How Technology Leverages Investing Basics
You're hearing more and more about automated investing, but what's the real advantage? This basic answer might surprise you.
Investing is often cast as a high-stakes Wall Street game, and high-tech innovations sometimes seem to add to the complexity.
In fact, automated investing methods can help you succeed because they rely on fundamental investing principles: diversification, risk management, low costs and automation.
When it comes to technology and investing, you might think that digital developments have added another layer of intricacy to an already high-stakes game.
But the systems that are emerging today actually hew closely to straightforward, well-tested investing principles: diversification, managing risk, keeping costs low, and using automation to manage your investments so you don’t have to. (This last, key component also reduces emotional reactions that can negatively impact returns, a major drag for most DIY investors).
Here, a review of investing basics, and how the use of online software and other technologies can help you get the most of these essentials.
Investing = Growth
When you sock away money in a savings account, you’re watching your money grow—largely thanks to how much and how often you save (i.e. you’re not getting a big boost from accumulating interest, because the rates on most savings accounts are currently less than 1%).
When you invest, however, you’re buying securities (stocks, bonds, shares of mutual funds) that earn a return or profit based on the performance of those securities. That can help your money to grow more rapidly than it would in a savings account. If you were to buy, say, shares of Company X stock for $100, and it gained $10, you’d have $110—a 10% ROI (return on investment).
Tech advantage: When you invest using an online wealth manager, it can automate your deposits, so that you’re buying into the market on a regular basis. This not only helps you automate your saving from your budget, it means you don’t have to think about when to enter the market—when fear or exuberance might cause you to make impulsive decisions. Steady as she goes.
Investing = Risk
Let’s say you bought $100 worth of shares of a stock mutual fund that was primarily invested in businesses overseas. If those stocks lost 10% on average, you’d have $90. A certain amount of risk is the price you pay for being in the market.
Risk tolerance is a phrase meaning how much volatility you’re comfortable with, in exchange for higher expected returns. You can avoid some risk by diversifying your portfolio. So you wouldn’t invest only in an overseas stock mutual fund; you’d include one from the U.S., and a bond mutual fund, and so forth. Never put all your eggs in one stock, bond or mutual fund basket; a variety of assets can even out gains and losses in different sectors, making your returns steadier.
Tech advantage: Managing risk versus return is a tough balancing act for many people. How do you know you’ve picked a good, diversified portfolio? Using an automated system that rebalances your portfolio for you, according to your own risk tolerance, means that a) you’re spared that particular chore; and b) you maintain an optimal asset allocation—and a comfortable level of risk—effortlessly.
Investing = Long-term
Despite the infamous stock market crash in the 1980s, the tech bubble bursting in 2000-01, the recession that began in 2008—investing in the market for the long haul (10, 20 years or more) will typically help grow your money, because of the risk involved. If you invested $100 each month in a well-diversified portfolio that gave you a 5% return, on average, each year, it would grow to about $148,856.50 over 40 years. If you kept that money in a checking account, likely earning 0%, you’d end up with about $52,000.
Tech advantage: Whether you like it or not, you’re likely to be an erratic investor—pulling your money out of the market when things look dicey, and jumping back in when there’s an upswing (a.k.a. timing the market). Being a long-term investor means hanging in there through ups and downs, so you don’t lock in losses or miss out on gains—and you’re more likely to stay the course with an automated program by your side.
Investing = Automation
If you look back on the history of Wall Street and the main street investor, one of the strongest trends has been the steady move away from hands-on, DIY investing styles toward more packaged products (like the emergence of the modern mutual fund in the last century, as well as index funds and target date funds in the last few decades) to more sophisticated online money management systems today.
And there’s a simple reason for that movement: repeated research has shown that the vast majority of people don’t make financial decisions that really serve their long-term interests. In fact, of all the behavioral insights about investors in recent years, perhaps the most critical in terms of driving financial innovation is the recognition that automating good behavior is crucial to most people’s investing success. The classic example is the so-called behavior gap:
For the two decades ending on Dec. 31, 2012, the S&P 500 averaged 8.21% a year, according to Dalbar, but the average equity fund investor earned a market return of a shockingly low 4.25%.
So the real question is how to invest wisely and do it in a way that’s efficient, keeps your emotions at bay, doesn’t cost much and gives you confidence that you have spread your risk around evenly—so that you come out ahead. Technology is the tool that can help you achieve those basics, which is really all that a smart investor needs.
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