I thought this post was too good to put at the end of the guest post queue, and given the nature of the topic, it’s more valuable information early in the year.
I’ve written about front-loading before, but have not done the rigorous analysis to see the numerical value of the benefit of maxing out your available retirement accounts early in the year. Mike has.
Thank you, Mike!
Do you front-load your retirement accounts? I know PoF does. I’ve considered it since it should provide a boost to my investments given the general trend of a rising market. This boost could really add up over a lifetime of investing. Vanguard performed a study that compared lump sum investing to dollar cost averaging. SPOILER: Lump sum investing wins. This article is about the yearly version of that decision.
I wanted to know the effect of front-loading retirement accounts and if I should be taking aggressive measures to make it happen.
Retirement Account Front-Loading Options
My 401k plan allows up to 25% of each paycheck to be directed to a 401k. In order to get all $18,500 (2018 limits) deposited in January, I would need a gross salary of $74,000 per month, or $888,000 per year. I’m not quite there yet. Any front-loading strategy would be spread out over much of the year.
The other factor is that my company match is based on each pay period. If I don’t contribute, I don’t get a match for the period. My maximum match is 3% to my 6% contribution. I would be giving up a guaranteed 50% return on that money.
I could try to be extra smart and contribute the maximum amount early in the year that would still allow me to contribute enough to get the match for the remainder of the year. But then any front-loading effect is even less powerful and I don’t think it’s worth the effort. Especially since I have to make a conservative guess on my raise to make sure I could contribute 6% (the max for my match) for the rest of the year.
There’s nothing that stops me from maxing out IRAs early in the year. Except that we don’t cash flow $11,000 a month in extra investment deposits.
But, maybe drastic measures are warranted if the benefit is large enough.
Front-Loading With Steady Growth
There are a few ways to look at the front loading “bonus” or monthly “penalty”. I’ll assume the market goes up at a steady 10% for the year, including monthly compounding, and $1,200 total invested. The year-end total return for front-loading is 10.5% ($1,325.66). This is 4.6% higher than the monthly contributions year-end total of $1,267.03.
Alternately, you can think of it as a penalty for not front loading. You get 95.6% (4.4% penalty) total return of a front-loading strategy.
Finally, you could calculate the annual return required for a monthly strategy to match a front-loading strategy (same principle invested). For a 10% steady yearly return, it’s 18.3%. 8.3% higher! This means the market would need to rise at a steady 18.3% with monthly contributions to match a front-loaded strategy with 10% growth.
ENOUGH WITH THE NUMBERS!
OK. It’s basically worth half of what the steady growth rate is. Of course, if the market rises early and then flattens, front loading has more of an advantage. If the market drops early and then rises, front-loading may have no advantage. In the worst case scenario, which happens roughly 30% of the time, the market is down for the year and front loading amplifies the loss.
Financing Front Loading
You could finance your front loading to get the front-loading bonus. Is it worth it?
If you have 0% financing, the net balance (investment – loan) is the same as the front-loading strategy. If you have financing equal to the growth rate, the net balance is equal to monthly contributions. Any financing rate between the two captures a little bit of the front-loading bonus. There is a complication though.
You don’t realize the net balance until you sell the investment. If this strategy is for a retirement account, you pay the interest now and get the benefit much later. If it’s in a taxable account, you have to pay taxes on the gains that are supposed to offset the financing interest.
Even with the complications, I’ve considered doing this. Except, the interest is a guaranteed expense and the front-loading benefit is not a guaranteed return. Also, that’s a lot of hassle. If I was churning cards anyway for travel hacking and had a 0% promotional rate, I might do that. Maybe.
One of our credit cards sends us 0% balance transfer checks since it’s not the card we typically use. They’re trying to get our business. This could be an option, except that there is a 3% fee on the check. Assuming an 8% return, 4.4% front loading benefit, and 3%, cost of financing this scheme, we could come out 1.4% per year ahead.
That’s savings account level returns combined with market level risk. One percent is still huge over the course of a lifetime if the trend holds though. But that assumes steady growth. 2017 would have been a good year for that strategy (12% higher return with front loading!). Hindsight makes us all genius investors of the past.
I want to determine how often front loading has a benefit, and what the benefit is using real returns over a longer time period.
Back Testing That Front-Loading Strategy
I’ll use a simplified version of the PoF asset allocation for this analysis and an all US stock run for a long term look. I assume $1,200 per year in the front loading scenarios or $100 per month for monthly contributions. The dollar amount doesn’t matter since I’m comparing overall performance and the percentage difference in these strategies.
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- Vanguard 500 Index Fund Investor Shares (VFINX) (60%)
- Vanguard Total Bond Market Index Fund Investor Shares (VBMFX) (10%)
- Vanguard International Growth Fund Investor Shares (VWIGX) (22.5%)
- Vanguard REIT Index Fund Investor Shares (VGSIX) (7.5%)
I used Portfolio Visualizer to test the strategies The information for these particular funds goes back to the start of 1997, which gives me a 21 year time period to test this portfolio.
This is what 2017 looks like:
Wow! That’s a big difference.
This next chart shows the difference in return for each year: (total return front loaded) / $1,200 – (total return monthly) / $1,200
1997 was the best year for front loading with a nearly 13% improvement over monthly contributions. Unsurprisingly, 2008 was the worst at -10.3%.
Here’s the result for investing over the full 21 year period:
3% better! Not bad. Well, wait. That’s 3% on the total return, not annual.
Math must be done. It turns out the strategy is worth 0.13% additional annual return.
Surely, this must be wrong. Let’s check the total US stock market. I ran it from 1972 through 2017 and here are the results:
4.9% better on the total return. Math again to the rescue to determine that the annual benefit is 0.1%. It’s so close to the first example. Math can be so satisfying.
Why Front Loading Investments & Monthly Contributions Even Out
Even with a large front loading bonus, like in 1997 or 2017, that percentage change applies to the contributions that year, not the entire portfolio. The next year, both strategies change by the next year’s return. The total percentage difference remains the same, but the annualized return is reduced as the timeline grows longer.
This explains why the effect is small compared to the effect of a high expense ratio or management fee. The fee applies to the entire amount under management, not just the contributions for the year.
What To Do?
You should not worry about not being able to front-load your investments. You should worry about being honest with yourself and if you can front load, then do it. There is a slight investment return benefit as well as a behavioral benefit.
Don’t try to get fancy and finance this strategy or give up any 401k match. You will lose money unless you happen to do it in a year that the market rises rapidly.
You could save up throughout the year in your personal escrow account and put a front load strategy into effect the next year. But that would actually be back-loading since you wouldn’t be putting the money in as soon as you were able.
Ultimately, the question isn’t usually “Should I front load or not?” Most people invest the money as they perceive they are able. The important thing is to invest as much as you can, as early as you can. Make as much as you can be AS MUCH AS YOU CAN by growing income and controlling expenses.
Don’t you feel better knowing you knew the answer all along?
Notes to run this experiment yourself
- You have to start with an initial amount, which is the January contribution. You also have to manually subtract one contribution amount from the final balance since portfolio visualizer assumes contributions occur at the end of the time periods.
- Turn off inflation adjustment.
Thanks again to Mike from Married & Harried for this in-depth analysis. Are you a front-loader? Which accounts do you fill up first?
47 thoughts on “The Actual Benefit of Front-Loading Your Investments is Smaller Than You’d Think”
Nice article. Not sure, but did you take into consideration the bump we see every year in possible contributions? 18K this year, then 19K the next?
One question I would have is how this changes in the more realistic scenario where investors are doing this every year, and not just one time and following it forward. True, a 12% benefit in the year of the investment gets diluted out over the following years. If you look at a typical investment horizon of 40 – 50 years for retirement, the difference from one year of investments becomes almost imperceptible. But that’s not what people do. People invest every year for a large chunk of those 40-50 years. A more realistic study would therefore look at the difference in investment returns when frontloading $1200 every year for say 20 years vs $100/month for those same 20 years. I of course have no numbers to work with, but certainly intuition and common sense dictate that the frontloading benefit would be substantially amplified in this scenario.
This analysis is that scenario you describe. The two traces for the long term investing scenarios are 100/month vs 1200/year front loaded. The bar graph shows the individual year difference for the last 21 years.
The effect is less than you might expect since the year following front loading, both portfolios (front loaded & monthly) move by the same amount. The next year may also have a front loading bonus, but it only applies to the amount invested that year.
Ah, my mistake. That’s obviously the scenario given the numbers on the Y axis. Clearly I should have studied the graphs more closely. My apologies.
Great article and nice to finally see the numbers behind the argument. Unfortunately, most of my colleagues and most Americans in general never get to this point in their finances. Just investing at all is a struggle for most.
That’s why for the general public, I recommend dollar cost averaging all day. It’s easy to understand and implement, and will get people at least 90% of the way there as compared to front loading.
So if he question of front loading or dollar cost averaging is a pressing issue for you, you’re probably doing it right!
Great article and very thought provoking. I’m curious, can you front-load in a solo 401k based upon anticipated income. For instance if you are a 1099 anesthesiologist and plan on making 300-500k, can you put the full 55k into a solo 401k in the first few months of the year, rather than waiting until the end of the year? Along those lines, what happens if something drastic happens later in the year (injury, loss of job, etc…) where you don’t hit your initial projections yet already contributed. Can you fix the over correction?
Slight mathematical benefit plus a behavioral benefit. What’s not to like? I’ll continue to front-load my most tax-advantaged accounts and then make taxable account investments later in the year.
That gives me an idea for another evaluation, but I don’t know how I would do it. Assuming you have the ability to front load retirement accounts and invest throughout the year, is it optimal to front load the tax advantaged accounts?
I think that as long as the tax advantaged accounts are maximized, front loading one over the other wouldn’t show much of an impact.
I think for many people on their way to FI, it’s a moot point because they’ll be putting away a set amount from their salary periodically so most people will be DCA-ing whether they want to or not. The question becomes whether to front load or DCA if you get a bonus or a windfall you weren’t expecting. For people who’ve had experience in the market, front loading makes sense, but for beginners–it’s REALLY hard to put in 1000 and then possibly watch it “vaporize” the next day. This happened to us in 2008 and trust me it is NOT fun. Very possible a newbie could panic and selling everything at the bottom, in which case, wading into the water slowly with DCA might make sense. Everyone “thinks” they have the balls to tough out a bad market, but you won’t really know until you’ve lived through one.
I agree that most people only can DCA, but I was especially thinking of the FIRE crowd when I wrote this. Many people are looking for every possible optimization to get to FI as early as possible. Front loading can help, but it’s possible to be too smart by half by financing the scheme or missing out on some company match money.
Great analysis. I don’t front load accounts on purpose, but my income is lumpy and favors the begining and ends of the year. As such it leads to automatic front loading of certain accounts. It’s still important to invest it when it becomes available.
This is very interesting. I suspected that front loading on an annual basis wouldn’t make a huge difference. It is still DCA over the long term.
What about this scenario? We front loaded our son’s College Savings account, the 529.
He’s 7 and we have almost $80,000 in his account. I added more early so it will have time to grow. We’ll still add about $4,400/year to this account. I think front loading the 529 gives us a better chance to pay for college in full.
If we just add $4,400/year, it probably wouldn’t be enough. The timeline is tighter than retirement and the amount per year smaller. Actually, probably around $5,500/year because we need to count the front load money.
I think front loading works better in this case. What do you think? Run the number for me. Thanks! 🙂
Here is a sample scenario to run.
Front load extra $30,000 in first year vs extra $1,666/year for 18 years.
Sounds like your son is set! I think 18 years is a long enough run that lump sum would always beat DCA.
The Vanguard study only took a 10 year investing period and the DCA portion was only up to the first 3 years. Since you’re talking about DCA over 18 years, I’m sure the difference would be significant.
Excellent analysis! When I saw the article headline, I knew it was a must-read article. You definitely disproved what I had assumed previously. I supposed I can relax a bit on my push to front-load. Like you said, do it if possible but don’t stress about it.
You also make a good point about the behavioral benefits that come with front-loading. I think that while the math revealed that the difference isn’t that great, the front-loading mentality can make a tremendous impact on one’s overall finances over the long-haul.
Great analysis. Thanks. I get paid in lumps based on how much clinical service I am on and how busy it is. My cashflow situation fluctuates wildly, but is firmed up a couple of times per year.
I invest one lump in my personal accounts in January to frontload since my personal tax year ends on the calendar year.
I invest a second lump in the early fall after my business fiscal year ends and corporate taxes paid. I try to avoid “saving to frontload, causing backloading”, but my income and taxes seem to fluctuate so wildly that I always need a buffer and end up doing that to a degree. I also somewhat “seasonally market-time” by not investing my corporate surplus as it builds over the late spring and summer, but waiting until the fall. That is the closest I come to attempting market timing and it just happens to fit with my financial calendar.
Great analysis. I certainly would have guessed a larger delta between monthly and front-loaded.
I’m not sure if I’m reading the tone a bit wrong, or if I’m just confused by the concept.
This is what’s getting me:
Of course, the annualized return matters when you’re accumulating. When you’ve retired though, who wouldn’t want an extra few percent in their nest egg?
3-5% isn’t going to break the bank, but on a few million dollars it’s nothing to sneeze at.
I agree that 3-5% on the total return is a good thing to have! I wanted to stress that it’s not enough of an annualized return to justify financing a front loading scheme or missing out on a 401k match.
It’s basically the same difference between using Admiral class shares and Investor class shares.
I didn’t think of it at the time I wrote this, but I woukdnt recommend financing to squire Admiral vs Investor shares.
Glad you liked it.
*aquire shares. That’s what I get for commenting on the phone.
I front loaded my 401(k) at my last job. I found it to have some non-monetary benefits. For example, in the past, whenever I worried about my job security, then I would always end up maxing it out early. I like making sure that I save that money for retirement every year, regardless of what my job situation looks like. So as long as the amount of employer match I get isn’t affected by frontloading, I will continue to do so. My salary is high enough that I can get it done in about two months.
As for the Roth IRAs, I’ve typically seen a bonus near the end of the year and then I’ve set aside part of that to make my contribution on January 1st. It’s not really backloading if you only keep it in cash for a month before using it.
One other problem with front loading that bit me is that some HR and Payroll systems can get quite confused with it. I failed to get my full match one year because their matching algorithm didn’t true up accounts that reached the max contribution limits prior to the end of the year. Even worse the next year they inexplicably failed to restart my contributions at the start of the year and I lost several months chance at contributing and with automatic deposit of my paychecks I failed to notice, I never did get made whole for that because there was no real way to do it. I went back to monthly contributions because they at least seemed to work reliably.
Investing is definitely a mind game. You will have your head handed to you even with the best researched strategies if you can not stay the course. I have read somewhere that the best performing portfolios were ones where the client was either dead or had forgotten about them. That certainly makes me pause. Nowadays, I think more about things like my current age and the ability to handle the larger drawdowns with a public equities portfolio. For my children, it’s simple since they can stay fully invested for over 30 years in the equities market. LSI or DCA would work equally well for them. They have the long runway to average down if they catch the market cycles.
Regardless, thank you for the detailed research. It was informative.
Great post and I appreciate that someone else was willing to run and share these numbers! Most years I don’t often end up front-loading because I like to max out my 401k with my year-end bonus so I avoid paying the higher taxes. So it’s good to know that there isn’t a huge different as long as I’m continuing to max out my tax-advantaged accounts each year. Thanks!
I’m not sure I agree with the backloading comment in regards to things like the Roth IRA. We front load ours on January 2 because they are capped at $5.5k each, so even if we saved later on in the year for next year’s, it’s moot because we can’t continue to contribute to them. Is that right?
I also like front loading the 401(k) (my employer contributes without a match). We get the max deferral in by the first half of the year or less. I like this because one never knows when you might lose your job, change jobs to one without a 401(k), or quit working at that job for a million other reasons. Front loading locks that deferral in as quickly as possible because we aren’t guaranteed tomorrow.
Backloading would be if you didn’t have the cash to front load, but wanted to starting NEXT year. Then you would save up all year just to start investing next Jan 2.
An interesting but complex analysis would be to figure out if it’s worth investing in a taxable account because you have the money now, but that reduces the amount you put into a sheltered account later.
I’m not a math whiz, but I would imagine investing in a taxable account then having to pay capital gains costs you far more than it gains in in the extra 12 months in the market on an annualized basis.
Wouldn’t the market essentially need to grow a % > than your capital gains rate to make the taxable now better than a Roth 1 year from now? That may be possible in a boom year like 2017, but over time that seems unlikely to happen.
Someone who understands this better than me can probably correct me here.
Yes the capital gains will cost more than the front loading bonus would give you. I was thinking of more active investors in the case of deciding which to front load.
If you front load the retirement account, you can trade within it throughout the year without tax implications (I think). If you front load the taxable, you could take advantage of tax loss harvesting if it’s a year that front loading is going against you.
I would bet it’s best to put as much as possible, as soon as possible into the retirement account and then fill the taxable accounts.
I really appreciated this thoughtful analysis. I’ve always preloaded because I liked to get the “pay myself first” done as early in the year as possible. Now I know that if I ever need to change this method due to external factors eg. getting company matches, it will not have much effect on returns.
Thanks for linking the study to Vanguard, definitely worth the quick read.
Front loading is interesting and something I could do in the future, for many of us just starting out in our career or journey to FIRE – 18.5K in January versus smaller increments throughout the year is a tough ask :).
Once this debt is knocked out – focusing on investing strategies will definitely be my next obsession!!
Thanks for sharing!
Our practice front loads our retirement accounts, but due to the accident of the date of incorporation in the 70’s, our fiscal year begins on June 1!
In my peak earning years I always front loaded because I had no company match coming to me! No reason not to. The thing about personal finance is it is personal. You should analyze whatever type of plan is available to you and maximize it.
I’m on board with keeping my 401k dollar cost averaging. This was the first year I could front load my Roth. I really like in your wrap up that you remind us, it’s personal fiance and ‘do what you can’.
Great article. Another proof that it is not how you invest that makes the difference, it is that you invest that counts. Just do it any way you can and you will get great results.
Dr. Cory S. Fawcett
Prescription for Financial Success
Fascinating… especially the note about “saving to frontload is backloading”. Since the large majority of our investing is paycheck based (401K and HSA) and the company match comes into play, we have not front-loaded investments. Rather, we just slowly chip away as we go… but who knows if that will change in future years 🙂
I’d like to be able to front load, but I don’t really think I have the cashflow to do it. But the extra return has convinced me to give it another look next time I look at the numbers.
Nice post! This argument could be extended to the lump-sum versus dollar-cost averaging argument. If you have a windfall, you could invest it all up front (front-loading) or dollar cost average over a year.
The difference is about 3-5% as you mention, which happens to be half of the expected annual return of the stock market (this makes sense because your money is being invested on average 6 months earlier with front-loading as opposed to spreading it evenly across a year).
It’s all about time in the market, and front-loading increases your time in the market.
So many articles come down to your last statement. Nothing beats time in the long run.
All the math makes my head spin. I think we hit the 30% of the time that front loading cost us money because we threw in almost 27 grand right before the correction. Loving your summary and the huge, huge importance of not over reaching just for potential benefits of front loading. Great job!
27 grand? That stinks!
Were you able to buy any discounted stocks afterwards?
Well, hubby dipped into our emergency fund to buy more stocks. We still have enough but he just didn’t tell me about it. I guess it was too good to pass up.
If you did the same thing last year it worked out though! (I hope you did).
Interesting post. I am glad he finished with that comment at the end that if you are saving money to ‘frontload later” that is actually backloading and defeats the point.
I think the major time where this argument is particularly valid is when you have a bonus or windfall. The question then becomes “should I dollar cost average this chunk of money or just put it all in?”
In that situation this post answers that argument. Of course, another situation where that may apply is if you have a sizeable emergency fund that you could invest and quickly replenish with a future bonus or earnings.
I also really liked the graphical representation of the two different methods. Helps to really show the difference, small as it may seem.
I didn’t actually catch the backloading comment the first time – totally makes sense now, thanks for sharing that !
Anytime! That’s why dialogue is a good thing.
Except if you are talking about a retirement account that only allows contributions in a given year, then frontloading IS an option.
If you want to “front load” a Roth in 2019, and you aren’t going to have $5500 extra in January 2019 cash flow to do it, then you would want to save $458/month to the side now to immediately frontload the next year’s Roth. This is of course assuming the current year Roth is already filled.
Glad you liked it. The Vanguard study definitely shows DCA loses to lump sum for a windfall type situation, no matter how anxiety inducing it might be at the time.