Mechanical Investing What It Is How It Works Examples

Mechanical Investing What It Is How It Works Examples

Mechanical Investing: What It Is, How It Works, Examples

What Is Mechanical Investing?

Mechanical investing automates the buying and selling of stocks based on pre-set criteria or triggers. Its primary purpose is to eliminate human emotional behavior, which can negatively impact rational investment decisions.

A systematic investment plan may also incorporate factors used by active investment managers, but it is mainly designed to be implemented on autopilot.

Key Takeaways

  • Mechanical investing is based on predefined rules or criteria.
  • Examples include automatically investing a portion of earnings into a retirement plan, buying or selling shares based on price triggers, or using a roboadvisor.
  • The goal is to remove emotion and psychological biases from investing.

How Mechanical Investing Works

Mechanical investing can take various forms. It can involve regularly contributing a set dollar amount or percentage of earnings to a 401(k) account. Alternatively, it can entail buying a stock when its valuation falls to a specific price-to-earnings ratio and selling it when the valuation reaches a predetermined level.

Valuation markers are commonly used in mechanical investing. Technical analysis indicators like moving averages (simple or exponential) and the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) can also inform automated investment decisions. The goal is to remove subjective feelings and second-guessing, adhering to a disciplined approach. Mechanical investing is akin to passive investing with well-defined criteria.

Examples of Mechanical Investing Strategy by Name

The Dogs of the Dow is a popular mechanical investing system. It involves purchasing the 10 stocks on the Dow Jones Industrial Average with the highest dividend yield at the beginning of each year. These stocks typically underperformed in the previous year. The strategy assumes mean-reversion over the coming year and adjusts the portfolio annually to include only the 10 highest yielding stocks. Advocates of mechanical investing claim that using such pre-set strategies eliminates human biases that often disrupt rational investment behavior.

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Another form of mechanical investing is algorithm-based, where all investment decisions are delegated to algorithms following predefined strategies like modern portfolio theory (MPT). Roboadvisors are automated investment advisory apps that execute this approach. They offer a cost-effective alternative to human financial advisors or portfolio managers, minimizing potential errors and emotional influences.

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