Why Front-Loading Is Part of Our Investment Strategy

June is a very significant month for us, financially speaking, because it’s the month that we get done with our task of front-loading our 401(k) accounts for the year. Front-loading is when you max out your 401(k) contributions ASAP at the start of a new year to the extent allowed by the IRS, as opposed to spreading out the contribution every pay period throughout the year. The contribution limit for this year is $18,000 plus an additional $6,000 catch-up contribution limit for folks that are 50 or older.

401k Plan Limits for the Tax Year 2016

2016 Contribution LImits

Courtesy of 401khelpcenter.com

Some people contribute enough to get their employer’s 401(k) match, but saving enough to meet the match means that you’re probably going to work well into your golden years, as it would take someone saving 4 percent of their income about 70 years to retire. If you make a lower income and that’s the best you can do at the moment, then saving enough to get the match is a great start. You can increase your contributions as your income level goes up or your liabilities go down. Since we can afford to save a lot more by having inexpensive lifestyles and making saving for early retirement/financial independence a priority, we go all the way, baby!

There are different points of views on whether it is a good idea to front-load vs. dollar average (making contributions throughout the year as you get paid). Other bloggers, such as MadFientist, have gone into more depth about the benefits of front-loading. Instead of reinventing the wheel, we’ll explain why we do it and you can read his post and do your own research to see if front-loading is a good alternative for you.

A great thing about blogging is that having to write about a topic forces us to really understand it. We have to understand things well in order to explain it and that makes us dissect with a scalpel every investment move we make. In investing, just like anything that you do in life, you have to know the purpose of your actions: Why should we allocate our money this way? Why should we buy this now vs. later? Why why why!

The reasoning behind our front-loading

1. It feels great to be invested early!

A millionaire once told me that a key to his business success was to concentrate on one thing at a time. If he was going to work on a new business or project, he’d work only on that for months, learn as much as he could about the business, and move on to the next project only after he was done with the current one. Somehow that advice stuck with me throughout the years and I try to finish one project before moving onto the next one.

I also don’t like to drag things that can be easily taken care of (wifey might have a different opinion on that when it comes to a few house chores). 🙂 Putting our dollars to work on front-loading during the first half of the year frees up the rest of the time to concentrate on other investment goals. And the best of all is that front-loading makes investment sense, since the money invested starts growing and earning dividends and interest sooner.

2. We don’t get penalized for front-loading

There’s no penalty whatsoever for us to front-load our accounts. Our employer offers a “true up” match contribution. After we’re done front-loading, our employer no longer adds the match because we’re no longer contributing to the 401(k)s, but they will add up the missed match amounts and put it into our accounts at the beginning of the following year. If your employer doesn’t offer a true up matching contribution, then you’re probably better off investing throughout the year to avoid leaving money on the table.

3. We prefer to invest lump sum

Let’s say that we decide to dollar average our contributions throughout the year. The fact of the matter is that the extra money in our paychecks is going to be invested anyway, so why not front-load and invest it in non-taxable accounts first?

Others argue that you’re better off doing dollar average to avoid investing it all at a high point, but Vanguard did a study and concluded that the best course of action when having a sum of money to invest is to do a lump-sum contribution:

“We conclude that if an investor expects such trends to continue, is satisfied with his or her target asset allocation, and is comfortable with the risk/return characteristics of each strategy, the prudent action is investing the lump sum immediately to gain exposure to the markets as soon as possible. But if the investor is primarily concerned with minimizing downside risk and potential feelings of regret (resulting from lump-sum investing immediately before a market downturn), then DCA may be of use. Of course, any emotionally based concerns should be weighed carefully against both (1) the lower expected long-run returns of cash compared with stocks and bonds, and (2) the fact that delaying investment is itself a form of market-timing, something few investors succeed at.”

4. We try to stay away from market-timing

We’re not in the business of market-timing. I tried that shit in the past, failed and learned some valuable lessons. When timing markets, you gotta be right at least twice every time: when you buy and when you sell. Ever noticed when you’re in a traffic jam and you have that driver that shifts lanes and tries to cut as many cars as possible? They’re probably stressed out from the activity, but they believe they’re winning because they’re “taking action”. They cut in front of others aggressively, hit on the brakes often, accelerate and shift lanes while you just keep driving in your lane, relaxed, minding your own business. And then 10 minutes later, lanes clear up and then you see the same driver right next to you! All that stress and lane shifting got them nowhere.

It’s the same with the stock market. You can buy and sell often, very often, with hopes of turning a profit short-term, and to your surprise, you might end up underperforming the investor that invests in stocks of solid businesses for the long-term and enjoys the rest of his time at the beach with his/her family.

We’re long-term investors that prefer our money to start growing right away. And yes, the market might tank after we buy, but who knows what the market will do. No one has a crystal ball. One thing for sure about the market at any point of a trading session is that it is either going to go up or down. Since we don’t know what the market is going to do, the best time to invest our dollars is now and let it work it’s magic by earning dividends that buy more investments when the market is down. With a proper asset allocation, there’s no need for us to worry or lose sleep over this.

5. Pay the Tax Man later

When we front-load we’re essentially postponing part of our federal taxes. As long as there are no penalties, we like to pay the tax man on the last day possible and gain some interest on that money instead. The money that we front-load is non-taxable, putting us in a lower tax bracket during the first half of the year. So we fund the 401(k) first, faster and then pay Uncle Sam.

6. Shield 401(k) contributions from a job loss

Another reason why we like to front-load is because if we were to lose our jobs, we won’t have to worry about not being able to max out our 401(k) accounts. This goes well with our FI strategy: invest first and then spend, and only on things that bring value to our lives. It’s the way we stopped living from paycheck to paycheck, accumulated FU money and are aligning ourselves to soon enjoy the fruits of our financial independence. Watch out world, we’re coming!

Do you like to front-load or dollar average your contributions?

Please like & share:
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Mr. Enchumbao

Mr. Enchumbao retired at 44. He worked for 13 years at Vanguard, primarily as a Communications Project Leader in the Institutional Division, helping people save for retirement.

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2 Responses

  1. Lynne says:

    I just found out about your site from PoF. I used to contribute an equal amount per paycheck in order to get the company match, dollar cost average, and have a large enough paycheck to meet other financial needs. Back then my company didn’t do the true-up.

    After a certain time I started front loading, plus aggressively paying down my mortgage, because I had uncertainties about my job lasting through the year. The company had been sold once or twice already. Luckily my company eventually also started doing true-up, which was useful as I could see how much money I was leaving on the table by front-loading without it.

    I’m still a fan of front loading, but I’d advise anyone whose 401(k) doesn’t have true-up to optimize their contributions so they continue to get the company match throughout the year. They can still do the bulk of the contributions earlier in the year, then adjust their contribution rate downwards for the latter part of that year.

    • Hi Lynne,
      Yes! I totally agree with you and doing the bulk upfront and then adjusting to get the match is a great idea. No need to leave money on the table unless you plan to leave your job. Thanks for commenting.

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