Don't delay IRA funding

Your Money

March 25, 2007|By Janet Kidd Stewart | Janet Kidd Stewart,Chicago Tribune

Scrambling to make a 2006 contribution to your individual retirement account before the April 17 tax deadline, but worried about dumping money into a volatile stock market?

That's the predicament facing many retirement savers this year. But holding back may not be the best strategy.

Charles Schwab Corp., one of the nation's largest IRA custodians, says 80 percent of contributions in its accounts in recent tax years were made during the first half of the year. Of the 2005 contributions made in 2006, 57 percent were made in April, just ahead of the tax deadline, according to Schwab.

Some are from procrastinators who need a deadline to jolt them into writing that contribution check, while others may have waited to see what type of IRA they will qualify for this year, given their final income numbers.

Others may be self-employed and wait until they can properly calculate their profit-sharing contributions based on year-end data.

Whatever the reason, a whipsawing market has to make anyone nervous about sending off a large contribution check right now.

Wouldn't it be better, investors might wonder, to dump the money into a cash account inside the IRA and then dribble it into the financial markets over time?

After all, the concept of dollar-cost averaging, or investing fixed amounts on a set schedule, is one of the most enduring concepts in personal finance education. And in workplace 401(k) accounts, investors are accustomed to having regular deductions taken out of their paychecks.

Turns out, however, that dollar-cost averaging is far from the last word in investment strategy. And when it comes to long-term money that you control, like money to plunk into an IRA, it might not make any sense for some people.

T. Rowe Price, another large IRA custodian, stacked the monthly dollar-cost-averaging strategy up against investing a lump sum in the Standard & Poor's 500 index each January from 1950 through 2004. The lump sum beat the monthly contributions over the course of the year nearly 64 percent of the time.

You can see this phenomenon for yourself at www.moneychimp.com/features/dollar_cost.htm.

Of course, some would argue that investing a lump sum every January is also dollar-cost averaging, albeit with yearly deposits instead of monthly.

And that's where it gets interesting for retirement savers.

For the best market performance in your retirement accounts, investors should make contributions as early as possible and not dribble them in if they have money sitting in the bank, said John Greenhut, a Texas A&M University finance professor who has written articles on dollar-cost averaging.

The optimal investment strategy, Greenhut said, is depositing your entire annual IRA contribution on the first trading day of the year in which you're eligible.

If you must save it out of income over the course of the year, go ahead and make those monthly contributions, he said.

The third-best option, for those who need to wait until tax time to figure out how much they can contribute, is to invest the entire lump sum in the financial markets as soon as that determination is made.

The least desirable option, Greenhut said, is making that April contribution into a low-yielding cash account inside your IRA and then dribbling it into the market over time.

Have a retirement question? Write to yourmoney@tribune.com, or via mail at Your Money, Chicago Tribune, Room 400, 435 N. Michigan Ave., Chicago, IL 60611. If your letter is selected, we may include you and your question in a future column.

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