The Case Against Front-Loading Your 401K


Let me preface this article with there is no absolute right or wrong answer regarding front-loading vs. dollar cost averaging contributions into a 401K or other tax deferred accounts. Decisions are mostly preferential and partially situational. Madfientist and Enchumbao both offer their views on why front-loading works for them. Both authors provide great insight and are worth reading.

1. Losing Free Money

The first reason why I do not front-load my 401k? My employer does not offer a “true match” for my contributions.  My company is rather generous with their 401k match; they provide a 6% match if we contribute 4%. BUT I will loose out on FREE MONEY If I maxed out my 401k in the first quarter of the year.

Assuming I maxed out my 401k in the first quarter, my employer would NOT contribute a 6% match based off my pre-tax income for the entire year. Rather, my employer would only contribute 6% based on my pre-tax income for the first quarter. By spacing out my contributions over the entire year, I will earn the full benefit of my employer’s match. This is an example of a situational reason for not front-loading a tax deferred account. I fully recognize that this does not apply to everyone.

Additionally, I like the predictability of the same lump sum being deposited into my checking account every two weeks. Front loading my account, though easily manageable, reduces cash flow for 3-6 months out of the year. I prefer constant cash flows, which allows me more flexibility to invest elsewhere (Real Estate).

2. Timing the Market

Generally speaking, I prefer my portfolio allocation to be overweight low-cost index funds (benched marked to the S&P 500) along with individual stocks that demonstrate strong fundamentals and dividend growth. My 401K contributions are allocated to index funds since my employer’s plan offers limited investment options.

By front-loading investment accounts, you are betting that the first half of the year will offer better buying opportunities than the second half of the year. This is considered “timing the market”. I do not believe in timing the market for index fund purchases, HOWEVER, I do believe in timing the market for individual stock purchases (more on my stock purchasing process in a future article). As a result, I elect to periodically purchase index funds 26 times a year (paid every two weeks 52/2 = 26) via my 401k account. This is an example of a preferential reason to dollar cost average 401k contributions.

Spreading out contributions evenly throughout the year allows for everything to be automated and function like clockwork. This systematic approach removes the guess-work out of investing and allows for a consistent paycheck all year long.

Several individuals argue investing a lump sum right away if you are comfortable with the market risk. I am comfortable with market risk but am not comfortable with this strategy. Some years this method pays off. Other years, this would cause you to miss out on substantial returns.

Lets start off by looking at 2015. The S&P 500 was down 2.15% for the year, which is not a stellar by any metric. The chart below shows the market was mostly up for the first part of the year, however, the market experienced a strong pull back during the fall and dropped 9.7%.

S&P 500 Performance 2015:

S&P 500 2015

If an investor elected to dollar cost average throughout the year, they would have enjoyed the benefits of the market pull back. In fact, the S&P 500 rebounded 7.96% from the August 25th low (see chart below). In this instance, dollar cost averaging proves to be more beneficial than front-loading.

S&P 500 Performance August 25th, 2015-December 31, 2015:

S&P 500 Aug 2015 to YE

Let’s look at another example. In 2011, the the S&P 500 was up for a majority of the first half of the year but finished the flat. The market dipped by almost 15% in August from it’s recent highs. The market also dipped significantly in September and November. Dollar cost averaging would have provided an investor substantial gains in the last 6 months of the year. Likewise, a front-loader would have lost money and missed out on these great buying opportunities.

S&P 500 2011

Alternatively, some years present great opportunities to front-load investment accounts. 2013 is one of the best examples for front-loading tax deferred accounts. The S&P 500 was up 31.3% for the year and did not experience any major pull-backs (see below). An investor would have benefitted by maxing out their accounts as early as possible and enjoyed sizable gains.

S&P 500 Performance 2013:

S&P 500 2013

In conclusion, there is no right or wrong answer on wether an investor should front-load or dollar cost average contributions throughout the year. There are dozens of examples where each method would have been “better”. Timing the market is a fool’s game but can sometimes be beneficial (see the graph for 2013). Dollar cost averaging throughout the year provides systematic  approach that removes the guess-work out of investing and allows for a consistent paycheck all year long. Selecting a method is mostly preferential and partially situational. Which method is for you?