Is there any benefit to contributing to 401(k) throughout the year?

Question

Let's say that I'm going to max out my 401(k) contribution limit for next year. ($18,000) My company offers no 401(k) match. Typically in years past I have contributed a percentage of my check every pay period and if needed a large contribution in November or December to max out my contribution.

It occurs to me that if I change jobs next year,it is likely that I'll end up at a company that has a matching contribution. If I've made contributions to my current plan I won't be able to take full advantage of the match because I'll be limited to contributing what is left of the $18,000 limit. Therefore I'm considering holding off on contributing much of anything and doing a couple of lump sum contributions in the last quarter of next year.

My question is, other than

• potential to miss out on investment returns (or losses)
• the potential that I may not actually make the contribution (laid off or because of financial issues, etc.)

Are there any benefits to making contributions spread out over the year vs as one or more large lump sums?

Answer 1

There are a few benefits of regular contributions to your 401(k), even without matching funds:

1. Benefiting from Dollar Cost Averaging (DCA) or periodic investing
2. Missing a large run-up in the market
3. Potentially not being allowed to make $18k of lump sum investments in the new 401(k) plan

First, you can take advantage of Dollar Cost Averaging (DCA) and average out your investment dollars regardless of whether the market goes up or down, thus reducing the risk to your investment.

Per Investopedia:

It's a strategic way to invest because you buy more shares when the cost is low, so you get an average cost per share over time, meaning you don't have to invest the time and effort to monitor market movements and strategically time your investments. (For more on how dollar-cost averaging works, see DCA: It Gets You In At The Bottom.)

This Bogleheads article make a distinction between dollar cost averaging and periodic investing:

Most investors make regular contributions through their 401(k) plans or by having a set amount auto-deducted from their bank account into an IRA or taxable account. When this money is automatically invested, it has the same benefit of dollar cost averaging that you buy more shares when prices are low and less when they are high. However, this form of investing is not dollar cost averaging. It is called periodic investing. The difference is that periodic investing is maximizing expected return, because you are investing the money as soon as you have it. DCA applies when you have the money to invest, but delay doing so.

Second, if the market makes a large surge during the period where you're not making contributions, you could be missing out on some significant gains. The converse, of course, is also true - you may miss out on a large dip in the market.

This Marketwatch article notes that:

Charts like the one below show the damage an investor would have done if they missed out on only the 25 best days (of 11,620) since 1970. If you somehow managed to do this, your returns would have gone from 1,910% to 371%, or 6.7% a year to 3.4%. To give you an idea of how lousy that is, 1-month U.S. T-bills returned 4.9% over the same period.

While you're likely to not miss these days due to your previous contributions to the 401(k), you're risking that a large portion of your year's contributions would not be participating in the rise of the market.

Finally, the last point revolves around your new company's 401(k) and payroll policies. Some key questions to ask:

• How soon will you be able to contribute? There's usually a delay of a pay period or two before HR/Payroll have enabled your account for contributions.
• How much can you contribute before the end of the year? Depending on how much time is left in the year (a quarter?), does your new company's payroll system allow you to make large enough contributions to max out your annual $18.5k max? Some companies restrict the maximum contribution per pay period to a certain percentage of the employee's pay, and might not be flexible enough to allow very large contributions to "top off" the max for the year.

While saving the entire $18.5k max contribution for the new company's 401(k) may make sense to maximize the gain from the company match, you may want to consider putting at least some funds into your current company's 401(k) for the reasons noted above. An amount smaller than your regular contributions into the old plan can be put in place while you prepare for your new 401(k) with matching funds.