The last contribution to my 2007 Roth IRA was invested last Monday. Ever since my first Roth IRA several years ago, I’ve been maximizing the contribution each year by automatically investing equal amounts twice each month. One reason for using that technique, usually known as “dollar cost averaging” was to reduce risk. With the market going up and down throughout the year, sometimes money is invested at a good prices while other times the prices are not as good.
The other option (although it certainly is possible to mix the two strategies) is to invest the entire $5,000 — the maximum for 2008 — in one lump sum. That would give me the benefit of having the entire year for the full amount to grow. That is, if the stock market grows next year, the full amount will grow. If the market is shaky, then I will have put my entire faith in one date in the year.
Another reason I used the dollar cost average strategy each year is it wouldn’t damage my cash flow. I didn’t always have enough savings ready to be invested, and slow, regular investments allowed me to spread out the contribution over twelve months. While I’d like to keep a large amount of cash on hand for when I eventually make a down payment on a house, if I needed to, I could withdraw Roth IRA contributions without penalty for that purpose.
On a side note, I called to stop my 2007 Roth IRA contribution at TIAA-Cref, and I intend on investing my 2008 Roth IRA with Vanguard.
If you maximize your Roth IRA contribution, how do you do it?
Updated October 9, 2016 and originally published December 22, 2007.
{ 24 comments… read them below or add one }
Flexo,
I make a single annual contribution…
I use ETFs instead of mutual funds, so I pay a one-time commission…
But, if you think about it, this is still dollar-cost-averaging – just over years and not over a single year – because I am going to leave this money in this account for at least 30 years..
Rock on,
NCN
NCN: Absolutely right. It’s easy (for me, anyway) to lose sight of the bigger picture. In a portfolio that destined for use decades from now, even a contribution once per year is still DCA.
Timothy Middleton at MSNMoney has an interesting article on how DCA typically lowers your returns.
http://moneycentral.msn.com/content/P104966.asp
DCA will smooth investments, but it typically lowers overall earnings versus buying all at once. His article has links to other articles that have more statistics.
That being said, it would be best to maximize your Roth investment at the start of the year. That is what I try to do.
Often, however, I don’t have that much money immediately available. In that case, maximizing the Roth contributions over the course of the year using DCA is still better than under funding it.
Lump sum maximum contribution to Roth IRA as soon as I can in January is what we’ve done the past several years (with Vanguard I might add)- for my wife and I both. This does cause our Money Market funds to take a significant hit though. That hit, plus the need to build up sizeable taxable retirement funds, will more than likely cause us to possibly not max the Roth for 2008. Don’t forget the taxable retirement accumulation we all will need.
In 2006, my first year of having the Roth, I opened with $3000 and added $1000 before the year was over.
In 2007, I originally scheduled bi-weekly contributions but after the first contribution of $154 in January, I gave lump sums of $2000 and $1846 in the same month.
For 2008, I will do a lump sum of $5000 as soon as I can in January.
I’m glad I do the lump sums. I like to transfer the money once and forget about it. I don’t want to worry about transferring a set amount from savings to checking on a regular basis to fund the Roth, even though it’s possible automate it.
The supposed benefit on returns of dollar cost averaging has been mathematically and statistically disproven. Under most market conditions, a lump sum investment upfront will yield better returns. The exceptions are when stocks are falling, since you’ll be buying shares at progressively lower prices and thus won’t lose as much money, and when stocks slump for a while followed by a quick run-up at the end of your investment period. But since stocks generally go up in the long run, DCA will usually result in lower returns than lump sum investments upfront.
DCA is useful if you can’t invest in a lump sum upfront, i.e. if you don’t have the money or if you find it psychologically easier to invest small amounts over a year.
Last year my wife and I invested it all in a lump sum, which is what we will probably do again this year. I need to rebalance my portfolio anyway, so instead of selling things off, I will likely just target my buying to do the rebalance.
I look at buying it all at once the same way as others mentioned – DCA over yearly increments instead of monthly increments. Hopefully, having the larger sum of money in for a longer period of time will result in better long term returns.
If I had my druthers (basically enough money to do the whole IRA contribution at one time) I would do a lump sum; however, given that I typically don’t, I end up using dollar cost averaging. In my book, either are okay, but I can only do what I can practically do.
I’m not eligible to contribute the full amount so I contribute through the year to reach about half of the annual limit. I put the rest after I’ve done my taxes for the year because that’s when I know how much I can contribute.
I have a stupid question about Roth IRAs…
With a standard IRA, a person has until April 15 of the year to claim contributions for the previous year. Does it work the same way for a Roth IRA? Or does it not matter since it’s after-tax money?
More specifically, I made no Roth contributions this year, and I’d like to know if I can contribute $4000 just prior to 4/15/08 and another $5000 after that, for a total of $9000 in calendar 2008 but treated as contributions to two separate tax years.
Fred: Not a stupid question at all. Like the traditional IRA, you have until the tax filing deadline to make your contribution for the previous tax year’s Roth IRA. So if you haven’t funded your 2007 Roth IRA by the end of the year, you can do so all the way up to April 15, 2008. You don’t want to wait until the very last minute, though, because your brokerage may take a while to process your contribution. They should be able to handle it as long as it’s postmarked by the tax filing deadline, but it’s better not to take any chances.
Your plan will work, but I would suggest making your 2007 Roth IRA contribution with at least a week before the tax filing deadline, if possible. During this time of the year, you can make contributions to either the 2007 or 2008 IRA. Make sure it’s clear when you make your contribution which year it’s for. Some brokerages are better than others… and if you do it online, follow up with a phone call if you have any questions.
Funds permitting, there’s no reason not to make the full contribution ASAP. If you feel the need to DCA in smaller chunks (I don’t) put your contribution into a money market within the IRA and schedule intra-account transfers into other funds. In the mean time you won’t incur any taxes on the money market dividends.
I do it all at once for two reasons:
1) I like to get it out of the way.
2) I’m a contractor at my full-time day gig so while my position is not on shaky ground, it’s definitely less secure than others. I do worry about losing my gig and not having the $ throughout the year to contribute to my Roth via DCA, so I do it all ASAP: will be putting in $5K on 1/2/08. I may be a bit paranoid, but I’m comfortable acting this way.
my plan is to do $2500 in january.. and $2500 in the middle of the 2008 year
i do it this way because i need that $2500 cushion for emergency savings
i guess it would depend on the minimum required to open an IRA. if you do not own existing shares in a fund or whatever, and there is a minimum, you are essentially forced to purchase in a lump sum. this year we will contribute $500ea per month into RIRA into existing funds.
The Moneycentral article cited in #3 is wrong and misleading. The author “proves” that “dollar cost averaging is bunk” by showing one counter example – – a single year and his own investments. In fact, he just got lucky. He could just as easily lost, compared to DCA. In fact, we can’t predict the future and so “market timing” does not work. Dollar cost averaging does work. You can prove it yourself. Say you invest $500 at a share price of $90 and $500 at a share price of $110. You will have 10.1 shares. If you invested all $1000 at the “average” price of $100, you would have 10 shares. That is the “magic” of DCA.
I too contribute a lump sum–the maximum–in January every year. Since I’m simply transferring funds from taxable index funds to similiar investments in my Roth IRA, it doesn’t make sense to wait.
Also, though, I’ve read articles indicating that one is better off investing a lump sum initially rather than dollar cost averaging. That assumes, of course, that the investor has that option.
I would DCA if my EF would take too big of a hit if I did it all at once.
Hi Flexo,
I am wondering if I can make contributions for 2008 now..as in before Jan 1st 2008?
I am planning to do it via Scottrade.
Thanks.
GD:
Definitely check with Scottrade but I’m 99.99999999% sure that you cannot. I asked both of my Roth mutual fund companies (T. Rowe Price and Fidelity) this question last year and each one of them said that this is not doable.
klerg,
Thanks for the response. Scottrade said I could do it but I am kindof unsure. The customer Rep said I could mention that the contribution is for 2008, on the check I write to them.
GD:
No prob…happy to help!
Hmmm…you may wanna talk to a good tax guy before you make the contribution. If Scottrade mistakenly submits the money for this year, you’ll have over-contributed to the Roth for ’07 and will get hit with a stiff penalty.
Wow. Here I am thinking that DCA is always the way to go! My wife and I will probably DCA since the max for ’08 combined for us both would be $10,000. Now I might consider a combination where we lump what we can in the beginning and DCA for the rest of the year. Thanks for the info!
I usually run a spreadsheet that indicates how much I should put away each week so that I can avoid the ‘Mid-April Rush’ > scrambling during the last week before taxes are due to scrounge up the $$$ for a contribution to take advantage of the tax deduction.
In the event I am lucky enough to have a portion of my IRA contribution that is not deductible, I put the balance in my Roth IRA.
Oh, and my IRA is a managed account, so Dollar-Cost-Averaging is not an issue.
Now, for my taxable accounts, I buy whole shares on days the market is taking a tumble > I guess you could call that ‘opportunistic allocation.’
Anyone think this is a good idea?
@ Daytona084 (rtfa):
this guy just pulled an example out of his butt to illustrate the point, but he points to academic research that says the same thing but takes a more thorough approach
http://www.sciencedirect.com/science/article/B6W4D-45JK782-6/2/bec35bbe850cf520ddbb20d9eb634271
check out the abstract
but of course, past performance is no guarantee of future results <3