Pod Insights Masters in Business At The Money: Automate Your Investing About this episode Have you taken full advantage of automating your investments? You can improve your returns, reduce emotional decision-making, and generally end up with better results simply by putting your investing on autopilot.
Jeffrey Ptak is the managing director at Morningstar. Previously, he was the chief ratings officer.
Each week, “At the Money” discusses an important topic in money management. From portfolio construction to taxes and cutting down on fees, join Barry Ritholtz to learn the best ways to put your money to work.
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Transcript Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.
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2:57 Barry Ritholtz? Have you taken full advantage of automating your investments? You can improve your returns, reduce emotional decision-making, and generally end up with better results simply by putting your investing on autopilot. To help us figure out how, let's bring in Jeffrey Patac. He's Managing Director at Morningstar. Previously, he was the Chief Rating Officer there. He's been with Morningstar since 2002, and his research has shown features like auto enrollment or contribution increases, default investments, and target date funds enable investors to
3:36 Barry Ritholtz? bypass common pitfalls of market timing and emotional trading. So Jeffrey, let's define the automation features you're discussing in your research. Things like steady paycheck deductions and regular rebalancing, how can an investor set that up?
3:54 Speaker 05 Sure. So it's relatively straightforward if you're working with a brokerage platform to enable those types of features. In some other contexts, like a retirement plan, it might be standard plan features. In fact, you might be defaulted into them, and so away you go. And so it's well within our reach as investors, either to switch these features on at our own election, or to be opted into them as we would be in a retirement plan.
4:23 Barry Ritholtz? So explain to me the difference between auto enrollment and auto escalation.
4:29 Speaker 05 For sure. Yeah. So auto enrollment, the notion is you're auto enrolled, you become a participant in the retirement plan. Auto escalation is you're in the plan, and then your contribution rate is steadily increased at a predetermined level. And so, you know, one is about being in, participating. The second is about the extent to which you are participating, both valuable.
4:54 Barry Ritholtz? So your research has found automatic investing reduces bad investor outcomes, reduces behavioral errors, promotes consistency. Sounds a little too good to be true. What sort of data have you found that supports automation leading to improved investor returns?
5:13 Speaker 05 Yeah, real good question. So it's a bit inferential, because we're not a brokerage platform, and so we don't have sort of the tick data. Nevertheless, we can look at the types of funds and where they tend to be used, and whether automation is common in those settings, you know, and draw some conclusions. And one of the more striking findings from our research, this is the Mind the Gap study that we conduct, is that investors in allocation funds, the most popular version of which are target date funds, they do the best job of capturing their funds' total returns. That is, they experience the fewest frictions related to the timing and magnitude of their transactions over time. And what do we know about target date funds? We know that people are commonly defaulted into them, that they
5:54 Speaker 05 regularly invest in them, just as part of their regular payroll deduction that takes place. And so they're kind of the signal example of Then take some other examples of fund types that you wouldn't find in a retirement plan. Like maybe the quintessential example would be something like a sector fund or a thematic fund. You're typically not going to find those in a plan lineup. We found those have some of the widest gaps and why is that? They're not used within that gilded cage of a retirement plan. Furthermore, they might be more subject to discretionary ad hoc off cycle trading decisions where there might be a greater propensity to trade on emotion than would be the case with something like a target date fund.
6:37 Barry Ritholtz? And it sounds like the key advantage of automation is it tends to reduce unnecessary trading. And it also reduces the emotional responses to just ordinary market volatility.
6:51 Speaker 05 It does. Yeah, it, you know, it basically, it's the best kind of inertia, I would say. We, we know that, you know, market bobbles can be unnerving to investors and left to their own devices. They might make a change to their allocation. They could elect to remove capital from the markets. And we know how harmful that can be to their long-term compounding power. Whereas in these settings, because they just continue to mechanically add to their investments. And those investments in turn, you know, take care of some of the mundane tasks like rebalancing and adjusting the asset mix. They just get on with it and, and I think that works to their benefit over the long term. And certainly our research seems to bear that out.
7:34 Barry Ritholtz? So we talked about the investor gap between their actual performance and their funds performance. When we're looking at automated target date funds or automated allocation funds, how measurable is the gap between those and people who kind of self-manage that allocation?
7:53 Speaker 05 Yeah. So with, with allocation funds, the largest subset of which are target date funds, we found almost no gap. It was basically point one percentage points per year. Then when you focus on every other type of fund, we found that the gap was around 1.2 percentage points per year. Now, yes, among those other types of funds, it is quite possible that some are. Using them in an automated fashion. Maybe they have some sort of investment plan that they've set up or they've otherwise mechanized the process. But I think it stands to reason that for a fairly large subset of that capital, it's being invested in a more discretionary fashion. And so you can see the difference between the two of those. It amounts to around 1.1 percentage points annually of return that's being foregone effectively.
8:37 Barry Ritholtz? So what are the automation features that have consistently good benefits for investors?
8:45 Speaker 05 So I would say that probably the biggie is auto enrollment. We don't have as much data that we collect, but there are others like Vanguard. Vanguard puts out a terrific annual study called How America Saves. In the most recent edition, they reported 61% of the plans they service as clients had auto enrollment and two thirds of those plans that offered auto enrollment also offered auto escalation. And then of those that that auto enroll, 98% of them are defaulted into a target date. And strikingly, the average participant holds only two funds. So that gives a sense of the reach of automation in our retirement system. If I had to choose between the two of those, auto enrollment versus auto escalation.
9:29 Speaker 05 It's a bit of a false binary, but all the same. I would say auto enrollment is far, far more important. Why is that? It's because we want people participating so that they can compound their wealth. Even if they were to experience a return gap, we would rather that they get some, if not all of their funds returns in auto enrollment and cease to that.
9:49 Barry Ritholtz? Yeah, before the default settings, there were stories were rife about people working at places for years and the money just piled up in cash and did nothing. It's kind of, it's kind of crazy. So, but that, that leads to an obvious question. How widespread has the adoption of automation been in, in the various retirement ecosystems that are out there?
10:09 Speaker 05 It's become very widespread as I might have mentioned before, you're talking about two thirds of plans that offer auto enrollment and then also a very significant number, auto escalation as well. And I think that one other thing from the Vanguard study that I mentioned before that I found quite telling, they found that 1% of target date fund investors transacted last year, that'd be 2024, compared to 11% of investors in other types of funds. And so it just gives a sense, not only the breadth of automation that's taking place here, but also some of the benefits it confers in tapping down transacting that we see within these plans.
10:51 Barry Ritholtz? Any particular demographic groups stand to benefit more or less from automating these strategies?
10:58 Speaker 05 That is a great question. It was one of the most eye-opening findings from that study. They found that auto enrollment disproportionately benefited younger and lower-earning participants. So you were really talking about a quantum among those cohorts. And I think that's critical because we want to get those folks into plans. In some senses, you're talking about socioeconomic demographics that may be more vulnerable, that otherwise wouldn't have the opportunity to compound wealth in the way we'd like to see. Auto enrollment has helped to ensure that those gaps get closed. And so I think that that's a really, really telling and encouraging finding from their study.
11:41 Barry Ritholtz? What about non-qualified plans, portfolios outside of 401ks or IRAs? What can we do to automate those sort of holdings?
11:52 Speaker 05 Yeah, so I think to the extent, so I think that one thing that you can do is you can set up sort of an auto investment plan, very similar to the kind of setup that you would find in a retirement plan, put that on autopilot. And then I would say to the extent that you can, automate your investments. I may have mentioned in other settings that it's important to have a plan, first of all. But then, once you've got that plan, maybe it's an allocation fund, a target date fund, or a target risk fund, where you're fixing the percentage of equity, fixed income, and other asset classes. And that obviates the need for you to go in and make adjustments on your own. Automate, automate, automate. I think those are the key things to ensure that we capture as much of our fund's total returns and compound as we can.
12:35 Barry Ritholtz? So there are a lot of new digital investing tools and AI is starting to have an impact on various strategies. What do you think is going to have a powerful impact on both automation and future investor outcomes?
12:50 Speaker 05 Yep. And so I think, you know, I'm an avid user of AI. I know how beneficial it's been in my own work, making me more productive. I think that it can confer the same sorts of benefits to investors, you know, maybe helping them to formulate a plan, maybe figuring out the optimal way for them to allocate their assets, you know, and otherwise sort of keeping them to, you know, sort of the goals that they've set consistent with their risk parameters. You know, the other side of it is it can engender overconfidence. You know, maybe we feel like we've got the capacity to make trading decisions that maybe really are outside of our circle of competence. And so we just want to make sure, like so many of these other
13:33 Speaker 05 tools and resources we have available to us, we use it in a way that advances our goals and we don't get carried away in an overconfident way, you know, sort of an impulse that we're, you know, maybe all, you know, likely to succumb to from time to time.
13:48 Barry Ritholtz? And for either an individual investor or perhaps a financial advisor, if they're seeking to automate investments, what are the most important factors they should be thinking about when they're either selecting a platform or a tool to use to help automate?
14:05 Speaker 05 That's a great question. So, you know, one of the corollaries to automating, at least in a retirement plan context, is it is a little bit of an all in one decision. So typically, the target date fund is going to be offered by a single provider. And so what that means is that we want to make sure that, you know, we're feeling very confident about that organization's culture, about its staying power, about its overall investor centricity. Those aren't necessarily easy things to tease out, but I think a little bit of research can tell you whether or not this is a firm that has a certain kind of pedigree, a certain kind of reputation. Look at the fees that it levies. Fees speak volumes about Organizational fiber, so to speak.
14:47 Speaker 05 And I think if you can go through and satisfy yourself that this is an organization that has my best interests at heart, that is levying a fair fee and is likely to be around for the years to come over which I'm looking to compound. Those are all good facts, and I think that they portend well for you to succeed in capturing your funds return and compound some real wealth over time.
15:07 Barry Ritholtz? So to wrap up, there are lots of automated tools that you could use. Platforms, specific allocation funds, other things you can do to improve your returns, reduce emotional decision making, and generally end up with better performance simply by putting your investments on autopilot. I'm Barry Ritholtz. You're listening to Bloomberg's At the Money.
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