Why is making a large investment in your savings at the beginning of the year better than waiting until the end of the year?
Arielle O’Shea answers that question in her article below. This strategy, front-loading your IRA, means you’ll benefit from compound interest for the entire year.
It isn’t always possible for people to make large, upfront contributions to their retirement savings. Which is why we want to help. At Dechtman Wealth, our financial advisors can help you determine the best savings strategy for your unique situation. Whether that means front-loading your IRA or making monthly contributions, we can help you identify options and make an educated decision about your retirement savings.
Front-Load Your IRA for Biggest Payoff
Happy New Year! Do you have $5,500 to spare?
It’s an uncomfortable question, especially if your credit card is still smoking from last month. There’s no hangover quite like a holiday financial hangover.
But I ask because that’s the amount it takes to fully fund a traditional or Roth IRA for a year, and there’s a lot of value — a five-digit value — in front-loading your contributions.
What that means: If you do have $5,500 — say from an end-of-year bonus, overstuffed emergency fund or taxable investment account — consider adding it to your IRA now, rather than waiting until the contribution deadline as most people do. (If you haven’t yet maxed out your 2016 contribution, do that first. You can contribute until the April 18 tax deadline.)
And if you don’t? You probably already know you’re far from alone. But you can still read this with an eye toward scraping the money together ASAP. January is all about stretch goals, right?
Why now is better than later
It comes down to compound interest, which is as close as you’ll get to having your own money tree. As your investment earns a return, future returns are based on that now-larger balance.
That’s why a 25-year-old can invest $10,000 today and end up with $100,000 at age 65 — assuming a 6% average annual return — but a 45-year-old would have to invest more than $30,000 to end up with $100,000 by the same age.
A smaller head start makes a pretty striking case, too. You have a little more than 15 months to make an IRA contribution for each tax year, from January until the tax-filing deadline the following April. The robo-advisor Betterment compared average gains on 10 annual $5,500 IRA contributions — one set made on the first possible day in January and one set made the last possible day in April the next year — using 10-year periods of S&P 500 returns since 1928.
The result: The early contributions had a $14,507 balance advantage after 10 years, on average.
“By front-loading, you end up with almost a third more after 10 years,” says Dan Egan, Betterment’s director of behavioral finance and investing. Egan found that only in individual years with serious market crises — the Great Depression, the dot-com bust — did early investors fail to earn a premium.
“This is purely a time in the market effect,” Egan says. “There are periods when you can get unlucky and happen to invest right before a market downturn, and [being early] ends up not being a good thing. But at the end of the day, what’s happening here is you have 15 months that you wouldn’t have if you waited until the following April.”
It also gets the money out of your hands
Your brain thinks now is better than later, too — but by that it means, “Happy hour today, worry about retirement when you’re old and gray.” The pull of instant gratification, as evidenced by the marshmallow test, is strong.
So there’s a behavioral perk to front-loading. The most successful savers treat savings as an expense. When deciding the rent, mortgage or car they can afford, they look at their balance after they’ve set money aside — ideally 10% to 15% of income.
You wouldn’t tell the electric company you’ll be paying only half your bill going forward because you bought a Lexus on a Toyota budget — not without a couple of flashlights handy. Shortchanging your savings to fund spending feels more reasonable, but it’s a good way to turn out the lights on your future self. (I say that somewhat jokingly, but that kind of financial insecurity is a very real concern for millions of retirees.)
When you fund your IRA at the beginning of the year, you’re not just mentally setting aside that money. IRA distribution rules make it hard — but not impossible — to get back.
Getting ahead is harder than it sounds
I’m not pretending that it’s easy to front-load your IRA. Many investors don’t fund them until the last possible second because they don’t have the money until then. NerdWallet’s end-of-year study found that only one-fifth of Americans who are saving for retirement planned to max out their IRA for 2016.
If you contribute a bit from each paycheck instead, you’ll still have a time advantage over people who wait and make their contribution at the finish line each April. This extra bump in investment growth isn’t worth “impoverishing yourself,” as Egan puts it. It’s just a nice bonus.
But if you want to be able to make a January lump-sum contribution for the year, consider this a first push. After all, holiday spending guilt isn’t the only feeling running high now — willpower and resolve are, too. Take advantage.
This article was written by Arielle O’Shea from Forbes and was legally licensed by AdvisorStream through the NewsCred publisher network.
So, do you have $5,500? If you’re ready to front load your retirement savings or to explore other options to maximize your savings, contact our financial advisors at Dechtman Wealth: 303-741-9772 or request an appointment online.
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Dechtman Wealth Management, LLC [“DWM”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from DWM. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. DWM is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the DWM’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.dechtmanwealth.com.
Please Note: DWM does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to DWM’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
Please Remember: If you are a DWM client, please contact DWM, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently.
Please Also Remember to advise us if you have not been receiving account statements (at least quarterly) from the account custodian.
"*" indicates required fields