Factors and investment strategies to consider in deciding how often you should contribute to your Roth IRA. The 2017 contribution limit for a Roth IRA is $5,500 for normal contributions, and a $1,000 additional contribution as a “catch up” if you are age 50 or over. Assuming you plan to open or build up your Roth, how often should you contribute the funds? What sort of schedule should you set up? And should your contribution plan be different if you just started investing today than if you have been investing for a while? Let’s take a look.
Set Your Roth IRA Contribution Schedule
Don’t trust yourself to simply remember to invest every so often in your Roth IRA. Inevitably life will get in the way and you’ll end up forgetting. Even though you technically have until April of the following tax year (for example, April 2018 for 2017 Roth IRAs) don’t leave your retirement fate in the hands of your always-busy brain. Make it automatic.
Putting your contributions on an automatic schedule is one of the easiest ways to insure you fund your Roth IRA to the maximum allowable contribution limit every year. But how often should you contribute? Daily? Monthly? Every two weeks? One massive payment every year?
Let’s scratch that first one off the list immediately. Sending in a massive $5,500 (or $6,500) contribution once per year isn’t a good move. I won’t say you shouldn’t do it—at least you’re contributing – but that’s the worst way to proceed. Why? There are a multitude of things that can go wrong. You might forget and go past the contribution date. That would be $5,500 you would never be able to put into a Roth. Also, assuming you invest your contributions immediately (rather than letting the cash just sit in the account), you would miss dollar-cost averaging.
What Is Dollar-Cost Averaging?
Some people swear by it, others think it is no big deal. But in our opinion, dollar-cost averaging, aka systematic investing – the process of spreading out your investment throughout a specific time period (a year, for our purposes) – is a disciplined approach that is tailored-made for contributing to Roth IRAs.
With dollar cost averaging, you invest a certain amount of money each and every month into an asset, generally either a mutual fund or a stock, regardless of what the investment’s share price is. In some months, you will end up owning less shares of the investment when the share price rises, but in other months, you will get more shares for the same amount of money when prices fall. This tends to level out the cost of your investments: You end up investing in assets at their average price over the year (hence the name, dollar-cost averaging).
For example, let’s say you have $500 to invest every month and are purchasing shares of a stock that fluctuates wildly from month to month. You can purchase 10 shares when the stock is at $50 per share. Now, say the stock falls to $25 per share the next month: Your $500 investment buys you 20 shares of the stock. Over two months, your $1,000 has obtained you 30 shares, which each now have an average cost of $33.33.
The Benefits of Dollar-Cost Averaging
This method of investing takes the guess work out of trying to time the market. Many investors simply automatically set their investments to occur on a specific day, regardless of what the stock market is doing on that particular day. Dollar-cost averaging takes the emotion out of investing as well. Since you know that you will be investing a set amount of money each and every month on a certain day, you do not have to watch the constant movement in the stock market to find the best place to enter a purchase order.
This strategy ensures you won’t be stuck by accidentally investing at the absolute highest point of the market. Of course, you’ll also miss out on some potential benefit if you had been able to invest all your funds at the absolute lowest point in the market for that year. But you and I don’t know what the high will be this year – or the low. And, at the end of the day, spreading out when you invest is a good idea, especially if you’re risk-adverse. It effectively reduces the average cost basis of your investment – and hence, your breakeven point, an approach known as averaging down.
How does this work? If we take our previous example, it would mean the share prices of your stock, last seen at $25, only have to rebound to $33.33 per share in order for you to break even. Even though some of those shares cost your $50 in value, you can still sell them at $33.33 (technically, a loss) and make money – because you purchased more shares for a price that was lower than the $33.33 breakeven point. It all averages out. You should embrace being average in this case.
Dollar-Cost Averaging with a Roth IRA
So how do you accomplish this in your Roth IRA?
Instead of dumping, say, $5,500 into your Roth IRA on January 1st (or April 15th, at the last possible moment), it would be better to spread that investment out over the year. Just divide the amount you plan to contribute ($5,500) by 12 months. The result is $458.33. Now you ask your Roth IRA provider to take that amount out of your designated checking or savings account every month. You’ll build up your balance throughout the year rather than all at once. Just make sure you have enough funds in your account on the days that the provider pulls the funds out. You don’t want to run into overdraft problems by trying to be smart with your retirement funds!
Maxing Out Your Roth IRA Contributions
Dollar-cost averaging can make it easier to fund your Roth IRA to the max each year too. When they look at the contribution guidelines, many investors (especially young ones) doubt they’ll ever be able to carve thousands out of their already-tight budgets. But, if you divide this year’s $5,500 maximum contribution into smaller pieces, it can become fairly easy to manage. Using dollar cost averaging, an investor would only need to commit $458.33 per month in order to reach the annual limit; or $211.54 every two weeks, if he’d like to think of it on a biweekly paycheck-to-paycheck basis.
Alternative Investment Schedules
I personally use monthly payments to fund my Roth IRA. It just makes sense. Nice, even, monthly payments. You could also consider every other month, every quarter, or even semi-annual contributions. Some sort of schedule is better than not scheduling payments at all.