Even if you have the best investment strategy in the world, your strategy isn’t worth much if it doesn’t get executed. Fortunately, this problem is very solvable.
This column, adapted from a chapter in my book Financial Fitness Forever , is the fifth and final entry in a series that addresses the four most important choices every investor faces: where you put your trust, whether you’re going to try to beat the market, how you deal with risk and properly diversifying your portfolio.
Here, we’ll look at how you can put your investments on automatic pilot.
Leave your feelings out of it
Emotion-based decisions can make investors more comfortable, but they almost always hurt in the long run. You may know what you should do, but if you wait until you feel like doing it… well, if you have ever tried to be serious about dieting or exercising, you know what’s likely to happen.
Fortunately, the solution is relatively simple, relatively easy and relatively inexpensive: Set up as much as possible on automatic — savings, rebalancing, withdrawals and more.
Part of your financial life is probably already on automatic. If you have a job or collect Social Security, money is likely deposited automatically into your bank account. If you have a mortgage, you may already use automatic payments.
Four ways to automate your financials
Let’s look at four things you can automate: savings, stock selection, rebalancing and withdrawals after you retire.
Savings
For an investor, the most basic task is saving money. But saving isn’t always easy — and if you wait until you’re sure you don’t have some other use for that money, saving might never happen.
Fortunately, saving automatically is easy. Most banks and credit unions can arrange automatic transfers from checking to savings. If you own a mutual fund, you can often set up an automatic investment plan (AIP).
The earlier you establish this habit, the better. If you’re not doing it already, it’s never too late to start. Putting savings on automatic pilot is one of those rare cases where “the easy way” tends to produce better results than the hard way.
Your portfolio
This may sound odd, but you can automatically diversify your portfolio — or select the stocks you own — through mutual funds or exchange-traded funds.
The simplest way is by owning index funds. An index fund helps you stay up to date with the changing makeup of an asset class.
When a rapidly growing company becomes more important, your index fund automatically increases your exposure. When a company declines, your index fund automatically reduces exposure.
Rebalancing
Rebalancing is the important task of shifting investments among asset classes to keep your overall risk aligned with your needs.
Suppose your target allocation is 60% stock funds and 40% bond funds. A strong bull market pushes stocks up, and before long stocks become 75% of your portfolio instead of 60%.
That’s good in one sense — you made money. But it also means you’re now taking more risk than you intended. To restore balance, you sell some stock funds and buy more bond funds. That is rebalancing.
To do it right, you ideally evaluate and rebalance across multiple categories: large-company vs. small-company stocks, U.S. vs. international, value vs. growth, and more.
That can be daunting, and many investors don’t do it consistently. I don’t know of any software that handles all of this automatically across separate holdings.
One practical approach is to have a financial adviser review the account once a year and make the needed trades.
Alternatively, if your funds are held within a single fund family (such as Vanguard), you may be able to call once a year and ask them to execute the trades needed to bring you back to target allocations.
If you’re adding money regularly, you may be able to maintain balance by directing new contributions toward asset classes that are below target. This can work best when contributions are meaningful relative to the portfolio’s size.
Payouts
Eventually, your portfolio starts paying you. If you must decide every month how much to withdraw for living expenses, you can waste a lot of time and energy.
Here’s a better way: Once a year, estimate your needs for the next 12 months, then set up automatic monthly transfers into your checking account. After that, you’ll know exactly what you have available each month.
Putting these mechanics on automatic isn’t difficult. The harder part for many people is getting emotions out of the way. That’s one reason I strongly recommend using an adviser to help implement the plan.
Once your finances are on automatic pilot, your decisions can become lasting policies instead of one-time turning points.
You’ll have less anxiety and more peace of mind. I believe that’s a win-win prescription.
To hear a reading of the chapter from Financial Fitness Forever on which this column is based, check out my podcast.
Richard Buck contributed to this article.