An automatic investment plan is an investment program you contribute to at predetermined intervals. By investing automatically, you remove both the temptation to spend and any fears about timing the market that may get in the way of consistency.
An automatic investment plan is a great strategy for building a nest egg, too. Learn about different types of automatic investment plans so you can choose the best option for meeting your financial goals.
Definition and Example of an Automatic Investment Plan
An automatic investment plan is an investment account you fund at regular intervals, usually through direct deposit or recurring transfers. It’s often used as part of a dollar-cost averaging strategy, which is where you automatically invest on a pre-set schedule—whether the stock market is up or down. Investors can choose to set up automatic withdrawals from a personal account, or contribute through their employer via an employer-sponsored investment account.
When you practice dollar-cost averaging by funding an automatic investment plan, your money will buy more shares when the market is down and fewer shares when the market is up. Over long periods of time, it often helps you pay a lower price per share.
Let’s look at an example. Say you wish to start investing, but are not sure how to start, so you decide to sign up for a robo-advisor. Robo-advisors are software products that can help you manage and automate your investments. When you sign up to use one, you will answer a series of questions about your financial background, current situation, and goals, as well as fill in financial details to secure automated deposits. From there, you don't need to do anything else until you want to withdraw money.
How Automatic Investment Plans Work
If you have a 401(k) or another type of workplace retirement account, you already have an automatic investment plan. A 401(k) plan is funded through automatic payroll deferrals that your employer may match. You decide how much you want to contribute, typically as a percentage of your salary, and the money is automatically invested.
If you invest in individual stocks that pay a dividend, you may have the option of enrolling in the company’s dividend reinvestment plan, or DRIP. A DRIP is an automatic investment plan that lets you reinvest your dividends to purchase more shares, rather than receiving the payment as cash.
It’s important to keep in mind that, historically, the stock market has averaged annual returns of about 10% per year, though real returns are closer to 6% or 7% per year when you account for inflation.
Some types of accounts can become automatic investment accounts if you opt for recurring transfers. For example, you can fully fund an individual retirement account (IRA) for the tax year at any point until April 15 of the following year. However, you could choose to automate your investments by setting up weekly or monthly transfers to the account. Likewise, you could make a 529 plan an automatic investment account if you set up recurring transfers.
Conversely, If you’re looking to boost your savings, an automatic savings plan is a good place to start. You can set up a recurring deposit so that money will automatically be transferred from your checking account to a savings account.
Pros and Cons of an Automatic Investment Plan
Enables you to budget for investing
Lowers investment costs
Avoids emotional reactions
There’s a risk of overdrawing your account
May be too hands-off
Potential for missed opportunities
- Enables you to budget for investing: One of the biggest advantages of an automatic investment plan is that it forces you to include investing as part of your budget. By having money automatically deposited to an account and invested, there’s less temptation to spend that money.
- Lowers investment costs: An automatic investing plan is usually part of a dollar-cost averaging strategy, which often lowers investment costs in the long term. Your money will buy less when the market is up, but you’ll also lock in lower-priced investments when the market is down.
- Avoids emotional reactions: An automatic investing plan can help you avoid emotional reactions such as selling your stock right away if the stock market crashes or drops significantly.
- There’s a risk of overdrawing your account: If you’re living paycheck to paycheck, an automatic investment plan may not be a great option because it increases your risk of overdrawing your account and racking up fees.
- May be too hands-off: While automation can help you save and invest more money, it’s important to revisit your goals, especially as your financial situation changes. For example, if you get a raise, you may want to increase the percentage of your income that you’re automatically investing.
- Potential for missed opportunities: Sometimes investing a lump sum does make sense, particularly if the stock market has dropped or you see potential in a particular stock. Automated investing could make you miss out on the opportunity to buy after the market has corrected.
- An automatic investment plan is an investment account you fund through recurring transfers on a predetermined schedule.
- A 401(k) is a common type of automatic investment account, since part of each paycheck is withheld and invested.
- You can make almost any investment account into an automatic investment plan by setting up recurring transfers.
- An automatic investment plan can help you practice dollar-cost averaging, which often lowers investment costs over time.