Lump Sum or Not? Should....

[Tommy_Dolitte]

...one max out the annual contributions into their 401-K and Roth @ the beginning of the year or send periodic payments?

How would you quantify the risks?  Is this where dollar cost averaging comes into play? :-/

TD

 

[trumpeting_angel]

I don't know the answer to this one, but I can say this: it's a lot more answerable than your OTHER post! At least I understand what you're talking about here.

Anne

 

[sgeeeee]

...one max out the annual contributions into their 401-K and Roth @ the beginning of the year or send periodic payments?  

How would you quantify the risks?  Is this where dollar cost averaging comes into play?   :-/

TD

There has been quite a bit of research on this topic. If you have a lump sum, historically you have had a higher probability of maximizing return (in stock market and bond investments) if you invest it as a lump sum as soon as possible. The reason for this is simple: there are far more periods of positive returns than there are for negative returns. Waiting to DCA the lump sum tends to reduce your overall return.

However, it is clearly possible to invest a lump sum just prior to a large decline in the markets. In this case, waiting to invest at least some of the money would avoid the losses associated with the decline in the markets. So there are no guarantees that a lump sum investment is best. What DCA does for you is reduce the risk of large losses. In a declining market, not all the money is losing at once.

So the choice of lump sum or dollar cost averaging a lump sum is simply another example of risk-reward trade-off.

There is another factor not explicitly mentioned in your post. Where is the lump sum currently residing that you are considering putting into your 401K or Roth? If the money is in cash, then the above arguments apply. If the money is in taxable stock or bond investments and is simply being laundered into equivalent tax deferred funds, the problem is different. Since the investments themselves are identical in this case, the movement of money into 401K or Roth provides only tax advantages. The details of your tax situation and the value of capital gains/losses on your income tax form has to be considered.

 

[charlie]

Hey guru,

Congratulations on your well thought out post.

I get the impression that TD is talking about his
annual cash contribution to a 401k. My feeling is
that both approaches would have very similar end
results if followed over a number of years. Your
explanation is perfectly valid if he is talking about
a one time event.

Cheers,

Charlie

 

[Tommy_Dolitte]

Guru.....nailed it!

Thanks for taking the time to respond!

8)