Why You Should Front-Load Your IRA With Your Tax Return

It’s tax time for most wage-earners dealing in w-2 forms and 1040’s. Ideally last year we maxed out our retirement accounts and took whatever deductions we could, and now have a nice refund coming back to us, as a reward for good behavior. The IRS can be warm and fuzzy after all. If you haven’t yet maxed out the IRA account for 2016, you have until you file your return to do so. You can magically time-warp your contribution to the prior year and get the deduction now. There is also the HSA contribution that you can make if you have one. I highly recommend it. I will visit the HSA in another article, but quickly, it is an account that you manage with your own investment direction. Money that goes into the account is used to adjust your income down on the 1040 (no need to itemize), and the 2016 contribution limit is $3,350 ($3,400 for 2017). You’ll need a high deductible health plan to get one of these accounts.

Now that you have filed and have a few thousand coming in from the treasury, what to do with the money? Many people will splurge this cash, feeling as if it is somehow “free money.” We won’t be doing that. You will direct this cash into one of your tax-adjustable arrangements (IRA or HSA). Default to the HSA if you are over the income limits to deduct traditional IRA contributions. HSA’s have no income limits (some sanity is still available in the tax code). The idea here is that you will be “front-loading” your investing for the year in all cases possible. Since this money is a lump-sum, it will put a drag on your net worth by sitting in cash, and affect your asset allocation. Instead of dollar-cost-averaging throughout the year, a single front-loaded investment will put your cash into the market for longer. This exposes it to dividends paid (and reinvested to buy more shares), as well as to any price appreciation.

The market may indeed drop at some point during the year, below that of your initial investment. So why not wait until then? We don’t wait because it may never happen! Or, if it does happen, we may miss it by being busy with other things. We may also be reticent to pull the trigger and buy, hoping it may go down further. Timing the market is for fools, and enriches only those collecting commissions on your trades. Time-in-the-market is what you want. Buy your index fund and forget about it. The dividends will still get paid, and eventually the market rises.

Vanguard published a study recently that states in the US, a 60/40 stock/bond portfolio invested in a lump sum beats a dollar-cost-averaged strategy 68% of the time, and earns 2.39% more. They used rolling 12-month periods to determine this. Since most of us have longer than 12-month investment time-frames for new money, this is sound strategy. Check out the Vanguard white paper here. You can also follow along with using this optimized strategy at the Mad Fientist’s Lab Rat Experiment (highly encouraged reading).

signing off – Josh – January 31, 2017

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