He’s thinkin’ about making those sweet, sweet 401(k) contributions.Photo: Pixabay
If you have the means, should you max out your retirement contributions (that’s $18,500 for a 401(k), $5,500 for an IRA or Roth if you’re under 50 and $24,500 for a 401(k) and $6,500 for an IRA/Roth if you’re over 50) as early in the year as possible, or spread them out?
First, I’ll note: It’s not a problem many people need to work out a solution to. But if you’ve recently received a generous payout or have a high salary that allows you to contribute the maximum amount at the beginning of the year, it might be worth it.
Dollar-cost averaging—or the premise that contributing smaller sums of money over a long period of time will be better for returns because it will ride out the ups and downs of the market—has long been heralded as the way to go. It’s less risky than putting all of your money in at once and seeing the market tank the next day—or so the thinking goes.
But a 2017 report from Vanguard calls that wisdom into question. It concludes that “investing immediately has historically provided better portfolio returns on average than temporarily holding cash” when investors have a large lump sum, like a pension pay out or an inheritance to invest. Walter Updegrave, retirement expert and founder of Real Deal Retirement, explains what the report found:
Suppose you have a large sum of cash that you want to invest for retirement in a portfolio of 60% stocks and 40% bonds. To determine whether you would be better off investing your cash in that 60-40 mix immediately or gradually—say, over 12 months—Vanguard calculated how the two strategies actually performed over the 1,069 overlapping 12-month periods from the beginning of 1926 through the end of 2015. Those decades included bull markets, bear markets and just about every type of market in between that you can imagine.
The result: Investing the lump sum of cash in a 60-40 mix all at once won out roughly two-thirds of the time, outperforming dollar-cost averaging by a margin of 2.4 percentage points on average over the 12-month spans. But that’s not all.
The researchers repeated this strategies over longer and shorter periods as well, and found similar results.
There are other reasons to consider front-loading. If you’re near retirement, about to take an extended leave from work, or you’re switching to a job with a less generous match or worse investment options, then it makes sense to contribute early. If you haven’t contributed the max to your IRA for the previous year before Tax Day, doing so all at once could give you a small break. And then there’s that Vanguard report to think about.
Another important thing to keep in mind: If your retirement account is a 401(k) or IRA, market volatility matters, of course, but it matters less than if you’re trying to make a quick buck. Your money will be there for the long term.
One key 401(k) consideration: Will your company continue to match your contributions throughout the year if you pay in one lump sum at the beginning? Some plans only match during the pay periods that you’re contributing to the plan. Talk to your plan administrator to find out if this is the case for you. And of course, always consider how feasible it is for you to contribute so much all at once, or over a shorter period of time. If it’ll stretch you thin and cause you to take on credit card debt, front-loading is not a good idea.
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