If you are like most people you have a 401(k) or some other investment plan through your employer. When you started, you were told that if you put a certain percentage of each paycheck into your retirement account, the company would match that with a contribution of its own. Seems pretty straight forward, you put money in, they put money in, you pick a few investments that will grow, and you set up automatic investing into the future. Bing Bang Boom, it took you ten minutes and you're done. You’re now an investor, and the best part is because you set automatic investing into the future you can logout and not have to look at your account until retirement. Pretty sweet right? The only problem is that like everything else in life, it’s not really that simple.
First, let's talk about what “automatic investing” actually means. For every paycheck you receive, you elect to have a certain dollar amount or percentage taken out and put into your retirement account. This is automatically taken out of each paycheck without you ever having to handle anything. Even better, this money then gets automatically invested into whatever funds and at whatever percentages you choose. So if you want your retirement account to be 80/20 stocks to bonds you can elect to have the 80% of that money put into a stock fund and 20% into a bond fund. Again, this all happens without you having to take care of it during each pay period.
This is certainly a great feature and one everyone should take advantage of if it's offered. However, as I mentioned above, there is more to it than just setting things up, picking your funds, toggling on the “automatic investing” feature, and then calling it a day. If you are driving your own 401(k), automatic investing helps, but isn't enough for you to let go of the wheel and take a nap. Don't confuse cruise control with auto-pilot or hiring a driver.
After choosing your funds and toggling on the “automatic investing” feature, you think to yourself, “wow this is awesome, every deposit will be invested at the 80/20 split I want and I don’t have to worry about things ever again until I retire.” WRONG!!! Unfortunately, you have only cracked the surface of all the things that still need to be taken care of in order to ensure your investments are working in an optimal way for your retirement. Again, think of it like setting the cruise control in your car, you still have to steer the car to get to your destination.
For example, what happens when the market acts like it did in 2020 and drops 33% only to violently swing back up 70%? That portfolio can easily become a 75/25 blend or 85/15 blend. It's not enough to set an automated investment option, the portfolio also needs to be rebalanced from time to time to ensure that the 80/20 blend stays at 80/20 through good times and bad.
Some plans do have an automated rebalance feature, but be wary of that. As we've written about before, an automated rebalance feature can present problems of its own. However, most plans don’t offer this feature, meaning that a manual rebalance is required when the account deviates from its modeled allocation target. This means that after all the work already done in setting up the account, choosing your desired allocation, picking the right funds, making certain you chose the right share class with the lowest fees, and selecting the automatic investing option, you still have to remember and take the time to go rebalance the account regularly.
How often is enough though? Do you rebalance annually on some arbitrary date like your birthday or the first of the year, or maybe you do it on the first day of every quarter or month. Once a year is definitely not enough and every day is way too much, so where is that middle ground? Why not instead just let go of the wheel and have a professional handle these decisions. Take a nap, read a book, watch a movie. Switch out the minimal effectiveness of cruise control for full-on "auto-pilot."
Picking investments may not seem that difficult at first, but there is more to it than just picking the funds with the best performance over the past five or ten year period. There are other things to consider such as the expense ratios and different share classes to choose from. Do those funds make sense for you and your current life stage, and do they help you achieve your retirement goals? Also, what about in two months when the market moves and the account needs to be rebalanced. Or what about when one of your chosen funds just keeps going down, at what point do you pull the plug, will you remember to do it? Even worse, what happens if the share class of the fund you are in goes away and now your fees just doubled, or the fund liquidates and 80% of your account is in cash, how long until you realize it?
As everything above has highlighted, what may seem straightforward at first can quickly spiral out of control into something where your options are A) go crazy while pulling your hair out trying to handle it all, or B) hire Exchange Capital Management and let our team handle these investment headaches, with the added bonus of working with you to create a sound financial plan. When you take a step back and think about it, it's as close to actual “automatic investing” as you can get while maintaining both your leisure time and your peace of mind.
Matt Farris, is a Portfolio Manager at Exchange Capital Management. The opinions expressed in this article are his own.