Should Pension Contributions Be Maximized at the Beginning of the Year?
If you have the funds, if you maximize 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 are over 50) as early as possible or spread them out?
First, I will point out that this is not a problem that needs to be addressed by many. But if you’ve recently received a generous payout, or have a high salary that allows you to deposit the maximum amount at the beginning of the year, it’s worth it.
Averaging the dollar value – or the premise that depositing smaller sums of money over a longer period of time will be better for making a profit because it will survive the ups and downs of the market – has long been hailed as the right decision. It’s less risky than investing all your money at once and seeing the market decline the next day – at least that’s how people think.
But a 2017 Vanguard report challenges that wisdom. It concludes that “investing immediately has historically yielded better portfolio returns than holding cash” when investors have a large lump sum, such as a retirement benefit or inheritance to invest. Walter Upgrave, retirement expert and founder of Real Deal Retirement , explains what was found in the report:
Suppose you have a large amount of money that you want to invest for retirement in a portfolio of 60% stocks and 40% bonds. To determine if you would be better off investing your money in this 60-40 combination immediately or gradually – say over 12 months – Vanguard calculated how the two strategies actually performed over 1069 overlapping 12-month periods from early 1926 to late 2015 of the year. These decades have included bull markets, bear markets, and just about every type of market you can imagine.
Result: Investing a one-time amount of cash in a combination of 60-40 simultaneously yielded about two-thirds of the benefits, beating the average dollar value by 2.4 percentage points on average over a 12-month period. But that’s not all.
Researchers repeated this strategy for longer and shorter periods with similar results.
There are other reasons to consider front-loading as well. If you are looking to retire, take an extended leave of absence from work, or are switching to jobs with less generous matching or worse investment options, then it makes sense to contribute as early as possible. If you didn’t pay the maximum amount to your IRA in the previous year prior to Tax Day, it might give you a little breathing room right away. And then you should think about the Avangard report.
Another important thing to keep in mind is that 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 a long time.
One of the key 401 (k) considerations is: Will your company continue to pay your premiums throughout the year if you pay in a lump sum up front? Some plans only match the billing periods that you add to the plan. Talk to your plan administrator to see if this is right for you. And of course, always consider how realistic it is for you to contribute so much at once or in a shorter period of time. If that drains you and makes you borrow a credit card, preloading is not a good idea.