An automatic investment plan is the cornerstone upon which wealth is built. Mindlessly putting away part of your paycheck each week keeps your plan on track even when you get distracted by life. Here is the how and why of automatic investing.
Over the past couple of weeks, I’ve laid out three steps to help you build a hassle-free money management system:
How to manage your spending without a traditional budget.
How to create a bank account buffer™ to eliminate the risk of overdrafts.
How to put your bills and savings on autopilot.
What I’ve written is incomplete, however, without one piece of the puzzle: an automatic investment plan.
Arguably, putting your investments on autopilot is the most important thing you can do for your finances.
If you don’t want to automate the rest of your finances—if you prefer to set aside a few hours a month to pay bills, transfer money to savings, and balance your checkbook, that’s fine. Some people will sacrifice time for that kind of control. But you should still consider setting up automated investments.
Investor and financial author Robert G. Allen sums up the biggest reason:
How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.
Many of us delay investing (or fail to start at all) because we’re either intimidated by choosing investments or we’re afraid of the risk. An automatic investment plan can help. One of the techniques I outline here requires zero investing knowledge to get started—it’s as easy as opening a bank account. And, when you put your investments on autopilot, you take your emotions out of investing, which can temper your fear—or at least limit fear’s ability to cost you money. Let’s look at how an automatic investment plan does this.
Dollar Cost Averaging
The technique of buying a fixed amount of an investment at regular intervals is known as dollar cost averaging (as opposed to investing a big chunk of money at irregular times).
If you were to buy $1,000 of a mutual fund when it’s per-share price is $100, you would own 10 shares.
If, however, you invest $100 a month for ten months and the fund’s price varies from $80 to $120, you may end up slightly more or less than 10 shares depending on the stocks prices. As the market climbs, the notion is you will end up buying more shares at a lower price than if you invested in a lump sum. Advocates of dollar cost averaging say this reduces risk, but critics disagree. The market goes up in the long run, so you want to get money in as soon as possible.
If you have a lump sum sitting around that you want to invest, then do it. Get it into the market and don’t worry about spreading it around and definitely don’t try to time the market or wait for the right time.
For the rest of us, an automatic investment plan makes sense for two reasons:
It lets you invest on a regular schedule.
It prevents self-sabotage.
INVEST AS YOU’RE PAID
Ask people who are successful at saving and building wealth and you’ll find that many of them have two things in common:
They invest, rather than leaving all of their cash in a bank account.
They pay themselves first.
I’ve recommended paying yourself first as a strategy for building cash savings for emergencies, and you can do the same thing with your investments.