Another take on “A tale of two investors”
A few readers had some strong reactions* to my recent post on the benefits of making investment purchases at the beginning of the year, as opposed to waiting until year-end.
Some folks doubted my premise. Others questioned my math. And some thought the whole post was laughably basic. Well, I agree that the post is about a very basic concept. But that doesn’t mean it’s not essential for investors to grasp. In my experience, many people don’t immediately realize that making contributions to a retirement account at year-end rather than “year-start” has the same consequence as forgoing a full additional year of compounding on the entire nest egg. While some may see giving up 7% of $2,500 each year as relatively trivial, giving up 7% of $158,000 (the ending account balance for “Investor B” in my example) may be another matter.
So I’ll stick to my guns, and I’ll reiterate my central point: If you care about an investment cost differential of 50 basis points, you ought to care just as much about maximizing the value of compounding by making long-term investments such as IRA contributions as early as you can, especially if your funds are otherwise going to sit in a money market or bank account.
Some preliminary research I’ve seen recently leads me to suspect that a lot of people—more than you might think—have money sitting around that could be working on their behalf, but they end up waiting to invest the money until the last minute. IRA owners, for example, often wait until April 15 to make their contributions, even if they could have done so months earlier.
Of course, there can be perfectly rational reasons for such behavior, as noted by other readers in their comments. But I suspect that often the real culprits are simply procrastination and a failure to appreciate the true cost of delaying—even if the concept is understood. I’m not pretending it’s rocket science!
If, like a lot of folks, you’re inclined to say “I’ll get around to investing eventually,” I hope this nudges you to get to it sooner rather than later.
* We weren’t able to publish all of the reader feedback we received on this post. Please read our guidelines before submitting comments.
I don”t doubt your math, just have a higher comfort level with twelve pieces over twelve months.
Hi John:
I think the (correct) point some folks made is that the money for the IRA contribution probably isn’t just “sitting around” for that year before it’s finally contributed. Rather, that money may well be invested in something that’s providing some sort of a return, if it’s available at all.
Perhaps a more valid point is that it may well be “sitting around” in a low-yielding money market while it could be in a longer-term (hopefully) higher returning investment, such as equities in the IRA.
As a result, the difference would still be dramatic, but perhaps just not as dramatic.
Best regards,
You are right on. When I contribute to an IRA, it is as early in the year that I can. Thanks for your back up info on something I knew all along
Lower expenses is the main reason we switched our companies 401k to Vanguard…the lower expense cost per year will save approximately 500k per year and that will only get bigger as the entire fund grows…
John, appreicate the article. My comments are two fold. 1)Since I am a new client of Vanguard and still in the starting out period of my life, I have had to save in a savings account every pay period so I can reach the Vanguard Minimums to purchase the desire funds for my Taxable and Roth IRA accounts. 2)Since I am trying to balance my asset allocation between my 401K at work and both mine and my wife’s Roth IRAs, I feel like I need to save our Roth Contributions till the end of the year to know how much to put into each fund to balance out my allocation. I hope that makes sense. Keep up the good work and the blog postings. I enjoy reading them.