Contribution timing

• Contribution timing
  • Front loading
  • Lump sum and dollar cost averaging
    • Lump sum
    • Dollar cost averaging
    • Which methodology do I opt for?

Timing the contributions towards investments is a bit tricky and can lead to long term impacts on returns. Before fretting about the decision, know that having this problem means you're saving, which is the key thing to worry about! At this point we're talking about optimizations.

Front loading

Front loading is an investment contribution methodology that applies to accounts that are time constrained. In the US, that generally refers to our tax advantaged accounts such as 401ks, IRAs, and HSAs, each of which have their own contribution restrictions.

Front loading, specifically, means contributing to these accounts as fast as you can afford to do so. This can be done via lump sum contributions (such as to your IRA), or via regular contributions, but set to hit the contribution limit before the end of the time limit. Some accounts, such as 401ks and HSAs are either limited outright to payroll contributions (such as 401ks), or are preferential to be payroll contributions (HSA).

Given the below information on Lump Sum vs DCA, the act of front loading contributions can be seen as “lump sum” investing, where the sum is the entirety of your contribution limit. By front loading your accounts, you are ultimately (statistically) growing your tax advantaged balances at a rate faster than if you did not front load. This is especially important to consider when taking Roth tax treatment into consideration.

Since Roth has the added benefit of gains not being taxed, front loading Roth accounts (or HSAs for that matter) can be especially beneficial.

Note: Front loading can have some impact to how your company makes matches/contributions on your behalf. However, a true up may be applicable.

Lump sum and dollar cost averaging

Lump sum

“Lump sum” is a term used to describe the process of contributing to investments as soon as funds are available in a single contribution. This is generally used in reference to receiving a windfall, such as inheritance, or things like home sale proceeds.

Dollar cost averaging

Dollar cost averaging is the process of taking an amount of money destined for investment, and splitting it into multiple contributions over a defined period of time. This is done in order to capture market trends without concentrating contributions to a singular point in time. For most, they are already dollar cost averaging in a way by making regular contributions to 401(k)s or other accounts via payroll. This is dollar cost averaging your salary into your 401(k).

Which methodology do I opt for?

Historically, lump sum beats dollar cost averaging nearly 2/3rds of the time. This is because your investments have more time in the market to yield returns, as the market trends upward. A common phrase is “time in the market beats timing the market” around this fact.

The concentration of your contributions via lump sum is the downside. The entirety of your contribution may be susceptible to having bad timing in the market. If you invest at a peak, then the market drops, your cost basis was established at the peak, but worth less on the market. With dollar cost averaging, only one of your contributions would have taken place at the peak, and subsequent investments at the lower market price (assuming downward trends after the first contribution).

However, since the market (generally) trends upward, time in the market ultimately prevails over dollar cost averaging.

One additional consideration often overlooked, is the emotional aspect of the decision. Lump sum investments are a bit hard to stomach due to the concentration on a single point in time. Are you the type of investor who beats themselves up over “buying now instead of tomorrow” or “selling too soon”? You may want to dollar cost average, instead. By spreading out your contributions, you’re less likely to look at the performance of your windfall in isolation. This can help decrease any regret associated with a decision that ultimately is at the behest of the market, which is entirely outside of your control.