Frontload Your 401k Contributions
The Grizzlies did something this week that everyone should take advantage of if they are able to. We set our 401k contributions to the maximum allowable under each of our respective plans. For Mrs. Grizzly that’s 50% of her pretax income and for me its 75%. Time is money, and it this case that statement is literally true. You will almost certainly be better off financially if you front load your retirement contributions. Let’s talk about what those reasons are and then get into some numbers on just how big an impact it can have.
Get Money in Your Pocket Earlier
Almost all of this reasoning comes down to the simple fact that you are always better off getting money in your pocket (or your investment accounts) earlier rather than later. Investing is all about understanding the time value of money. What that means at its most basic is that a dollar today is worth more than a dollar tomorrow. And so if someone is offering you a dollar today you should take them up on the deal. Maxing out your 401k contributions as early as possible is one way to do that. But why is a dollar today worth more?
The market (almost) always goes up
A dollar today is worth more because you can start earning a return on that dollar immediately. The average return on the stock market over the last 100 years has been 10% per year (I’m using nominal, not inflation adjusted on purpose).Which means the average monthly return has been about 0.8%. If you can get $1000 invested a month earlier you immediately have an extra $7 working for you forever. This may not seem like much but it can add up to significant amounts over time.
And yes, there are ups and downs in the market, but as we discussed in the first note on stocks you are much better riding up and down that wave than not. The earlier you start investing, even by a few months, the better off you are. However, even if you decide to be a bit more conservative and dollar cost average into the stock market (fancy talk for putting money in gradually to ride out highs and lows), you could still hold everything in a relatively safe short-term bond fund while you wait that will at least earn some return (about 2% annually right now).
The bottom line from all of this is that you would always rather get money earlier rather than later. But this is true of ANY savings plan. You’d rather invest sooner rather than later. However, there are a couple features of 401k plans that make this even more attractive.
Earlier Employer Match
The most significant dollars that you can get earlier are any employer match provided. We’ve already talked about how funding a 401k up to employer match limits should almost always be your first priority for any savings. By frontloading your contributions to the beginning of the year you can get all of that sweet free money as early as possible.
The second primary benefit of 401ks is the tax deductibility of any contributions. Up your contributions early in the year and you’re keeping more money away from the taxman for as long as possible. Pay the taxes at the end of the year, save in your tax advantaged accounts at the beginning of the year.
What sort of difference does it make?
Quite a bit Actually. At the end of the first year, with a 50% employer match your 401k account would have more than double the amount in a normal taxable account. But add in frontloading the contributions and you gain an additional $1145 over the course of a year. Over a longer period of time, this is even more significant. After 10 years, simply by frontloading your contributions you would be sitting on over $18k in additional savings. Not bad for just changing the timing of when you invest.
You can find my calculations here.