TheWriter blogs over at The Writer’s Coin on all things personal finance and about the craft of writing.
So the markets are in a tailspin. If you have any money invested in the stock market, you’re probably not very happy right now. With all the panic and commotion going on, what can a regular investor do? If you’ve heard the advice to go out and buy more stocks right now because they’re so much “cheaper” than they were earlier in the year (and even last year), then you already know what to do.
The Roth IRA Debate
At the beginning of the year, there some debate online about how and when to fund a Roth IRA. I wrote about it at the end of June, claiming that dollar-cost averaging was the way to go. That means putting in a portion of the Roth IRA limit ($5,000 this year) throughout the whole year.
But a lot of people thought that the best option was to fund the whole $5,000 right away. The reason? There were a few, but mainly it was to give their money as much time to compound as possible and to just get it all done right away and not have to think about it the rest of the year.
Well, the markets are WAY off their January numbers and it’s one of those rare times I get to look back at something I wrote earlier in the year and go, “I was right.” I just hope karma doesn’t come back to bite me in the butt.
If you put the whole $5,000 in your Roth back in January and invested in index funds (like the S&P 500), you’d have around $4,100 right now, that’s a loss of around 18%. But the worst part about it is that you can’t buy any stocks right now even though they’re “cheaper”! You’ve reached your limit and lost all flexibility. There is nothing you can do.
On the other hand
If you put $1,000 into the market in January, then in April, and then in July, you’d have around $2,641 left, a drop of only 12%. And you’d have the flexibility to put more money ($2,000) in at these lower prices, which would reduce your losses if the market keeps going down.
I know that we’re talking a few hundred dollars and, in the grand scheme of your retirement it’s not “that much.” But for me, my retirement is a big deal and if I can do a little maneuvering here and there to save me a few hundred bucks, that’s great. That’s another couple hundred dollars I can compound for 30-some years, and now we’re talking some serious money (around $25,000 compounded at 8%). And don’t forget that you’d be buying more stock at a lower price.
For those of you that find it more convenient (and you have $5,000 laying around in January) to contribute the whole amount right away, I won’t argue with you. But for those of you out there that like to squeeze every last penny out of important things like retirement accounts and that have the time to send money to your brokerage four or five times a year, dollar-cost averaging is a no-brainer.
Since it’s a retirement account, I know it doesn’t really matter how much money you have in your Roth today – you care about how much money you’ll have when you retire. It’s a marathon, not a race – so what happens over the course of one year shouldn’t be too important. But if you can do a little bit every year to make your overall returns that much better, isn’t that a good thing?
P.S. What if the market is going up, smarty pants? Well, then this whole argument needs to be re-evaluated. Maybe when the market is actually going up I’ll revisit that side of the coin.