Buzz
If you’re in a position to do so, should you contribute the maximum allowed to your retirement accounts early in the year (i.e., $18,500 for a 401(k), $5,500 for an IRA or Roth if you're under 50, or $24,500 for a 401(k) and $6,500 for an IRA/Roth if you're over 50), or should you pace your contributions throughout the year?
To begin, it’s worth noting that this isn’t a dilemma most people need to solve. However, if you've recently received a sizable payout or have a high income that lets you max out your contributions right at the start of the year, this strategy may be worth considering.
Dollar-cost averaging—an investment strategy where smaller, consistent contributions over time are believed to yield better returns by smoothing out market volatility—has long been advocated as the safer approach. The thinking is that it’s less risky than investing a lump sum only to see the market decline shortly after.
However, a 2017 report from Vanguard challenges that conventional wisdom. The report concludes that “investing immediately has historically provided better portfolio returns on average than temporarily holding cash” when investors have access to a large sum of money, such as from a pension payout or inheritance. Walter Updegrave, retirement expert and founder of Real Deal Retirement, explains what the report uncovered:
Imagine you have a large sum of cash that you wish to invest for retirement, targeting a portfolio with a 60% allocation to stocks and 40% to bonds. To determine whether you’d be better off investing all that cash into this 60-40 mix right away, or doing so gradually—let’s say over the course of 12 months—Vanguard analyzed how both approaches performed across 1,069 overlapping 12-month periods from 1926 to the end of 2015. These decades spanned bull markets, bear markets, and everything in between.
The outcome: Investing the lump sum all at once into the 60-40 portfolio beat dollar-cost averaging about two-thirds of the time, with an average performance advantage of 2.4 percentage points over the 12-month periods. But that’s not all.
The researchers also ran the same strategies over both longer and shorter periods, and the results were consistent with their findings from the 12-month spans.
There are additional reasons to consider front-loading your investment. If you’re approaching retirement, planning an extended leave from work, or transitioning to a job with a less favorable match or inferior investment options, contributing early makes sense. Similarly, if you haven’t maxed out your IRA contribution for the previous year by Tax Day, doing so in one lump sum might provide a small advantage. And, of course, the Vanguard report should be kept in mind.
Another important factor to remember: If your retirement account is a 401(k) or IRA, market volatility still matters, but it’s not as crucial as it would be if you were aiming for short-term gains. Your investment is designed to grow over the long haul, after all.
An important factor to consider with your 401(k): Will your employer continue matching your contributions if you pay them all at once at the start of the year? Some plans only match during the pay periods in which you’re contributing. It’s worth checking with your plan administrator to confirm whether this applies to you. Also, always evaluate whether it’s realistic for you to contribute such a large sum at once or over a short time frame. If doing so would strain your finances or lead to credit card debt, front-loading isn’t the best option for you.
