Welcome to the last in a series of articles discussing how I choose to invest.
Today we’ll be exploring the timing of my investments.
But first, we need to get into a debate on investment timing.
Lump Sum Investing vs. Dollar Cost Averaging
Here’s the question: Are you better off putting all of your money into the market at once or spacing it out over time?
If you want to invest $1,000, are you better off investing $1,000 once or $100 per week for ten weeks?
Investing the lump sum is referred to as lump sum investing. Go figure. Spreading the investments out is called dollar cost averaging. Less intuitive name, but still makes sense.
This is an issue that the personal finance community has debated extensively. However, there is a right answer according to the numbers.
Invest as much money as possible as early as possible to get the best returns.
Investing for More Money
In 2012, Vanguard released the definitive analysis of lump sum investing vs. dollar cost averaging. What they found is that you will make more money investing the lump sum up front two-thirds of the time.
This makes intuitive sense if you stop and think about it. The market goes up more often than it goes down. Giving your money extra time in the market means that it will probably have more extra up days than extra down days.
This means that if you have $1,000 available to invest, then go invest it now! If you have an extra $100 per week, then invest $100 per week rather than waiting until you have $1,000 saved up.
(This is assuming that you are not paying transaction fees on each purchase. You can avoid these by buying only Vanguard funds from your Vanguard account or only Fidelity funds from your Fidelity account.)
Statistics vs. Psychology
The Vanguard study does include a caveat.
They say that if your primary goal is to minimize risk and potential feelings of regret, then dollar cost averaging may be the better choice for you. It is tough not to second-guess yourself if the market drops the day after you put your lump sum in.
That said, I follow the numbers. Knowing that I made the right statistical choice is enough for me in this scenario.
Plus, I don’t need the money any time soon, so there’s no risk of financial calamity if the market drops the day after I invest.
Vanguard’s findings steer my investment timing.
Every year I max out my IRA in one lump sum contribution on January 2. This gives my money the most possible time in the market and buys me the most possible upside from that account.
I contribute a very large portion of each paycheck, starting in January, to my 457(b). This is under the same theory. I want to max this account out as early in the year as possible so that I can buy myself the best possible returns.
For my taxable account I invest a set amount from each paycheck. I set this up on the Vanguard site so that the day after every payday that money is automatically pulled from my checking account and invested without me doing anything. I increase this set amount each time I get a raise.
After the 457(b) account is maxed out, I suddenly have much larger paychecks coming home. That extra money goes a bunch of different places.
Some of it gets set aside so that I can max out my IRA on January 2 of the following year. Some of it gets set aside as savings that I can spend at the beginning of the following year so that I can dedicate more of my paycheck to my 457(b) account. Some of it gets added to my taxable investment account.
Some of it gets spent. It is nice to have larger paychecks at the end of the year when planning Thanksgiving travel and Christmas presents.
There is another reason that I like to max out my 457(b) as quickly as possible that is probably not relevant to anyone else, but that I will share in the interests of full disclosure.
While 457(b)s and 401(k)s are similar in a lot of ways, they are governed by different laws. The relevant takeaway here is that the $18,000 contribution limit ($18,500 next year!) applies to each separately.
This means that if I spend half the year working for an organization that has a 457(b) and half the year working for an organization that has a 401(k), I could max out both accounts. Next year that means deferring taxes on $37,000 of income.
This is not something that I am seeking out. I have no plans to leave my current job. But things happen. Life takes unexpected turns. And double retirement contributions is a cool option to have on the table.
So what do you think? How are your investments timed? Am I overthinking this? Underthinking it? Let us know in the comments!