Even for someone who helps people with investments for a living, I can admit that investing can be complicated. Not only that, just being in the industry doesn't mean I have all the right answers for how to invest and when to invest. Humans are prone to make errors, and one way we can try to reduce our tendency to err, is to leave some decisions up to computers.
Let's check out how automating some of your investing decisions can work for you.
Automate Contributions
In order to automate your investments, you have to have investments in the first place. And the best way to kick off the automation process is to automate the way you put money in the market.
There are reasons automating your savings is a good idea even when you take the stock market out of the conversation. One of those reasons is a concept called Present Bias.
Present Bias states that when a person has the option to make two choices - one that will benefit their future self, and one that can benefit them now - they're more likely to reward their Present Self. With savings then, with forced with a choice to put aside money for the future or blow the money today, we're more inclined to blow the money on our present wants and even needs.
From an investing perspective, though, the case for automating contributions to the market is made even stronger.
Let's say we have two investors who both commit to contributing $400 to the stock market over a 4 month period, and with that money they'll buy as many shares of Mutual Fund XYZ as possible. The price of the investment will rise and fall during this period, so let's see which investor turns out best:
Investor 1 contributes their $400 at irregular intervals, investing $200 in months 1 and 3. Their timing was terrible, as these were the months our mutual fund cost the most. As a result, Investor 1 receives 12 shares of the fund, for an average cost per share of $33.33.
Now let's check on Investor 2:
Investor 2 breaks their $400 in contributions up evenly, investing $100 each month into the fund over the 4 month period. As a result, they are able to take advantage of the two months in which the share price fell, scooping up more shares in a period their fellow investor put no new money in the market.
By the end of the four months, Investor 2 has 22.67 shares, almost double that of Investor 1. Their average price per share, $17.64, is also significantly lower, meaning they were buying low, which is always the goal.
This process - investing consistent amounts of money at regular intervals in hopes of purchasing at the lowest price per share - is called Dollar Cost Averaging, and it can be automated through your investment account.
Dollar Cost Averaging is probably the most popular form of automating investments, but there are many more available to you.
Automate INCREASES To Contributions
In the past decade or so, company 401(k) plans have become much more complex creations than their early counterparts. There are more 401(k) recordkeepers, streamlined investment options based on the year you'd like to retire, even retirement calculators to help see if you're on track.
With this evolution, companies have also invested resources in making sure employees actually use the plans in the first place. One such resource is the auto-enrollment 401(k) plan.
Rather than waiting for employees to opt in to 401(k) participation, auto-enrollment plans automatically enroll participants and set their contributions at a percentage of their pay. These plans take have led to a significant increase in the percentage of people saving for retirement. But there is a downside to only offering an auto-enrollment plan; participants may not increase their contributions over time.
Auto-enrollment plans often enroll participants and start them off contributing 3% of their pay towards their 401(k), which may have to do with the requirements for operating a type of 401(k) plan called a Safe Harbor 401(k).
You've likely heard the general guide of saving 10%-15% of your income towards retirement. If employees roll with the 3% auto-enrollment but never take steps to increase their commitment, they risk falling fall short of their retirement needs. That risk is borne out in studies that show savings rates for participants in auto-enrolled plans lag behind savings rates for those who have to opt in to their 401(k) plan.
Enter the auto-INCREASE feature that can be paired with auto-enrollment. Auto-increase plans work just how they sound. Participant contributions increase automatically by a particular amount or percentage each calendar year, with 1% being the standard. These plans also allow a cap to be placed on the increases. As an example, an auto-increase participant can set automatic increases of 1% per calendar year, with a cap of 10%.
Just like auto-enrollment plans capitalize on our laziness and ability to adapt, auto-increase plans capitalize off of that adaptability AND the likely pay increases you'll have over the years, which could dull the impact to your cashflow of increasing your retirement contributions. After all, if your retirement contributions increase by 1% the same year you get a $25,000 raise, you'll still have more money in your pocket every two weeks than you've ever had before!
Automate Rebalancing
Account rebalancing is all about adhering to a concept called Portfolio Weight. Portfolio Weight is the breakdown of how much certain investments, like stocks and bonds, represent in your portfolio. As an example, a portfolio "weighted" 75% in equities means 75% of its components are stocks and 25% are in other investments, like bonds, precious metals or even cash.
Investments like stocks and bonds are often placed in the same portfolio because they can act as a good counterpart to the other. Stocks for the most part, are seen as more aggressive than bonds, so adding bonds to a portfolio can hopefully add stability when stocks aren't performing well. And since stocks hopefully have higher potential returns, investors come up with different portfolio weights to try and find the right blend of weighing the potential for risk witht the potential for return. An aggressive investor might choose a portfolio weight of 80/20, meaning 80% stocks and 20% fixed income, while a conservative investor might choose an account that's 40/60: 40% stocks and 60% fixed income instruments.
With these different asset classes comes the likelihood that when one is going up, the other may be going down. When that happens, you can risk becoming over or under-weighted in a certain category, meaning you have more or less of that type of investment than your portfolio weight calls for. If you truly believe in your ideal portfolio weight as a long-term investment strategy, a portfolio in this scenario would need to be rebalanced. Let's look at an example:
At the beginning of a quarter, an investor opens a portfolio with a preferred weighting of 60% stocks and 40% bonds.
In that quarter, the stocks in their portfolio go gangbusters, and their performance skyrockets to the point where they actually represent 70% of his portfolio by the end of the three months, 10% higher than his preferred weighting.
While this was a great run in the short term, our investor believes the 60/40 weighting fits their risk tolerance and long-term investments. They need to rebalance their portfolio, and they do so by selling off enough stocks and using the proceeds to purchase more bonds, so that at the start of the next quarter, their portfolio sits again at the desired 60/40 weighting.
One huge positive of rebalancing a portfolio is it adheres to the first rule of investing: buy low and sell high. By selling off parts of your portfolio that have outperformed and using them to purchase portions that have underperformed, you're selling an investment at a gain and using it to purchase others at what is hopefully a discount.
A large number of investment platforms now offer auto-rebalancing, where the trades needed to correct your portfolio weighting can be done at regular intervals you set up with your provider. While quarterly rebalancing is common, you can also do semi-annual or annual rebalancing based on your preference.
By setting up auto-rebalancing, investors aim to take both the human error and the tracking error of long-term portfolio management
Automate Dividend Reinvestment
Companies that have shareholders want to find a way to reward them. After all, the shareholders of public companies have a lot of power: they can vote on major issues, they own a portion of the company, and can even band together to sue the company.
Shareholders are also entitled to dividends. Dividends are when corporations operate at a profit, and they divide that profit amongst their shareholders. Companies can issue dividends regularly, with some even doing so monthly
If you invest $100 in Company XYZ's stock and they issue a dividend of $2, you have a decision to make.
You can receive the dividends in cash, and receive a check in the mail or have the funds deposited in your bank account. Some investors invest purely for dividends, and use them to live off of or to fund other ventures.
You can have the dividends placed in your investment account's core position, meaning it will be held in cash until you make a decision on what to buy next with the money.
Or you can REINVEST the dividends into the same investment. Reinvesting dividends pushes more contributions into your investment, and is seen as a wise choice for long-term investors who have no current need for dividend income.
You can manually decide to reinvest your dividends each time you receive them, but because you don't know when they'll come and you could be invested in many companies, setting your dividend options to automatically reinvest can save you a significant amount of time, and make sure you have as much money going back into your investments as you can.
One word of caution though: remember that dividends are a company sharing its profits with you, and these profits are taxable. Even if you choose to reinvest your dividends, you still earned them, and thus, you must pay taxes on them. If you have a portfolio that generates significant dividends that you're reinvesting, it's worth meeting with a tax professional to form a plan for covering the subsequent taxes.
Automate Your Sales and Purchases
Let's say there's a couple investment funds you have your eye on, Good Mutual Fund and Bad Mutual Fund (I know, I'm not very creative). You already own shares in Good Mutual Fund and it's been rising for months, but you feel it's reign at the top may be coming to an end soon. It can't keep rising, and you feel if it reaches a certain price, holding on to it any longer might be risky.
Bad Mutual Fund is in a different situation. Its price has been tanking for months and is still falling. But you think it has good bones, and that eventually things will turn around. Your belief is so strong that if the price falls to a certain point, you'd like to BUY.
Can automation help you in these scenarios? Absolutely, and it helps by way of limit orders.
Limit orders allow you to set certain prices at which you'd like to buy or sell a stock, a mutual fund or other types of investments.
For portfolios that hold many investments, or for particular investments whose prices can change quickly, like stocks or Exchange-Traded Funds, relying on yourself to be aware of those pricing changes and available to make the trade at that exact moment is unwise. Limit orders ensure that your wishes to buy or sell are carried out at your preferred price.
THAT'S IT!
Automating investments helps protect us from ourselves. It protects us from missing opportunities because we're busy. Protects us from making bad decisions because we trust our own timing more than we should. And trusts us from getting caught up in the moment when an investment is flying too close to the sun. There are many ways to do it; find the ones that work for you and implement them in your own finances.