2008-06-19

Four Specific Paths To Automatic Saving and Investing

There are folks who’ll tell you that how much you save and invest is as important or more important than lots of other things, like most individual investment decisions.

I’m one of them.

And I think the best way to increase the amounts you save and invest is through an automatic investment plan. As I’ve mentioned, I think automated saving and investing has been the most important part of our personal-finance plan so far. (See: Inside The Millionaire Mind of Mush—How We Became Millionaires.)

An automatic investment plan is where you have a set amount of money automatically taken from each paycheck—or from one of your accounts on a regular schedule. That gets sent into some sort of investment account and automatically invested according to your pre-set plan. It has the advantages (though some might say disadvantages) of dollar-cost averaging. The biggest advantage to me is that you just keep on saving and investing, like clockwork. Or if you subscribe to the “Pay yourself first” phrasing/mantra of many personal-finance gurus, you just keep on paying yourself first, like clockwork.

We have to make a larger purchase, like a new washer/dryer. Our automatic saving and investing keeps on going.

We have some setback, like having to buy a new roof. Our automatic saving and investing keeps on going.

I do something stupid or make an ill-advised purchase. Our automatic saving and investing keeps on going.

Energizer Bunny, beware!

Some of you are already doing this just with savings. And that’s become easier and easier, with lots of banks allowing you to set up plans where your set amounts of money from your paycheck or checking account are automatically moved into a higher-interest savings account. But I don’t think that’s enough, because of the lower returns with savings accounts.

So how do you do it with investing? There seem to be four main ways:

  1. 401(k) or Other Retirement Plans
  2. Mutual Funds
  3. DRIPs
  4. Fractional-Share/Basket Brokerages

I haven’t done all of these, so take my thinking with the usual grains, pinches, and truckloads of salt. But here’s some more explanation. All of these options allow you to invest fixed amounts of money each period—regardless of the current market prices of the mutual funds, ETFs, or stocks that are in your plan.

401(k) or Other Retirement Plans. Many employers offer 401(k) or other retirement plans that provide for automatic deductions from your paycheck into your retirement account, with the money being automatically invested according to your pre-set plan. Most plans offer a range of mutual funds—with mutual funds being the only options available for automatic investment with each pay day. For me, the path of automatic investment through 401(k)/retirement plans is: highly recommended (pick appropriate funds with low costs).

Mutual Funds. You can set up automatic investing with mutual funds outside of retirement accounts too. You can open up an account direct with the mutual fund company, usually with some minimum initial investment and some minimum monthly investment. If you look around though, it is possible to find well-regarded funds whose minimums are not that high (e.g., $100 minimum initial investment). Many discount brokerages are also supporting automatic investment plans now. A possible advantage of going with a brokerage is you could set up automatic investments with different mutual funds from different companies all within one account. For me, the path of automatic investments in mutual funds is: highly recommended (pick appropriate funds with low costs).

Resources:

DRIPs. A DRIP is a “plan offered by a corporation that allows investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the dividend payment date.” Corporations vary quite a bit as to whether they offer such a plan or what they offer within the plan.

Typically, you’ll have to buy at least a single share of a company through a brokerage—and then, as an existing shareholder, you can sign up for a DRIP (unless the company also has a DSP plan that allows you to buy the initial shares direct from the company). Depending again on the company, the DRIP may then allow you to set up an automatic investment plan.

From my concededly limited experience, managing a DRIP is more hassle than other investments we have. We had to deal only with paper, as none of the ones in which we participated allowed downloading electronic account information (which would have made it easier to get it into Quicken, where we manage most of our finances). And I found it a fair amount of trouble to move the stock out of the DRIP with the company and into our regular brokerage account—and I would expect some greater hassle in making sales.

For me, the path of automatic investment through DRIPs is: recommended for those who are comfortable picking individual stocks and who are okay with a little more management of the “account.”

Resources:

Fractional-Share/Basket Brokerages. Historically, if you wanted to invest exactly $100 each month into the stock market, you really were sticking with mutual funds—as they were set up to allow fractional shares. So they could handle a $100 purchase regardless of the current market price per share. Now there are brokerages like ShareBuilder and FOLIOfn that, one way or another, allow you to hold fractional shares of individual stocks and ETFs. This allows an automatic investment plan including individual stocks and ETFs.

Individual stocks are not the best choice for everyone, but ETFs are more similar to mutual funds (and can contain more built-in diversification). Even so, costs could be a concern.

As of the date of this post, ShareBuilder’s pricing programs charge $4, $2, or $1 per trade through an automatic investment plan; and the last two are parts of $12/month and $20/month subscription fees. So if you were trying to achieve trading costs of no more than 1%, you’d have to have an automatic investment plan running at $1,200 per month ($14,400 per year) or $2,000 per month ($24,000 per year). If you want trading costs lower than 1%, well, you can do the math.

My impression is that FOLIOfn’s pricing programs have changed a few times, as what is up on its site today is somewhat different than the last time I looked at it (which was probably a year or more ago). As of the date of this post, it seems to offer more of a flat-fee plan: $29/month for “unlimited folios.” I haven’t parsed through it all, but at first glance, it sounds like as many trades through an automatic investment plan as you like. But again, if you were trying to achieve trading costs of no more than 1% per transaction, you’d have to have an automatic investment plan running at $2,900 per month ($34,800 per year).

For me, the path of automatic investment through a fractional-share brokerage is: recommended primarily only for investors who will be investing larger amounts each month, because of the costs, or for investors for whom it is particularly important to be able to buy fractional shares of multiple individual stocks within one account.

Resources:

So there you have four ways to implement your own automatic investing plan. To wrap up, here’s a quote from the book, Multiple Streams of Income, by Robert Allen, that I think sums up my own thinking on automatic investing:

The sooner you buy, the longer you have your money at work and the more money you have to compound. Take 50 percent of your monthly savings and sock it away into your chosen index fund(s). Do this every month without fail for the rest of your life. [¶] If you’ll do this—even if you do nothing else I describe in this book—then in due time the floodgates of prosperity will pour into your life.

Floodgates of prosperity, huh? I don’t know about that, but I’ll agree in this way: automatic investing is absolutely my #1 tip, recommendation, piece of advice, blah blah blah.

I hope you'll do it.


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Inside The Millionaire Mind of Mush—How We Became Millionaires

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