Automated investing is critical. In this post I share the why and how of it.
Money flows through our lives and bank accounts. We work, receive income and then spend it. And the years pass. I’ve talked to many people at the end of their career lamenting, “I wish I’d started saving for retirement earlier.”
I’ve heard, “I can’t afford to invest right now because I’ve got all these bills to pay, but I’ll set it up soon.” And soon doesn’t come until it’s too late. It’s the same with health. We all know we should eat better to improve our health, but there’s, “always next week…” Until there isn’t. Until we get a bad diagnosis.
Like Any Other Bill
We should approach investing like any other bill. For instance, we pay our income tax bill through the year. People don’t say, “I’m not going to withhold for taxes out of my paycheck this year.” Employer sponsored retirement plans offer the same convenience. It’s simple to set the contribution percentage on your company’s HR portal. Then log in to the investment provider’s site and select an allocation (which could be one fund). Takes less than 10 minutes. Yet, why do so many fail to complete these two easy steps? Lack of understanding or experience with compound interest.
If we understood the concept, we would make those 2 elections. Unfortunately, many don’t grasp compound interest until it’s too late. We study quadratic equations in high school, but not investing 101. Curriculum covers compound interest and growth from a scientific or mathematic angle. But it’s not translated well into personal finance scenarios. I recommend a mini-unit study using financial calculators to run personal finance problems. Calculating future value portfolios and taught by someone passionate about the subject. At least half the class will grasp the importance of starting their money machine early.
King of the Hill
Set your retirement contribution to 20% and increase it with raises. Starting with your first W2 job and continuing for future employers. I’m confident anyone would be thrilled with that approach in 20 years. Like tax withholding or health insurance premiums that come out first. You spend off what lands in your bank account every two weeks. Allow your savings rate to dictate your housing and transportation budget. Not the other way around.
I remember playing this game “King of the Hill.” A kid (usually the biggest) takes charge atop a mound of dirt. Other kids attempt to run up the mound and throw the “King” down. But the King has high ground advantage, with leverage and gravity on their side. And they can spin in any direction and fend off attacks. Make your Savings Rate “King of the Hill.” Fending off attacks from housing, transportation, food, travel, entertainment, etc.
The First 5 Years
The first few thousands you save will be the most important. As you progress in your career always remember to make those 2 elections. Within 5 years, you’ll feel the power of compounding interest. It won’t be the full power, that comes later. In a 5-year window, you will likely see at least one double digit year in the markets. And if you’re investing you will notice it. You do need to compute an annual net worth statement and savings rate to help you see it. Once you experience compound growth, it’s full speed ahead.
You’ll develop intermediate term goals like homeownership, cars, having children. This is a great time to follow the same approach you did for your 401k with an after-tax brokerage account. Setting up automated contributions to this account timed around paydays. You’ll notice brokerage more than 401k contributions as they come out of your bank account. You’ll see and feel the absence of those dollars more than pre-tax 401k contributions. Most investors realize the power of compounding interest first with retirement assets in employer sponsored plans. Inexperienced investors can get discouraged by volatility in brokerage accounts. But, after a few years of 401k investing, you have seen enough success to stay the course.
Stay in the Pool
With automation established you’ll be in a great position in 20 years. Especially if you started your savings rate at 20% and increased from there. Without automation, the 20-year outlook is uncertain. I have encountered people who never automated for various reasons. Then realized they missed great stock market returns. Usually, this realization occurs following good years in the market. About the time the market is ready for a pullback. They invest a newly acquired lump sum, or worse, money sitting in a checking account for years.
They jump into the market like that first jump into the pool at the start of summer. Their lump sum investment occupies a lot of their attention. Checking it daily and hand-wringing with each 1% move down. If that frothy market heads downward for a few months (as it can do in the short-term), the new investor might give up. Then jump out of the pool and into a hot tub with their 10% smaller lump sum. You’ll know you’re talking to someone like this when you hear, “the stock market is gambling. I like to put my money into real assets.” Meanwhile, others have stayed in the pool, acclimating to the cold temps and are now having a great time. Those investors acclimated to market ups and downs through automated investing over years. And are comfortable to invest any future lump sums.
The hot tub investor won’t invest in the “rigged” stock market and will tell everyone else why they shouldn’t. Unfortunately, they might go from one sales pitch to the next over the years. Trying to find the best investment: gold, guns, Iraqi Dinar, etc. Or, sit in cash and safely lose to inflation.
In conclusion, automate your savings rate to at least 20% today and you’ll be happy in 20 years. You’ll feel compound interest and gain investing experience through full market cycles. As lump sum investing opportunities present, you will have the confidence to invest and allow the market time to work.