How and when to make contributions to an IRA is a frequently asked question and debatable topic. Those that like to contribute the maximum amount to an IRA at the beginning of the year support the theory of compounding. They believe that if you invest your money early on in the year, it will have more time to grow. On the other hand, those that support equal monthly contributions to an IRA suggest that you will be better off because you don’t have to try to time the market and you will benefit from “dollar cost averaging.”
Most people will choose among one of the two techniques mostly because of discipline and budgetary reasons. Some kind can find it tough to save up the maximum amount in a savings account without dipping into it for other reasons. Contributing an equal monthly amount by automatic withdrawal can keep you from cheating yourself and subscribes to the theory of “paying yourself first.”
Because I haven’t found a clear answer on which method is best, I am going to conduct a long-term experiment. The experiment will track two simulated IRA accounts and their performance over time. One IRA account will invest the maximum contribution at the beginning of each year. The other will contribute the maximum yearly amount through monthly installments. I will update the performance of both accounts on a monthly basis. Over time, we’ll be able to see which method creates a higher return.
Monthly Or Yearly IRA Contribution Timing Experiment Rules
- Both accounts will be invested in simulated Roth IRA accounts.
- The Yearly Contribution Roth IRA will contribute the yearly maximum on January 1st each year. Investments will be purchased on the first trading day of the year.
- The Monthly Contribution Roth IRA will contribute an equal monthly amount on the 1st of each month. The total contributed at the end of the year will be the maximum allowed contribution to a Roth IRA. Investments will be purchased on the first trading day of each month.
- Both IRA’s will purchase the same mutual funds. The simulated accounts are assumed to have no annual fees, no transaction fees, no commissions, and no investment minimums. All forms of income (i.e. dividends and capital gains) from the investments will be reinvested. There is no interest earned on any cash balance (caused by any delay from the day the contribution is deposited until trading day).
- The following asset allocation and Vanguard mutual funds in the Investor Shares class will be used in both accounts.
- 65% – Vanguard Total Stock Market Index Inv (VTSMX)
- 25% – Vanguard Total International Stock Index Inv (VGTSX)
- 10% – Vanguard Total Bond Market Index Inv (VBMFX)
- The portfolios in both accounts will be re-balanced once per year on the first trading day of each year. Otherwise, no selling will be allowed. Both accounts will subscribe to the “buy and hold” mentality.
I am really looking forward to seeing the results of this experiment at the end of the year, and even beyond. Additionally, I am excited to show you how you can get started investing with just three low-cost index mutual funds. This very basic portfolio can fit many people’s investment needs while maintaining some diversification.
I hope seeing the results monthly will encourage you to start investing, if you haven’t started already. If you already contribute to an IRA, which contribution method do you prefer? Which experimental IRA account do you think will do better over time?
Talk to me, Goose.