Are you committed to investing a part of your monthly income towards retirement? You can insulate your financial future against unforeseen emergencies and economic risks if you use an automatic investment plan (AIP) to ensure consistency in your retirement contributions. An AIP is like putting your investments on auto-pilot.
Automatic investment plans are investment programs that let you contribute your savings to an investment account at periodic intervals to be invested in a pre-determined portfolio or strategy. Funds are diverted automatically each month from your personal account or paycheck to be invested.
A number of pension funds are invested automatically with pretax money or with dollar amounts matched by employers. You also have the choice to structure your own AIP according to your unique financial position.
Here are some of the key guidelines and strategies to help you start your own AIP.
Set aside a percentage, not an absolute amount
When you are considering an AIP, the best way would be to invest a percentage of your monthly income, and not a fixed dollar amount. Your income is not going to remain constant over time.
With a percentage, your automatic investment plan helps you invest proportionately as your income grows. At any given point of time you will be investing the right amount without disrupting your budget.
A good rule of thumb is that you should invest 20% of your monthly income, provided you have no debts and have an emergency fund that will cover your expenses for at least six months. This “20% rule” works well for most people.
Investing more than 20% may not be practical if you want to have some income left over to pay off your mortgage early or to save funds for your child’s college education.
Investing less than 20% may be imprudent because you will need money when you retire. Even if your mortgage is paid-off and your children have excellent college education, it still won’t help you if you don’t have any funds left for your retirement.
Set up your direct deposit
Check with your employer if they will offer you direct deposit. If you can set up this system, you will have your paychecks automatically transferred to your bank account.
This will reduce the risk of indulging in an unnecessary or unplanned expenditure. If you employer cannot help you with direct deposit you could set up your 401(k) or IRA to withdraw funds automatically from your account.
Choose investment options
If you have a traditional or Roth 401(k) or another retirement plan which is company-sponsored, your employer will be able to transfer your investible amount automatically. All you need to do for this is complete some paperwork and you will be on your way with this automatic investment plan.
You could invest the entire amount in a Roth 401(k) if your employer is offering this choice and enjoy tax-free income later in life. If they offer a traditional 401(k) along with a matching amount from the employer, it may be a good idea to use a Roth IRA as well.
But if a company match is not available to you you should first invest in a Roth, and then invest the remainder of 20% in the 401(k) plan of your employer. This is useful because you will get better tax breaks with the Roth.
Automate paycheck contributions
If you plan to make contributions to a Roth IRA, you will be required to do some legwork just the way your employer does with a 401(k). In the case of a 401(k) you simply inform your employer the contribution you want to make in percentage terms and they will do the calculations.
But with a Roth IRA you will have to do the math yourself to determine your contribution amount so that you know how much monthly investment you need to make. In other words, it is going to be your responsibility to increase your contribution as your salary increases in order to maintain your figure of 20%.
Based on what your employer is offering, you will have to set up either an automatic bank account withdrawal or automatic paycheck deduction.
Automatic paycheck deduction: You should check whether your employer is offering to deduct a contribution directly from your paycheck for putting it into your Roth IRA. To accomplish this, you may have to request for an account number and a routing number from your Roth IRA custodian.
Once you have obtained these details, you can set up automatic paycheck deduction so that a pre-set amount of money gets transferred to your Roth IRA each time you receive a paycheck.
Some employers will simply issue two checks, one large and one small, and you then divert the smaller one to your retirement plan.
Automatic withdrawal from the bank: If automatic paycheck deduction is not an option you should request that your IRA custodian set up an automatic monthly (or weekly) bank account withdrawal. Take care to ensure that the date of payment transfer comes after you have actually received the pay.
Failing this, your automatic contribution could be withdrawn prior to the arrival of your paycheck, and that may get you into a trouble with your bank.
Automatic investing with robo-advisors
With the rapidly expanding fintech market, an automatic investing option called robo-advisors is gaining popularity. A number of fintech firms are offering platforms for micro-investing, which enable you to make your automated investments in tiny increments.
One of the better-known robo-advisor platforms is Acorns, which will connect with your bank account to invest round-ups (spare change) from every purchase in a pre-determined investment portfolio. Betterment and Wealthfront are other examples of popular robo-advisor platforms.
Robo-advisors primarily automate index investing strategies with a long-term horizon. They usually adopt passive investing approaches, which are driven by the modern portfolio theory to allocate funds in accordance with your risk tolerance and your desired returns. The advantage is that robo-advisors are an extremely low-cost option.
You can get started with very low minimums and have an optimized investment portfolio even with a very small amount. If you are looking for a set-it-and-forget-it automated investing strategy, robo-advisors could be a worthwhile option to consider.