If you had a choice between getting $100 or $80, which would you choose? The answer seems self-evident, but many investors are, in essence, opting for the lower figure when they procrastinate in making contributions to their IRA or other investment accounts.
There is a span of 15½ months in which you can make your annual contribution to an IRA, from January 1 of the applicable tax year through April 15 (the tax return deadline) the following year. While more investors are taking advantage of early contributions, Vanguard research found that many more are still holding their contributions until right before the deadline.
Throughout my career as a financial adviser, I’ve come across both early-bird contributors and “night owls” who wait until the last minute. The math usually points to better outcomes for the early birds, and here’s why.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The penalty of procrastination
Imagine two investors, one contributing $7,000 to her IRA in January of every year, the second investor making his annual contribution 15 months later. Over 30 years, both would have contributed a total of $210,000, but the first investor would have a final balance that’s almost $42,000 higher, assuming 6% annual returns. For the second investor, that difference is a “procrastination penalty” that’s about 20% of his total contributions.
Of course, this is a hypothetical scenario only that does not represent any particular investment and the rate of return is not guaranteed; final results will vary considerably depending on market returns and your portfolio construction. But it illustrates that there is a heavy cost in delaying your contributions.
Making early and regular contributions easier
I rarely have to remind my older clients to make early contributions. Over the years, they’ve witnessed the power of compounding and the benefit of investing early and regularly. But they often relay that their adult children won’t follow the same practice, citing their busy daily lives, budgeting concerns or just plain forgetfulness.
For them — and for you if you face the same challenges — here are a few suggestions:
Automate your investment life. You can usually set up automatic investments on a weekly, monthly, quarterly or annual basis. Doing so removes all the hassles of remembering to make contributions. It has the added benefit of dollar-cost averaging — a fancy way of saying that, instead of investing in one lump sum, you invest a smaller fixed amount at regular intervals at different share prices. Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling, but it can help reduce, if not necessarily eliminate, the risk of loss through bad market timing.
Contribute a safe estimate now, the balance later. The previous suggestion may not be feasible for those with an unpredictable earned income stream, such as part-timers or freelancers. Instead, they may want to contribute a conservative amount now and then contribute the balance later once they have a firm idea of their reported income. However, I encourage consulting with a financial adviser to get a firm idea that their reported income will meet or exceed the amount of their contribution.
Don’t delay any investment transfers. Some may opt to contribute to a money market fund now within an IRA to make the deadline, then later transfer the money into asset classes that are more appropriate for their long-term financial goals. But don’t procrastinate on that transfer. While money market funds are providing more attractive returns recently, they are still no substitute for the higher returns that equities and bonds have provided historically over the long run.
Maximizing investments across the board
If you have more disposable income for savings, the following are also worth considering:
Frontloading your investments. While dollar-cost averaging lowers risks, Vanguard research indicates that, in most cases, investing in a lump sum early usually generates higher returns because of the extra time for compounding to take effect. If you’re contributing to your IRA for the 2023 tax year now, consider making contributions for 2024 at the same time. If you have an employer-sponsored retirement plan like a 401(k), you might consider increasing your payroll contributions, so you reach your maximum in the first few months rather than over the full year.
Don’t forget your other family members. Remember that you can contribute to your spouse’s IRA even if they don’t have earned income. If you have children who have earned income, also consider opening a Roth IRA for them. Limitations do apply.
Of course, all investing is subject to risk, including possible loss of the money you invest. But, as our examples illustrate, it usually pays to be the early bird. Invest early and regularly to avoid the procrastination penalty. And don’t forget, these principles can be applied to all aspects of investing for long-term success.
Related Content
- Types of Income the IRS Doesn't Tax
- Want to Reduce Investment Taxes? Consider These Five Ways
- Tax Season Is Here: Big IRS Tax Changes to Know Before You File
- How Retirement Income Is Taxed by the IRS
- Are You Overlooking Your Most Valuable Retirement Asset?
-
Selling Your Haunted House? What You Have to Tell Buyers (and What You Don’t)You don’t need ghosts to spook buyers, sometimes a home’s past is enough. Here’s what sellers should know about disclosure laws, pricing and perception when a property has a haunted history.
-
CMS Brings Back Furloughed Staff for Open Enrollment LifelineThe government has recalled approximately 3,000 workers to assist with Medicare and ACA Marketplace Open Enrollment.
-
Debunking Three Myths About Defined Outcome ETFs (aka Buffered ETFs)Defined outcome ETFs offer a middle ground between traditional equity and fixed-income investments, helping provide downside protection and upside participation.
-
This Is Why Judge Judy Says Details Are Important in Contracts: This Contract Had HolesA couple's disastrous experience with reclaimed wood flooring led to safety hazards and a lesson in the critical importance of detailed contracts.
-
A Lesson From the School of Rock (and a Financial Adviser) as the Markets Go Around and AroundIt's hard to hold your nerve during a downturn, but next time the markets take a tumble, remember this quick rock 'n' roll tutorial and aim to stay invested.
-
I'm a Financial Pro: This Is How You Can Guide Your Heirs Through the Great Wealth TransferFocus on creating a clear estate plan, communicating your wishes early to avoid family conflict, leaving an ethical will with your values and wisdom and preparing them practically and emotionally.
-
To Reap the Full Benefits of Tax-Loss Harvesting, Consider This Investment Strategist's StepsTax-loss harvesting can offer more advantages for investors than tax relief. Over the long term, it can potentially help you maintain a robust portfolio and build wealth.
-
Social Security Wisdom From a Financial Adviser Receiving Benefits HimselfYou don't know what you don't know, and with Social Security, that can be a costly problem for retirees — one that can last a lifetime.
-
Take It From a Tax Expert: The True Measure of Your Retirement Readiness Isn't the Size of Your Nest EggA sizable nest egg is a good start, but your plan should include two to five years of basic expenses in conservative, liquid accounts as a buffer against market volatility, inflation and taxes.
-
New Opportunity Zone Rules Triple Tax Benefits for Rural Investments: Here's Your 2027 StrategyNew IRS guidance just reshaped the opportunity zone landscape for 2027. Here's what high-net-worth investors need to know about the enhanced rural benefits.
