Many people want to create wealth for themselves and their families but are avoiding the step of creating an investment plan out of fear of risk or out of lack of knowledge. Those are real and understandable concerns. Yet the key to investment success when that fear and lack of knowledge are holding you back might just be the automatic investment plan.
An automatic investment plan is simply defined by making regular contributions to an investment account, whether that be through your employer’s 401(k), a self-directed retirement account such as an IRA or a non-retirement investment account such as a mutual fund or an index fund.
Here are two reasons why an automatic investment plan is a worth consideration…
Regular investment contributions ensure you aren’t sabotaging wealth growth
In today’s world where 51% of Americans are saving less than 5% of their income, it’s clear that the majority of people are choosing the YOLO lifestyle over proactively growing their wealth. If you choose to start an automatic investment plan, you’ll be saving money relatively pain-free. Just like autopay for your bills, the money comes out of the account with little effort on your part and will soon become a non-issue in your mind, all the while secretly growing your net worth behind the scenes.
Smaller methodical contributions don’t seem (or aren’t) as risky
When you’re depositing a smaller amount of cash into an investment account on a regular basis – say $100 a month – it’s not as taxing on your psyche as if you were to contribute a lump sum such as $1,000, $5,000 or $10,000 into investments. It seems risky to take large amounts of money out of savings and put it into investment accounts where financial loss is a possibility. But since most people blow $100 a month on stupid stuff anyway, people associate less risk with evenly distributed smaller contribution amounts, even if the total invested at the end of the year adds up to a big amount.
As an aside, some investing experts believe that dollar cost averaging (making small, regular contributions over a long period of time) makes for less inherent risk in your investments too. Dollar cost averaging ensures that your regular contributions will sometimes be buying in high and other times buying low. Thus, the automatic investment plan helps you avoid trying to time the market and works to help you adapt a consistent buy-and-hold strategy for investment growth.
Knowing that you’re not working to time the market—but instead making small and steady contributions toward future wealth—helps reduce your fear of risk. It also ensures that you are saving at least something towards wealth accumulation each and every month.
How to make an automatic investment plan work for you
Here are three keys to maximizing success with your automatic investment plan.
Make investing a part of your budget
You are doing a budget, right? If not, check out this article on how to create a budget that will help you reach your financial goals.
By using a monthly budget, you can more accurately determine how much cash you can comfortably put into an investment plan each month.
Create the right investment strategy
Creating the right investment strategy really isn’t as difficult as it sounds. The right investment strategy for you should be based off of two things: Your age and your risk tolerance.
The closer you are to retirement age, the less risky your investment choices should be. Fewer years to a non-working income means less time to recover from a market dip. So be sure to take your age into consideration when choosing the right investment strategy for you.
Your investment strategy should also be based on your risk tolerance. If the thought of losing money in an investment sends your blood pressure rising, think about a safer investing option such as an index fund.
If you’re young and the risk factor doesn’t bother you, be more open to diversifying your investment strategy and include some higher risk choices such as mutual funds. If you choose a more risk-filled portfolio, however, be prepared for more intense ups and downs in that portfolio as your wealth grows over time.
Age-based portfolios are great to consider if you aren’t quite sure what risk level you should be taking on. Figure out your likely retirement age and invest in a plan that is closest to that. For instance, if you think you’ll retire in 20 years, your best option is to invest in a Target Retirement 2035 plan. These plans are riskier the further away you are from that retirement date and they automatically become less risky as you near the date.
Set up an automatic transfer
The next step in creating a successful automatic investment plan is to set up an automatic transfer each month for the amount of money you feel you can safely afford to invest. If you have a 401(k) account, you can just determine the percentage of your income you want to invest and have it taken right out of your paycheck each pay period.
If not, you can create an automatic withdrawal plan through an investment company such as Vanguard and have it deposited into a retirement or a non-retirement investment account by way of automatic bank withdrawal on a pre-determined, regular basis.
The sooner you start making investing an automatic part of your life, the sooner you can take advantage of the compound interest growth that will help speed up your path to financial independence.