Automate Investing

One of the best pieces of investment advice I can give is to automate investing. What does that mean? How do I automate investing? Automating your investing involves contributing a set amount of money “automatically” at pre-established intervals. It takes the effort out of investing and ensures consistency. Everyone knows that investing is best to start at an early age, but the typical investment growth calculator is based on consistent contributions, such as $500 per month.

How do I automate investing?

The first step to automating your investing is determining how much you can afford to invest. You should contribute as much as possible without placing yourself in a bad financial position. In other words, do not invest so much that you have difficulty paying for necessities (housing, groceries, transportation, healthcare, etc.). A good goal to aim for is investing 25% of your income. This is going to be challenging for most; you likely cannot start with 25% now, but start at an amount you can afford, maybe it is 5% or 10%, then gradually work on increasing your contribution. A great time to increase contributions is when you receive a pay increase. Rather than increasing your standard of living, try to continue living on your existing budget and contributing the amount of your raise towards investing. If you are already financially established enough to invest 25% of your income, then do more. Investing 25% is not the limit, it is just a good benchmark to achieve, and it is challenging for most of us, but every worthwhile goal is a challenge. If you need help determining where to cut expenses and how to keep yourself on track, check out our “Create A Budget” article.

Once you know how much to invest, the next step is to start the automation. To do this link your investment account to your bank account. Ideally, you will maximize the use of tax advantaged accounts, such as an IRA, 401(k), or TSP. However, there are maximum contribution limits to each of these accounts, and the money will be inaccessible until you reach retirement, so if you need it sooner, look at a traditional brokerage account. After you have linked your investment account to your bank account, setup automatic transfers from your bank. Setup these transfers to correspond with your paydays. For example, if you get paid every second Friday, then setup the transfers to occur every other Friday. The benefit of aligning the transfers with your paydays is that the money will be put into your investment account before you even see it. As a result, you will get used to living on the amount left after your investments are made. Additionally, you will be paying yourself first and ensuring your financial future.

After the automatic transfers are setup, you will need to select the investment type that the transfers will purchase. It is not enough to simply setup the transfers, as the money will go into the investment account but not be invested. You may already have an investment type, mutual fund, or index fund in mind. If so, then you can select that fund. If you are still undecided about the type of investment, then consider a stock index fund. You can learn more about choosing a fund by checking out our “Mutual Funds” article. However, a great place to start is an S&P 500 Index fund. These funds typically have very low expense ratios, meaning the fees you pay the fund managers are minimal, and their performance will mirror that of the stock market. You will also benefit from diversity, as you will be invested in a variety of stocks in the Standard & Poor's 500 Index. You can compare S&P 500 Index funds among several major brokers, such as Fidelity, Charles Schwab, and Vanguard to choose the best fund. Typically, the performance will be similar, but there will be slight variances. Additionally, the expense ratios will differ. In general, all other factors being equal, a lower expense ratio is better because it means you have less fees taken out of your investments and more principal to invest.

If you have determined how much to invest monthly or bi-weekly, linked your bank account and investment account, setup automatic transfers, and selected the fund to invest in, then you have successfully automated your investing. The amount you decided, will be transferred and invested at recurring intervals with no effort on your part. As a result, you can rest assured that your investments will continue growing and your contributions will be consistent.

Dollar Cost Averaging

Why should you automate investing? There are a number of reasons to automate investing, but one such reason involves the principle of dollar cost averaging. One of the benefits of dollar cost averaging is that it takes the emotions out of investing. Investors have a tendency to follow a group think mentality. When investors start selling, other investors see the price going down, and they sell as well. Similarly, when investors are buying, the price gets driven up, and more investors are enticed to buy because the price is rising. However, the more prudent thing to do is let others’ panic work for you. Stock market investing is based on buying low and selling high, but if you follow the crowd, it is difficult or impossible to achieve this. Instead, you should buy bargains and stay away from overpriced stock. Dollar cost averaging does this by buying a set dollar value of stock (or other investment type) at set intervals. For example, if you automate your investing to be $250 every two weeks, then you will utilize dollar cost averaging because when the stock is priced high, you will buy fewer shares, and when it is priced low, you will buy more shares. For example, if the stock price is $20, then you will buy 12.5 shares. If the stock price increases to $25, you will buy 10 shares with your $250. Thus, it forces you to buy more when it is a bargain and less when it is not.

Conclusion

Consistency is the key to investing. You can establish a consistent pattern of investing, ensure you pay yourself first, and take advantage of dollar cost averaging by automating your investing. With minimal effort, you can setup automatic transfers from your bank that correspond to your paydays and choose an investment type for those funds to go towards. A good investment goal is 25% of your income. Strive for this, and if you can surpass it, then do not stop.