How automatic investing works
Summary: One way to build good financial habits is to automate your investments. While you cannot control the market or your returns, automatic investing may help reduce risks through dollar-cost averaging and alleviate emotional financial decision-making.
Investors with an array of choices to make about their money can turn to a growing number of automatic investing tools to save time on routine decision-making.
Automatic investing plans—commonly referred to as AIPs—may also help investors grow their portfolios, stick to a budget, and take advantage of the power of compounding.
Automatic investing in a nutshell
Automatic investing tools allow you to set recurring contributions to an investment account.
When you set up an automatic investing plan, you decide how much and how often to invest, and then the recurring investments are made for you. If your time horizon, risk tolerance, or goals change, you can easily review your plan and adjust as necessary.
Depending on the type of automatic investing plan you use, money can be withdrawn from your paycheck, checking account, or savings account, and then deposited into your investment account.
Why consider automatic investing?
Automating your regular investments can help reduce risks and keep some of the emotions of financial decision-making at bay.
This investment strategy has the advantage of dollar-cost averaging. When you plan regular periodic contributions to your portfolio, you are less likely to mistime the market with reactionary investment choices. When you set the frequency of your investments, other factors like an asset's price won't influence your investing decisions. The result is that the dollar-cost averaging strategies of AIPs tend to minimize the effect of market volatility on your portfolio.
Automatic investing is a great tool to help you stick to a budget because you're planning for investment decisions in advance. So, you are less likely to be tempted to use money budgeted for long-term investing in other ways, like spending it on a vacation. On the flip side: Don’t fall into the “set-it-and-forget-it” trap. While AIPs allow you to put much of your investing on autopilot, you don’t want to be caught off-guard when unexpected expenses arise (e.g., car repair or medical bill). Check in on your investing plan if your budget is thrown off kilter and make adjustments if necessary.
Automating routine investing decisions can also help with your investment goals. You can check in on your portfolio periodically and make changes instead of constantly monitoring the market and assessing your financial situation each time you want to invest.
Over time, regular deposits from automatic investing can help grow your portfolio.
An investment portfolio grows both with additional contributions and through the power of compounding. With compounding, profit or interest generates more profit or interest to create exponential growth.
How to use automatic investing plans
Automatic investing plans are used in several ways. In fact, you may already be taking advantage of automatic investing if you participate in a 401(k) plan with your employer.
Employer 401(k) plans often deduct money from your paycheck and deposit it into your retirement account, perhaps with matching funds from an employer. You choose your investing plan when you sign up for the 401(k) and then your investing is essentially put on cruise control.
You can also set up automatic investing plans on your own. One way is to use a robo-advisor with your brokerage firm to automate rebalancing and maintain your planned asset allocation without much effort. That way, you can keep the proportion of stocks, bonds, and other asset types you choose to meet your investing goals.
Dividend reinvestment plans are another form of automatic investing. If the stocks you hold in your portfolio pay dividends, you can choose to reinvest those dividends instead of taking the payouts.
With most automated investing plans, you can change the amount or timing of the withdrawals and investments or cancel contributions at any time with no penalty.
Bottom line: As you enjoy saving time with automatic investing tools, make it a regular habit to check in on your portfolio. Review your investing strategy and asset allocations, perhaps with the help of a financial advisor, to keep your investment choices aligned with your financial goals.
How can E*TRADE help?
Looking to build good financial habits? Consider setting up recurring investments in a retirement or brokerage account.
With Core Portfolios, we’ll build, manage, and rebalance a diversified ETF portfolio for you, including portfolios with socially responsible ETFs.