Automated Investing: A Smart Path to Financial Freedom

Sep 6, 2024

In our rapidly changing modern society, reducing everyday decision-making can significantly improve our quality of life. Just as innovative appliances like dishwashers and programmable coffee makers simplify our daily routines, automating your savings and investments can revolutionize your financial life and help you build wealth consistently with minimal effort.

Financial automation goes beyond mere convenience — it is a powerful tool for achieving long-term financial goals. By setting up an automated system, you can ensure that your money continues to work for you, regardless of market conditions or life’s distractions.

What Is Automated Investing?

Automated investing involves regularly depositing money into an investment account through automatic transfers, either directly from your paycheck or your bank account. In other words, you create a system where savings and investments happen automatically without frequent decision-making. The biggest advantage of this method is that it allows you to stay on track with your financial goals, even when faced with market fluctuations or other life distractions.

By automating your investments, you can consistently save and invest without worrying about the temptation to overspend, market volatility, or the burden of managing your investments. Once the system is set up, you can “set it and forget it,” avoiding the pitfalls of impulsive spending or emotional reactions to market swings.

Benefits of Automated Investing

The key benefits of automated investing include:

Reduced Spending Temptation: When money automatically flows into your savings or investment accounts, it’s less likely to be spent on impulse purchases.
Consistent Contributions: Automation helps ensure that you consistently contribute to your savings and investment accounts, avoiding the common mistake of stopping or reducing contributions during tough times.
Emotional Detachment from Market Fluctuations: Automating your investments reduces the likelihood of reacting emotionally to market fluctuations, which is crucial because emotional decisions often lead to poor investment outcomes.
Avoiding the Pitfalls of Market Timing: Attempting to time the market can be tempting, but history shows that it often reduces long-term returns. Automation ensures that you continue to invest consistently, regardless of market conditions.
Mental Energy Conservation: Automating your finances reduces the mental burden of managing your money, giving you more mental space to focus on other important tasks.

Why Automation Works

Automating your finances may not sound like a groundbreaking financial strategy, but small changes can have a big impact. Briana Middlewood, head of behavioral economics at Fidelity, explains, “People tend to stick with the path they’re already on. Once they decide to start, it becomes easier to keep going.” Automation eliminates the need for repeated decisions, reducing stress and mental fatigue.

A great example of automated investing is a workplace retirement savings plan. In a typical 401(k), the amount you contribute is automatically deducted from your paycheck before it’s deposited into your bank account. This is one form of automation that makes retirement saving highly effective.

Outside of workplace plans, automated investing is simple. Once your account is set up and investment choices are made, you can set up automatic transfers from your bank account. Although this may seem like a small step, it can make a significant difference in your financial future.

The Power of Compounding

Regularly saving and investing that savings is a powerful combination that harnesses the power of compound interest. For example, let’s say you invest $100 a month in a diversified portfolio. With an average annual return of 7%, after five years, you could accumulate approximately $6,300. After 10 years, that amount could grow to $17,000. If you were to invest $500 a month, after five years, you could have around $35,000, and after 10 years, $84,900. These scenarios illustrate how important it is to start early and invest consistently. While investments can fluctuate with the market, the key to long-term growth is to keep investing and let time do the work.

Of course, these estimates are based on assumptions and do not account for taxes, fees, or inflation. Actual investment performance may vary, and investing always involves some degree of risk. However, the core message is that consistently investing through an automated system can help you accumulate wealth over time.

Getting Started with Automated Investing: 5 Steps

Here are five steps to effectively begin automated investing:

Set Up Automatic Contributions to Your Workplace Retirement Plan

One of the easiest ways to start automated investing is to contribute to a workplace retirement plan such as a 401(k) or 403(b). If your employer offers matching contributions, make sure to take full advantage of them. Matching contributions are essentially free money that can significantly boost your retirement savings over time.

The contribution limit for 401(k) plans in 2024 is $22,500, and if you are over 50, you can contribute up to $30,000. By setting up automatic contributions, you can consistently invest for your future without having to think about it every month.

2. Consolidate Your Investment Accounts

Many people have multiple investment accounts due to job changes or opening new accounts over time. Consolidating these accounts can simplify your financial life and make it easier to manage your investments. For example, rolling over an old 401(k) into an IRA can reduce fees, improve returns, and provide more freedom in your investment choices.

Consolidating your investment accounts also makes it easier to automate across all your assets. Take this opportunity to consider setting up automatic investment accounts for other goals, such as a 529 plan for your children’s education or a Health Savings Account (HSA) if you’re eligible.

3. Set Up Automated Investments in Other Retirement Accounts

While a 401(k) may be the cornerstone of your retirement savings, it’s not the only option for automating your investments. Many people prefer to invest additional funds in an Individual Retirement Account (IRA) after receiving their employer’s matching contributions. You can set up automatic transfers from your bank account to automate your IRA contributions.

The IRA contribution limit for 2024 is $6,500, with an additional $1,000 catch-up contribution allowed if you are over 50. By automating your transfers, you can consistently contribute to your IRA and maximize your retirement savings.

4. Set Up Automatic Investment Purchases

Once money is regularly flowing into your investment account, consider automating the purchase of investments as well. Many brokerage accounts allow you to set up automatic investment plans, where cash is automatically invested in your chosen assets, such as low-cost index funds.

Automated investment purchases ensure that your money is always working for you, preventing idle cash from sitting in your account. It also helps you avoid the temptation of market timing, which can lead to costly mistakes.

5. Automate Dividend Reinvestment

If you own individual stocks or funds that pay dividends, automating dividend reinvestment can significantly increase your returns over time. Most brokerages offer the option to automatically reinvest dividends to purchase more shares of the same stock or fund. This reinvestment process takes advantage of the power of compounding, helping your assets grow faster than if you left the dividends as cash.

Overcoming Challenges in Investing

Investing can be intimidating, and psychological barriers often prevent people from getting started. Cognitive biases such as loss aversion (the fear of losing money) or present bias (the tendency to prioritize immediate rewards over future gains) can make confident investing difficult. While these biases are natural, they can hinder long-term wealth accumulation.

Automation helps overcome these biases by allowing you to make one decision and let the system handle the rest. This approach reduces the pressure to time the market or make perfect investment choices, enabling you to invest consistently.

What You Need to Open an Automated Investment Account

To open an automated investment account, you’ll need the following information and documents:

Name
Social Security number (or taxpayer identification number)
Address
Phone number
Email address
Date of birth
Driver’s license, passport, or other government-issued ID information
Employment status and occupation
Whether you are employed by a brokerage firm
Annual income
Net worth
Investment goals and risk tolerance

Conclusion

Automating your investments is a simple yet powerful strategy for achieving financial goals with minimal effort and stress. Whether you’re saving for retirement, building wealth, or investing for your children’s education, automation allows you to execute your plan and stay on track, even in the midst of a busy life.While it’s essential to review your investment strategy regularly and make adjustments as needed, automating your investments ensures that your savings plan continues to work, even when life gets hectic. By harnessing the power of automation and compound interest, you can steadily build wealth and secure your financial future.