Buzz
Dear Two Cents, Financial advisors often champion automating finances. But is this always the wisest decision? For example, I'm interested in starting to invest, but I'm feeling a bit lost and lack much experience. The common advice for beginners is the "set it and forget it" strategy, which sounds appealing and would free up time for other priorities. But is this truly the most effective way to grow my money?
Appreciate your help,
New Investor
Dear NI,
Indeed, many financial experts are strong advocates for automating not just your investments, but your entire financial strategy. We'll delve into the reasons behind this, but first, let's clarify what automation really means.
Understanding What It Means to "Automate" Your Finances
Automating your finances involves setting up systems that require minimal ongoing management. Here are a few examples:
Establishing a regular automatic deposit into your savings account
Signing up for automatic contributions to your 401(k) directly from your paycheck
Opting for auto-pay to manage your bill payments
With automation in place, your budget practically manages itself. You instruct your money on where to go and what to do, and it quietly works for you without further effort.
"Set It and Forget It" Investment Strategy
Active investing requires expertise and effort—building a portfolio stock by stock and consistently monitoring your assets. This process is time-consuming, which is why many personal finance experts and investors prefer the "set it and forget it" strategy you mentioned.
Investing legend Warren Buffett has been a key advocate for this strategy. He frequently discusses index funds. These funds track the stock market's performance and require very little maintenance, allowing you to invest without needing to track their daily fluctuations. Buffett has said:
Allocate 10% of the funds to short-term government bonds and 90% to a low-cost S&P 500 index fund. (I recommend Vanguard's.) I believe this approach will deliver long-term results that outperform most other investment strategies…
The reasoning is simple: most people can't outperform the market. Index funds consist of a select group of companies and are structured to generate returns that mirror the market's performance. So, if you're not an experienced investor (and even skilled investors struggle to beat the market), index funds are the best option.
To wrap it up, here's how to implement a "set it and forget it" investment strategy:
Open a brokerage or retirement account.
Select your index funds.
Understand that your funds will appreciate over time, without the need to monitor daily changes.
Occasionally check to ensure your portfolio remains balanced.
The Benefits of Automation
A major benefit of automating your finances is that it helps you build positive financial habits effortlessly. By making one smart decision, you set up a system that pays off consistently without much attention. For instance, if you commit to saving 10% of each paycheck and set up an automatic deduction, your savings are deducted every time you're paid. This eliminates the temptation to save less than you intended, like only 5% or 8%.
As you pointed out, another key advantage is the time it frees up. You can dedicate your time to other priorities. Financial expert Ramit Sethi would likely agree. In a post on automating your finances, he writes:
By establishing a robust personal finance system, you can take control of your finances while allowing the system to work passively on your behalf. It will help you manage your money effortlessly, guilt-free, for years to come. Bills, payments, and even investments will be automated, leaving you with more time to focus on what truly matters.
Sethi is a strong advocate for automating your finances so you can redirect your time and energy toward boosting your income. For instance, not having to worry about investments gives you more time to refine your career skills.
The Drawbacks of Automation
However, there are valid reasons to remain active in your finances as well. J. Money, the author of the financial blog Budgets are Sexy, shares that while he generally supports automation, it’s also wise to stay engaged at times:
It's easy to overlook mistakes and end up overpaying if you're not paying attention—this is the main downside of automation, aside from the risk of bounced checks or missed payments due to poor fund management. Also, sometimes it's valuable to experience the "sting" of paying bills manually—it makes you more mindful of your spending and encourages you to reconsider the purchases you're about to make.
We've discussed this before. Financial writer Carl Richards suggested the slow-tech approach to finances. The concept is: by manually reviewing your finances, you re-establish a connection with your financial situation, which may help you save more and improve your spending habits.
The Downsides of "Set It and Forget It" Investing
Index funds are quite popular, but they're not universally embraced. To help you make an informed choice, it’s important to consider the disadvantages of a hands-off investment approach. Wayne Pinsent from Investopedia outlines five reasons to avoid index funds:
No Protection from Losses: When the stock market experiences a downturn, your funds will too. Passive investing offers no safeguards against this.
No Ability to React: Pinsent points out that sometimes companies are mispriced. Active investors can capitalize on these opportunities by buying or selling accordingly.
No Control Over the Portfolio: With an index fund, you have no say over the specific stocks included—it’s a predetermined mix.
Limited Strategy Diversity: Pinsent mentions that active investors can explore a variety of strategies for potentially better risk-adjusted returns.
Less Personal Satisfaction: While the stock market can be stressful, investing in index funds doesn’t guarantee you won’t be concerned about your investments or the economy.
Of course, each of these points has its rebuttal. Many of the actions mentioned require significant time and a deeper understanding of investing.
In the end, you need to weigh the pros and cons and choose what works best for you. But, as a general rule, we lean toward efficiency and productivity. And that's the essence of "set it and forget it" investing. You earn the same return as most others, without the stress of being out of your depth. This allows you to focus your time and energy elsewhere—perhaps on other ways to invest in your future, like becoming an indispensable worker, for instance. Sethi refers to this as the bigger picture.
However, there's one important note: it's still essential to periodically review your finances, even if they're automated. You need to ensure you haven't misjudged your budget and confirm that your portfolio remains balanced.
While automation is fantastic, it's also important to get involved every once in a while.
