How Automation Helps Your Finances

The financial world is full of complex terms and principles. Alpha, beta, dividend yield, coupon rate; even the most simplest of terms are hard to understand if you haven’t read Investing for Dummies. And because this world can seem so complex, and because it seems like investing for your future should be difficult, that’s what many people expect when they come into our offices. They want charts and Monte Carlo analyses. They want to be told advanced investment theory and how utilizing it is the key to success. In actuality, it doesn’t have to be that complicated. There are ways to invest that are automated, and simple, and allow you to take advantage of the market without having to know as much as Warren Buffet. How can automating your finances help you follow solid financial principles, whether you know all of the ins and outs or not? Let’s see

Automated savings account

As human beings, we’re wired for immediate gratification. We want to do things now, see results now, and get all of our benefits right now. When it comes to money, that can manifest itself in two ways: paying down debt, or blowing money. When we have a surplus at the end of the month, we get an immediate gratification from seeing our debt reduced, and an immediate gratification from blowing money, so that’s often what we do. Since putting money aside for a rainy day doesn’t give us anything to satisfy that urge, it can be difficult to maintain the discipline needed to save. Automating your savings takes the battle out of your hands. Pick your busiest day of the week, when you know you won’t be checking your accounts. Through online banking, set up a weekly draft that pulls money from your checking and sends it to your savings. You might also have the option of doing this at your job by asking the payroll department to send a portion of each check to a separate savings account. By taking these steps, you ensure that money is being put aside whether you’re disciplined or not. Think about how much money you spend on the average lunch with friends. Is it $10? Just by saving that amount each week automatically, you’re adding over $500 in savings each year.

Dollar cost averaging*

We’ve talked about the power of automatically contributing to your savings accounts. But what about your investments? Automating your contributions to investments, such as your 401(k) or brokerage accounts, allow you to take advantage of a powerful investing tool: dollar cost averaging. When you put money in your accounts sporadically, you could be doing so at a time when your investment is not cost-effective. For example, you put money into Stock XYZ in February when it was $100/share, but in January you could have bought it for $80/share and gotten more for your money. By investing the same amounts each month, however, your consistency is rewarded in the months when your investments aren’t as expensive to purchase. Let’s look at an example:

Investor 1, no dollar cost averaging:

Investor 2, dollar cost averaging:

Hypothetical chart/situation for illustrative purposes only and does not represent actual or future performance of any specific product or investment strategy.

Over the course of time, dollar cost averaging can lead to you owning more shares (and thus, potentially more money) than even a seasoned investor who contributes the same amounts, but does so at irregular and inopportune times.

Auto-rebalancing**

In your investments that are subject to the market, you may have a few if not dozens of different funds within one account. You may have some that are growth oriented, some fixed income, some that are more moderate in nature. Hopefully, the amount or percentage that you have in each fund (e.g. 60% in stocks, 40% in bonds) is given careful consideration. And because these funds are invested differently, throughout the year, some will do better than others. Let’s introduce an example so we can see how auto-rebalancing can come into play when two investments perform differently.

John starts a brokerage account with $100. He invests $25 each into four mutual funds. After six months in the market, his account has doubled, and is now worth $200! He looks at the mutual funds and sees that they now have the following balances:

Mutual fund 1: $25

Mutual fund 2: $75

Mutual fund 3: $75

Mutual fund 4: $25

Hypothetical chart/situation for illustrative purposes only and does not represent actual or future performance of any specific product or investment strategy.

Two of the four funds have clearly outperformed. But John wants equal amounts in each fund; it’s out of balance. So to rebalance them, he sells $25 each from the high performers and uses it to buy into the low performers. So now, his $200 is broken up into $50 in each mutual fund, and is balanced.

By selling off money from the high performing funds, what did John do? He sold when the price was high! And by using the money to buy into poor performers, what did he do? He bought when prices were low! He followed the first rule of investing, and he didn’t even have to follow the stock market. All he had to do was set his account so that each quarter, or each year, his account automatically rebalances itself. If he simply sets this up and lets it work, he will always buy high and sell low, and over the course of time, hopefully have himself a good return on his investments.

That’s it, guys; three basic principles that require no knowledge and little effort on your part. Are there more things involved in a financial plan? Sure. Can they be complex? Sure. But starting with the basics doesn’t mean that you end up with basic results. The simplest things in life are sometimes the most effective, and using automation to overcome your shortfalls and take advantage of the highs and lows of the market can help put you on your way to better finances. Even Warren Buffet couldn’t argue with that.

*Dollar-cost averaging does not ensure a profit or protect against a loss in declining markets.  This investment strategy involves continuous investment in securities, regardless of fluctuating price levels.  An investor should consider his/her financial ability to continue purchases in periods of low or fluctuating price levels.

**Diversification/Asset Allocation does not ensure a profit or guarantee against loss.