productive work in the private economy.

Reviewed by Cierra Murry

Despite their infamous reputation for their role in the financial crisis of 2007-2008, there are several different arguments in favor of allowing market participants to trade and own mortgage-backed securities (MBS).

At its basic level, an MBS is any investment solution that uses commercial or residential mortgage or a pool of mortgages as the underlying asset. Like most financial innovations, the purpose of an MBS is to increase return and diversify risk. By securitizing pools of similar mortgages, investors can absorb the statistical likelihood of non-payment.

However, an MBS is a complicated instrument and comes in many different forms. It would be difficult to asses the general risk of an MBS, much like it would be difficult to assess the risk of a generic bond or stock. The nature of the underlying asset and the investment contract are large determinants of risk.

Advisor Insight

• Mortgage-backed securities(MBS) are tradeable securities backed by the cash flow from a portfolio of mortgages.
• In theory, MBS diversify risk by providing access to a broad portfolio of mortgage debt.
• Mortgage-backed securities played a key role in the 2008 financial crisis when many of the underlying loans defaulted.
• Today, mortgage-backed securities are still popular among investors seeking diversified exposure to real estate lending.

Improved Liquidity and Risk Argument

Mortgage debt and pools of mortgages are sold by financial institutions to individual investors, other financial institutions and governments. The money received is used to offer other borrowers loans, including subsidized loans for low-income or at-risk borrowers. In this way, an MBS is a liquid product.

Mortgage-backed securities also reduce risk to the bank. Whenever a bank makes a mortgage loan, it assumes risk of non-payment (default). If it sells the loan, it can transfer risk to the buyer, which is normally an investment bank. The investment bank understands that some mortgages are going to default, so it packages like mortgages into pools. This is similar to how mutual funds operate. In exchange for this risk, investors receive interest payments on the mortgage debt.

Suggesting that these types of MBS are too risky is an argument that could apply to any type of securitization, including bonds and mutual funds.

Aggregate Arguments: Consumption Smoothing and More Homes

Economic research has suggested that, in both domestic and international markets, the securitization of the mortgage market has led to the sharing of consumption risk. This allows banking institutions to supply credit even during downturns, smoothing out the business cycle and helping normalize interest rates among different populations and risk profiles. Theoretically, the level of consumer spending in the market is smoother and less prone to recession/expansion fluctuations as a result of increased securitization.

The unquestioned result of mortgage securitization has been an increase in home ownership and a reduction in interest rates. Through the MBS and its derivative, the collateralized mortgage obligation, banks have been more able to provide home credit to borrowers who otherwise would have been priced out of the market.

$1.59 trillion

The total value of mortgage-backed securities issued in the U.S. in 2024.

Federal Reserve Involvement

While the MBS market draws a number of negative connotations, the market is more “safe” from an individual investment stand point than it was pre 2008. After the collapse of the housing market, and on the back of strict regulation, banks increased the underwriting standards and made their loans more robust and transparent. 

The Federal Reserve remains a big player in the MBS market. As of Feb. 2025, the Fed’s balance sheet included $2.2 trillion in MBS. With the central bank a significant player, the MBS market has clawed back much of its credibility. 

Free to Contract Argument

There is another argument in favor of allowing MBS that has less to do with financial arguments and more to do with the nature of capitalism itself: Capitalism is a profit and loss system, built on the argument that voluntary exchange and individual determination are ultimately preferable to government restrictions. Nobody coerces a borrower into taking out a mortgage loan, just as no financial institution is legally obligated to make additional loans and no investor is forced to purchase an MBS.

The MBS allows investors to seek a return, lets banks reduce risk and gives borrowers the chance to buy homes through free contracts.

What Are the Risks of Mortgage-Backed Securities?

There are three main risks for investors in mortgage-backed securities: interest rate risk, prepayment risk, and default risk. Interest rate risk refers to the chance that market-wide interest rates will increase, thereby reducing the market value of existing contracts. This is common to all fixed-income investments, not just MBS. Prepayment risk is the possibility that some borrowers will pay off their loans early, thereby reducing the total income for MBS holders. Default risk is the possibility that a large number of borrowers will default, thereby reducing the investors’ income stream.

How Did Mortgage-Backed Securities Contribute to the Financial Crisis?

Prior to the 2008 financial crisis, many banks and lenders chose to securitize their mortgage assets and sell them, rather than keep those loans on their own balance sheets. As the housing bubble inflated, lenders began to lower their lending standards, and used mortgage-backed securities as a convenient way to dispose of high-risk loans. When borrowers started to default, MBS investors were left with underperforming assets.

How Big Is the Market for Mortgage-Backed Securities?

The market for mortgage-backed securities is significant. In 2024, nearly $1.6 trillion of mortgage-backed securities was issued in the United States. The largest component was Agency MBS, issued by government-affiliated bodies like Ginnie Mae.

The Bottom Line

Although mortgage-backed securities(MBS) are commonly associated with the 2008 housing crash, they are still a popular choice for institutional investors. By bundling together a large number of loans, these securities provide investors with broad exposure to a large portfolio of loans, rather than betting on the solvency of a single borrower. Moreover, they also have the effect of smoothing out regional and demographic variations in mortgage interest rates.

Investors around the globe are increasingly worried about the state of China’s economy—the world’s second-largest economy after the United States—which has been severely impacted by rising credit levels, a slowdown in its gross domestic product (GDP), and the ongoing trade war with the U.S.

Very few economies have grown at the rate of China’s; according to The World Bank, the growth rate of China’s economy over the past 30 years has averaged about 9% per year. However, China’s GDP growth in 2020 was 2.2%, the slowest year since 1990. Accelerating credit growth, the overvaluation of the yuan, and a frothy housing market have contributed to a slowdown in the second-biggest economy in the world.

Key Takeaways

• Investors around the globe are increasingly worried about the state of China’s economy, which has been severely impacted by rising credit levels, a slowdown in its gross domestic product (GDP), and the ongoing trade war with the U.S.
• China’s GDP growth in 2020 was 2.2%, the slowest year since 1990.
• Accelerating credit growth, the overvaluation of the yuan, and a frothy housing market have contributed to a slowdown in the second-biggest economy in the world.
• If China’s troubles persist, there could be significant consequences for foreign trade, financial markets, and economic growth in the U.S. and around the world.

Accelerating Credit Growth

Economists Wei Yao and Claire Huang of Société Générale consider that much of the growth in China’s economy was due to credit expansion. In an attempt to shift from an investment-based to a consumption-based economy and reverse the 25-year trend of slowing economic growth, the Chinese government adopted an accommodative monetary policy.

From 2016 to 2024, China’s overall debt soared from 242% to 303% of its GDP. In an attempt to alleviate its supply of debt, China has tried to increase demand by easing restrictions on market entrance for foreign investors. These efforts have achieved little success. Theoretically, when bond markets become more accessible, foreign investor demand should increase. However, there hasn’t been any data to support an increased level of investor interest in Chinese bonds.

Overvalued Currency

In addition to its credit woes, China is facing a currency crisis. Through excessive debt creation and money printing, the People’s Bank of China (PBOC) has created one of the largest money supplies and total banking system assets of any country. An aggressive monetary policy has led to total banking system assets of $60.59 trillion (439.52 trillion yuan) at the end of the third quarter of 2024. From 2010 to 2017 alone, the total assets of banking institutions in China increased by over 200%. This has contributed to an overvalued yuan.

Perhaps even more concerning are the statistics about China’s total social financing (TSF). Total social financing reflects an economy’s credit level, taking into account off-balance-sheet financing, or “shadow banking,” including initial public offerings (IPOs), loans from trust companies, and bond sales. As of January 2025, China’s total outstanding TSF was $973.2 billion. This is an indication that debt growth is accelerating via China’s shadow banking system.

Frothy Real Estate Market

After the loss of $3.2 trillion during China’s stock market crash in 2015, the PBOC attempted to encourage potential equity investors. Compared to Americans, the Chinese have historically invested more of their capital in real estate than in the financial markets. The 2015 stock market crash reinforced that trend; Chinese direct investment in the United States that year hit a record $15.7 billion.

In 2024, the median price per square foot for real estate in China was about $238, almost 6% higher than the median price per square foot of real estate in the U.S. that year ($225), despite the fact that per-capita income in the U.S. was 1,670% higher than China in 2023, the most recent year for which annual data is available. This housing data indicates that, for a time, the Chinese continued to invest in real estate for their economic growth. Historically, real estate has been the main driver of growth in China’s economy, accounting for a large portion of its GDP. China’s efforts to float its housing market, keeping prices rising and continuing development, might have hurt other areas of its economy.

Housing prices have been falling in China since the third quarter of 2021, according to the U.S. Federal Reserve. In May 2024, China rolled out its strongest measures so far to fix its broken housing market, easing mortgage rules and pushing city and local authorities to buy up unsold homes to be converted into affordable housing. Before this, policymakers tightened policies in order to crack down on speculative buying that had been prevalent since 2015. Before the downturn, housing prices were consistently rising in every major city for several years, although income level lagged.

How Is the Chinese Economy Structured?

China has a socialist market economy. This means that it has both state-owned enterprises and a market economy. China’s communist government plays a significant role in the economy, guiding development with five-year plans.

What Is the Status of the U.S.-China Trade War?

On Feb. 1, 2025, U.S. President Donald Trump ordered 10% tariffs on China, which took effect three days later. China responded with duties on the imports of some American goods and an antitrust probe into Alphabet’s (GOOGL) Google. Trump said he imposed the tariffs over China’s role in the flow of fentanyl, a powerful synthetic opioid, into the U.S.

What Is the Forecast for China’s Economy?

China’s economy in 2025 is expected to see slower growth, with most forecasts predicting a rate around 5% or below. This is mostly due to weak consumer demand, a struggling real estate market, and high debt levels, despite the government’s attempts to stimulate domestic consumption through policy changes.

The Bottom Line

China’s economic situation can be difficult to assess. While China has taken steps toward becoming more transparent in its financial sector, its GDP data is known to have been manipulated in the past. Some economists and analysts speculate that official data about Chinese industrial profits are also manipulated and do not reflect the true state of the economy. It’s likely that China’s economy is underperforming compared to government reports.

If China’s troubles persist, there could be significant consequences for foreign trade, financial markets, and economic growth in the U.S. and around the world.

Fact checked by Yarilet Perez
Reviewed by Natalya Yashina

Balance of Payments Overview

A country’s balance of payments (BOP) is the record of all international transactions (payments and receipts) between the individuals and entities (including government) of that nation and other countries during a specific time period.

The current account, the capital account, and the financial account make up a country’s BOP. Together, these three accounts tell a story about a country’s economy, economic outlook, and strategies for achieving its desired goals.

For example, a large volume of imports and exports may indicate an open economy that supports free trade.

On the other hand, a country that shows little international activity in its capital or financial account may have an underdeveloped capital market and little foreign currency entering the country in the form of foreign direct investment (FDI).

Current, Capital, and Financial Accounts

A current account records the flow of goods and services in and out of a country, including tangible goods, service fees, tourism receipts, and money sent directly to other countries either as official aid or family to family funds.

The capital account measures the capital transfers between U.S. residents and foreign residents.

A financial account measures the increase or decrease in a country’s ownership of international assets.

In this article, we focus on the capital and financial accounts, which reflect investment and capital market regulations within a given country.

Key Takeaways

• A country’s balance of payments is represented by its current account, capital account, and financial account.
• The current account records the flow of goods and services in and out of a country (imports and exports).
• The capital account measures the capital transfers between U.S. residents and foreign residents.
• The financial account reflects increases or decreases in a country’s ownership of international assets.
• Positive capital and financial accounts mean a country has more debits than credits and is a net debtor to the world; negative capital and financial accounts make the country a net creditor. 

The Capital Account

A country’s capital account records all international capital transfers. The income and expenditures are measured by the inflow and outflow of funds in the form of investments and loans.

A deficit shows that more money is flowing out, while a surplus indicates that more money is flowing in.

Along with non-financial and non-produced asset transactions, the capital account includes:

• Dealings such as debt forgiveness
• The transfer of goods and financial assets by migrants leaving or entering a country
• The transfer of ownership of fixed assets and of funds received for the sale or acquisition of fixed assets
• Gift and inheritance taxes
• Death levies, patents, copyrights, royalties
• Uninsured damage to fixed assets

Complex transactions involving both capital assets and financial claims may be recorded in both the capital and current accounts.

The Financial Account

Sub-Accounts and Their Effects

A country’s financial account can be broken down into two sub-accounts. One is the domestic ownership of foreign assets. The other is the foreign ownership of domestic assets. Together, these two sub-accounts measure a country’s ownership of international assets.

If the sub-account for the domestic ownership of foreign assets increases, the overall financial account increases.

If the sub-account for the foreign ownership of domestic assets increases, the overall financial account decreases.

Thus, the overall financial account increases when the foreign ownership of domestic assets sub-account decreases.

Together, these two sub-accounts of the financial account measure a country’s ownership of international assets.

The financial account deals with money related to:

• Foreign reserves
• Private investments in businesses, real estate, bonds, and stocks
• Government-owned assets such as special drawing rights at the International Monetary Fund (IMF)
• Private sector assets held in other countries
• Local assets held by foreigners (government and private)
• Foreign direct investment

How the Capital and Financial Accounts Work

Capital transferred out of a country for the purpose of investing in a foreign country is recorded as a debit in either of these two accounts.

Specifically, if it’s a portfolio investment, it’s recorded as a debit in the financial account. If it’s a direct investment, it’s recorded as a debit in the capital account.

Since these transfers involve investments, there’s an implied return. In the BOP, this return is recorded as a credit in the current account.

The opposite is true when a foreign country earns a return. Paying a return on an investment would be noted as a debit in the current account.

Important

The U.S. Bureau of Economic Analysis records and provides information to the public about the current account, capital account, and financial account balances.

Understanding the Balance of Payments

Accounts in Balance

Unlike the current account, which theoretically is expected to run at a surplus or deficit, the BOP should be zero. Thus, the current account on one side and the capital and financial account on the other should balance each other out.

For example, if a Greenland national buys a jacket from a Canadian company, then Greenland gains a jacket while Canada gains the equivalent amount of currency. To reach zero, a balancing item is added to the ledger to reflect the value exchange.

According to the IMF’s Balance of Payments Manual, the balance of payment formula, or identity, is summarized as:

Current Account + Financial Account + Capital Account + Balancing Item = 0

Positive Capital and Financial Accounts

However, when an economy has positive capital and financial accounts it has a net financial inflow. The country’s debits are more than its credits due to an increase in liabilities to other economies or a reduction of claims in other countries.

This is usually in parallel with a current account deficit—an inflow of money means the return on an investment is a debit on the current account.

Thus, the economy is using world savings to meet its local investment and consumption demands. It is a net debtor to the rest of the world.

Negative Capital and Financial Accounts

If the capital and financial accounts are negative, the country has a net financial outflow. It has more claims than it does liabilities, either because of an increase in claims by the economy abroad or a reduction in liabilities from foreign economies.

The current account should be recording a surplus at this stage. That indicates the economy is a net creditor, providing funds to the world.

Liberal Accounts

The capital and financial accounts are intertwined because they both record international capital flows. In today’s global economy, the unrestricted movement of capital is fundamental to ensuring world trade and eventually, greater prosperity for all.

For this flow to happen, countries must have open or liberal capital account and financial account policies.

Today, many developing economies implement capital account liberalization as part of their economic reform programs. This removes restrictions on capital movement.

Note

Liberalization of a country’s capital account may signal a shift toward more open economic policy.

Benefits of Foreign Direct Investment

This unrestricted movement of capital means governments, corporations, and individuals are free to invest capital in other countries. That can pave the way for not only more FDI in industries and development projects. It can also allow for more portfolio investment in the capital market as well.

Thus, companies striving for bigger markets, and smaller markets seeking more capital and the achievement of domestic economic goals, can expand into the international arena. This can result in a stronger global economy.

The benefits that the recipient country reaps from FDI include an inflow of foreign capital into its country as well as the sharing of technical and managerial expertise. The benefit for a company making an FDI is expanding market share in a foreign economy and, potentially, greater returns.

Another benefit, according to some, is that a country’s domestic political and macroeconomic policies can take on a more progressive stance.

That’s because foreign companies investing in a local economy have a valued stake in the local economy’s reform process. These foreign companies can become expert consultants to the local government on policies that will facilitate businesses.

Other Benefits

Portfolio foreign investments can encourage capital market deregulation and boost stock exchange volume. By investing in more than one market, investors are able to diversify their portfolio risk. They can potentially increase their returns by investing in an emerging market.

A deepening capital market based on local economic reforms and a liberalization of the capital and financial accounts can speed up the development of an emerging market.

Capital Account Control Can Be Good

Some sound economic theories assert that a certain amount of capital account control can be good.

Example

Recall the Asian financial crisis in 1997. Some Asian countries opened up their economies to the world. An unprecedented amount of foreign capital crossed their borders.

Primarily, it was portfolio investment—a financial account credit and a current account debit. This meant short-term investments that were easy to liquidate.

When speculation increased, panic spread throughout the region. Capital flows reversed. Money was pulled out of these capital markets. Asian economies were responsible for their short-term liabilities (debits in the current account) as securities were sold off before capital gains could be reaped.

Not only did stock market activity suffer, but foreign reserves were depleted, local currencies depreciated, and financial crises resulted.

Analysts argue that the financial disaster could have been less severe had there had been some capital account controls.

For instance, had the amount of foreign borrowing been limited (debits in the current account), that would have limited short-term obligations. In turn, some degree of economic damage could have been prevented.

What Does the Balance of Payments Mean?

The term “balance of payments” refers to all the international transactions made between the people, businesses, and government of one country and any of the other countries in the world. The accounts in which these transactions are recorded are called the current account, the capital account, and the financial account.

Why Should an Economy Be Liberalized?

A more open or liberal economy can mean more international trade for a country. The income that results from that trade can benefit a country’s citizens. It could raise their standard of living. For a country as a whole, freer trade can raise its standing in the world and attract investors. That can open up all kinds of beneficial financial and economic opportunities.

What Is the Capital Account?

The capital account is one of the accounts used in the balance of payments. It’s used to record international transfers of capital between the residents in one country and those in other countries. The capital account can reflect a country’s financial health and stability. It can indicate how attractive a country is to other countries that seek to invest internationally.

The Bottom Line

A country’s balance of payments is a summarized record of that country’s international transactions with the rest of the world. These transactions are categorized by the current account, the capital account, and the financial account.

Lessons from the Asian financial crisis resulted in new debates about the best way to liberalize capital and financial accounts.

Indeed, the IMF and World Trade Organization historically have supported free trade in goods and services (current account liberalization). They are now faced with the complexities of capital freedom.

Experience has proven that without controls, a sudden reversal of capital flows can destroy an economy and result in increased poverty for a nation.

Fact checked by Vikki Velasquez
Reviewed by Erika Rasure

The major types of 401(k) plans are traditional 401(k)s and Roth 401(k)s. Smaller employers may offer you a SIMPLE (Savings Incentive Match Plan for Employees) 401(k) or a safe harbor 401(k) plan. If you’re an entrepreneur, you may be able to set up your own 401(k) account, too. These types of 401(k) plans have grown in popularity since the introduction of the 401(k) plan in the late 1970s and early ’80s. Nowadays, about 70 million workers participate in this type of retirement savings account. Learn more about these types of plans to decide which is right for you.

Key Takeaways

• Larger employers typically offer both traditional and Roth 401(k)s.
• Smaller employers may favor SIMPLE (Savings Incentive Match Plan for Employees) and safe harbor 401(k) plans, which can be less complex and less costly to administer.
• Solo entrepreneurs can set up a 401(k) just for themselves.

5 Types of 401(k)s and How They Work

All 401(k)s are defined contribution plans. They’re funded by employee contributions. Sometimes employers contribute, too.

With a 401(k), the amount of money that employees will have available for retirement is determined by how much they contributed to the plan and how well the investments in their account have performed over the years.

There are several different types of 401(k) plans. These are the ones you are most likely to encounter as either an employee or an employer. 

Traditional 401(k)

This is what most people probably think of as a 401(k). The employee contributes pre-tax money to their account each pay period, usually through regular payroll deductions. That money goes into the investments, typically mutual funds, that they’ve chosen from the plan’s offerings.

The maximum that employees can contribute is set by law. For 2025, it is $23,500 a year for anyone under age 50 or $31,000 for those 50 or older—unless you’re 60, 61, 62 or 63. In that case, you can contribute up to $34,750.

On top of that, many employers will make a matching contribution, such as 50 cents per dollar of the employee’s contributions, up to 6% of the employee’s salary.

With a traditional 401(k), the money that the employee contributes is not immediately taxed. Instead, the amount of their contribution lowers their taxable income for the year. So, for example, an employee who makes $50,000 a year and contributes $10,000 to their 401(k) plan will pay income taxes only on $40,000 of their income that year. The account’s earnings will also grow tax-deferred until they’re eventually withdrawn.

When the employee makes withdrawals (often referred to as distributions) from the account, that money will be taxed as regular income. In addition, because 401(k)s are intended for retirement, employees generally can’t withdraw money before age 59½ without paying a 10% early withdrawal penalty. There are, however, some exceptions to that rule.

Traditional 401(k) plans are also subject to required minimum distribution (RMD) rules. Account owners must take RMDs each year starting at age 73. (Your birth year may mean that your RMDs started earlier. Internal Revenue Service (IRS) Publication 590-B has tables and worksheets that you can use to calculate your RMDs.) 

Note

In addition to 401(k)s, other types of defined contribution retirement plans include 403(b) plans for schools and nonprofits, 457 plans for government workers, and profit-sharing plans in the corporate world.

Roth 401(k)

The Roth 401(k), sometimes called a designated Roth account, is like a traditional 401(k) but with one key difference: Contributions don’t receive an upfront tax break, but withdrawals will be tax free if the employee meets certain requirements. Specifically, they must generally be 59½ or older and have had the Roth account for at least five years; however, as with traditional 401(k)s, there are exceptions. Contributions to a Roth 401(k)—as opposed to the account’s earnings—can be withdrawn tax free at any time because they have already been taxed.

Some employers offer both traditional and Roth 401(k) options. Employees can, if they wish, split their contributions between the two types, but their maximum total contribution (in 2025) can’t exceed $23,500 a year for anyone under age 50 or $31,000 for those 50 or older—unless you’re age 60, 61, 62 or 63. In that case, you can contribute up to $34,750.

Roth 401(k)s were subject to the same RMD rules as traditional 401(k)s before 2024. Now, RMDs are no longer required from designated Roth 401(k)s during the account owner’s lifetime, per the SECURE 2.0 Act of 2022.

SIMPLE 401(k)

SIMPLE (Savings Incentive Match Plan for Employees) 401(k) plans are designed for businesses with 100 or fewer employees.

With a SIMPLE 401(k) plan, employees can contribute up to $16,500 (in 2025) if they’re under age 50 or $20,000 if they’re 50 or older. The exception is if you’re age 60, 61, 62 or 63. In that case, you can contribute up to $21,750. As with a traditional 401(k), that money isn’t taxed as income until it’s eventually withdrawn from the plan.

The employer must make either a matching contribution of up to 3% of each employee’s pay for those who contribute to the plan or a nonelective contribution of 2% for all eligible employees, regardless of whether they participate in the plan.

Like traditional and Roth 401(k)s, SIMPLE 401(k)s can be subject to early withdrawal penalties before age 59½ and to required minimum distributions after age 73.

Safe Harbor 401(k)

Safe harbor is a legal term for a provision in the law that exempts a person or company from certain regulations if they meet other requirements. A safe harbor 401(k) allows employers to skip the nondiscrimination tests that most 401(k) plans are subject to. Nondiscrimination tests are intended to ensure that plans do not discriminate in favor of highly-compensated employees in terms of employer matches or other benefits. Because safe harbor 401(k)s are easier to administer, they are especially popular with small businesses.

In return, employers with safe harbor 401(k)s must make annual contributions to every eligible employee’s plan, regardless of whether the employees themselves contribute. In addition, that money is immediately vested, regardless of how long the employee has been with the
company.

(Other types of 401(k) plans often have vesting requirements for their employer contributions, while employee contributions are always immediately vested.)

Employers can make their required contributions in one of three ways:

1. Nonelective contribution: The employer contributes an amount equal to 3% of compensation on behalf of each non-highly compensated employee. Employees are not required to contribute.
2. Basic match: The employer matches 100% of each non-highly compensated employee’s elective contributions, up to 3% of their compensation. Also, it matches 50% of the next 2% in compensation. So, for example, an employee who earns $50,000 a year would be eligible for a maximum match of $2,000 (100% of their first $1,500 in contributions plus 50% of the next $1,000).
3. Enhanced match: The employer can base its match on up to 6% of the employee’s compensation, rather than just 5%, as with a basic match.

Aside from those differences, safe harbor 401(k)s work much like any other 401(k) and are subject to the same rules on contributions, early withdrawals, and required minimum distributions.  

Warning

If you have multiple 401(k) plans, such as one with an employer and another for your own small business, your total contributions can’t exceed the maximum for a single 401(k) plan.

One-Participant 401(k) 

These plans go by a variety of names, including solo 401(k), individual 401(k), and self-employed 401(k). They are designed for businesses with no employees other than the owner, plus their spouse if that person also works in the business.

Because the owner is considered both an employer and an employee of the business, they can contribute to the plan in both capacities.

As employees, they can contribute up to 100% of their compensation or net income from self-employment, with the same annual contribution limit as traditional and Roth 401(k) plans: for 2025, it’s $23,500 a year for anyone under age 50 or $31,000 for those 50 or older. There’s an exception if you’re 60, 61, 62 or 63. If you are, you can contribute up to $34,750.

As their own employers, they can also make additional, nonelective contributions. The maximum depends on how their business is set up for tax purposes (S corporation vs. self-employed sole proprietor, for example).

In total, as employer and employee, the business owner can contribute as much as $70,000 to their 401(k) plan (for 2025), plus another $7,500 if they’re 50 or older (or $11,250 if they’re 60, 61, 62 or 63).

Spouses who earn income from the business can also contribute to a one-participant 401(k), up to the same maximums, and they are eligible for the same additional employer contribution.

One-participant 401(k)s can be either traditional or Roth plans and are subject to the same rules as those plans for early withdrawals and required minimum distributions.

Other Retirement Savings Vehicles

There are also other ways you can save for retirement. Individual retirement accounts (IRAs) offer a traditional option and a Roth option. You can open an IRA on your own with a broker and potentially get a tax deduction for contributing every year.

Additionally, your employer may offer a health savings account (HSA). An HSA is a place where you can save pre-tax money every month and use it for medical expenses. It’s often paired with a high-deductible health plan. It’s a tax-advantaged account that can be used as a retirement savings account. That’s because you can invest the funds in an HSA similar to how you would with a 401(k) or IRA. You can also leave the funds where they are and roll them over year to year if you don’t use them. And when you reach age 65, you can use the money in your HSA for other expenses, not just qualified medical expenses. (If you do so, however, you’ll pay income tax on those expenses.)

Can You Have Both a 401(k) Plan and an Individual Retirement Account (IRA)?

Yes, you can contribute to both a 401(k) plan at work and an individual retirement account (IRA) on your own. However, if either you or your spouse has a 401(k) plan, your traditional IRA contributions may not be tax-deductible. It depends on your tax filing status and income. For example, for married couples who file jointly, the income phase-out range is $126,000 to $146,000 if the spouse who is contributing to the IRA is covered by a workplace retirement plan, like a 401(k). (Roth IRA contributions are not tax-deductible.)

How Does Vesting Work in a 401(k) Plan?

Employee contributions to a 401(k) plan vest immediately, meaning that they belong to the employee from day one. Employer matching contributions can work differently, depending on the type of plan. With some types, such as safe harbor 401(k)s, matching contributions vest right away. With other types, such as traditional 401(k)s, employers can set different rules if they wish to. For example, the employer match might vest only after three years of service or vest gradually over a six-year period. If the employee parts ways with their employer before that period is up, they lose access to those matching contributions.

What Is Automatic Enrollment, and How Does It Work?

Automatic enrollment is a provision in some 401(k) plans that allows employers to defer a portion of an employee’s wages and deposit the money into a 401(k) account on their behalf. Employees can opt out if they wish to do so. Plans with this provision are sometimes referred to as automatic enrollment 401(k)s. Automatic enrollment (with an opt-out provision for those who don’t want to join) is mandatory for newly created 401(k) plans for plan years beginning after December 31, 2024.

Are 401(k) Plans Federally Insured?

No, unlike most bank and credit union accounts in the U.S., 401(k) plans are not covered by the Federal Deposit Insurance Corp. (FDIC).

In addition, the money you save in a 401(k) is invested. Investments are always subject to losses, and gains are never guaranteed.

The Bottom Line

There are several types of 401(k) plans that employers may offer their workers. Traditional and Roth plans are most common among larger employers, while SIMPLE and safe harbor plans are often found at small businesses. Business owners without other employees can also open one-participant 401(k) plans. If you have any questions about your plan, reach out to your employer or plan administrator.