An automatic investment plan automatically transfers money at regular intervals from a saving or checking account to an investment account. There, that money is used to purchase an investment which has been previously chosen by the account holder. Once it has been set up by the investor, the automatic investment plan continues these regular transfers automatically without the investor having to take the time to authorize each separate transfer.
In most automatic investment plans, money is transferred on a weekly, biweekly, or monthly schedule. The schedule can also be quarterly, semi-annually, or annually. The time interval is most commonly chosen based on the schedule of automatic pay deposit from the account holder’s place of employment. Because of this, automatic investment plans are often marketed as “pay yourself first.”
The investor chooses the amount of money to be transferred each interval. The amount of money to be transferred can be based on a fixed amount or on a percentage of deposited earnings. For very long-term investments, transferring funds based on a percentage of deposited earnings often means that the investment contribution rises over time in proportion to salary, which can make it easier to build up a large enough retirement base to maintain an expected standard of living.
The investor can also choose whether the automatic investment plan transfers funds into a tax-deferred or tax-exempt account, such as a 529 or Coverdell account, or a 401(k) or Roth IRA. It is possible to set up multiple automatic investment plans, each transferring money into a different investment account.
The investor chooses the type of investment for each automatic investment plan. The investment may be a series of fixed-rate term deposits, an emerging markets mutual fund, blue-chip stocks, bonds, or anything in between.
Some types of investments work better with automatic investment plans than others. In general, short-term investments which require a great deal of flexibility to buy, hold, or sell in order to turn a profit are not good candidates for an automatic investment plan.
Investments which are appropriate for dollar-cost averaging strategies are best for automatic investment plans. The steady rate of investment in an automatic investment plan will even out market dips. Over time, an automatic investment plan can also mean a lower average cost per share, because the same amount of money will buy more shares when the price is low and fewer shares when the price is high.
Some automatic investment plans are flexible and will allow you to end the plan at any time, but others have strict terms and will impose fees or penalties for closing the plan outside the agreed-upon term. As well, many automatic investment plans have penalties if the automated transfer cannot be made. Depending on your circumstances, it may be better not to set up an automatic investment plan if you do not have a stable income.