This Basic Investment Decision Can Have a Big Impact On Your Retirement

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The stock market crash in March kicked off a year of ups and downs on Wall Street, and the turmoil seems likely to continue through the election next month.

From spikes after stimulus bills to slumps from high unemployment numbers, investors have been whiplashed. In a turbulent market, should you change your retirement investment strategy accordingly?

The short answer is simple: No.

Experts say you shouldn’t try to predict the market. For a long-term, retirement-focused investor, a slow and steady approach is the way to go. And there are essentially two account funding strategies to consider, according to Rebecka Zavaleta, creator of the investing community First Milli. 

One is a lump sum strategy, while the other is called dollar-cost averaging. A lump sum strategy entails depositing money in investment accounts in large amounts at one time, while dollar-cost averaging calls for spreading out deposits over time.

Both approaches have pros and cons, but dollar-cost averaging is likely your best bet this year. 

“Dollar-cost averaging has demonstrated that it actually performs better during a period of high market crashes,” says Zavaleta. “And the frequency of market crashes is more than ever, especially with the election coming up.”  

But even the market lows present an opportunity for retirement investors, who can benefit in the long-term from investments bought when prices were lower. “You don’t want things to just go up and up and up, because if things go up and up and up within a 401(k), where you’re dollar cost averaging every month, that means every single month your dollars will buy less shares,” personal finance expert and NextAdvisor contributor Suze Orman told a NextAdvisor reader in an August Instagram video.

The important thing is to make a plan and stick to it. The threat of more market swings – caused by an election or otherwise – doesn’t mean you should change your investment strategy, warns Kaleb Paddock, a CFP with Ten Talents Financial Planning in Colorado

“I’m not changing my client allocations because we have an election coming up,” says Paddock. “We can’t let our politics affect our investing decisions.”

Lump Sum  

Lump sum investing involves making a single contribution to your retirement account, usually at the beginning of the year, instead of contributing monthly or bi-monthly out of your paycheck. 

For example, with a Roth IRA and its $6,000 yearly investment limit, you would deposit all $6,000 into that account at one time, rather than depositing funds throughout the year. In some cases, a lump sum strategy can help you reap better returns.

“This is mainly because the U.S. stock market trends upward,” Paddock says. “When you put your money in immediately, you can get it to work for you faster, and start compounding and collecting dividends.” 

But not everyone has a large sum of cash available for retirement investing at the beginning of the year, and it’s not a perfect science. Some investors will see a lump sum investment go down in value after they invest, Paddock says. For example, someone who invested a lump sum at the beginning of 2020 probably took a hit to their investment after the stock market crash in March. 

“Let’s say I invested $6,000 in February, pre-COVID. I invested when [the market] was at a peak, but then the markets crashed,” says Zavaleta. “Had I waited another month, I would have been able to afford much more than what my $6,000 bought me in February.”

But, as Paddock says, the U.S. stock market has a long record of trending upward over time. To mitigate short-term risk, invest in a diversified portfolio no matter what approach you take. Don’t put all of your money into one type of stock or bond to balance the risk in your portfolio across multiple categories of assets.  

Even with a diversified portfolio, this year’s market turbulence and volatility demonstrates the appeal of another investment approach, and one that doesn’t require forking over a large amount of cash upfront: dollar-cost averaging.

Dollar-cost Averaging

Orman has been a proponent of dollar-cost averaging for years. 

“Making consistent investments over time, such as monthly or twice a month, is called dollar-cost averaging,” Orman wrote in 2016, “It’s a great way to invest.” 

The strategy involves spreading out your retirement contributions over the course of the year. For example, if your yearly goal is to invest $6,000 into a retirement investment account, you would contribute $500 a month throughout the year. 

Dollar-cost averaging helps Zavaleta “stomach risk” since “the market is up and down like crazy right now,” she says.

While dollar-cost averaging helps mitigate risk if the market crashes – since not all of your money is locked in ahead of time –  less risk can mean less reward. In this way, dollar-cost averaging is not a strategy to maximize an investment return, but more “a risk management strategy,” Paddock says. 

For many people, dollar-cost averaging is the most realistic and accessible way to ensure that you’re getting into the savings game, and will still give you great returns, especially if you have a longer-term time horizon. 

“The truth is, if you have 10, 20, or 30 years till you need this money — you should wish and pray and hope that these markets go down,” Orman told Yahoo Finance in February. “These are the best things that could possibly happen to you if you are dollar-cost averaging, which means you take a specific amount of money every single month and you invest it.”

Pro Tip

Read the specifications of your employer’s retirement match agreement carefully to make sure you’re getting the most out of your contributions.

Employer match

If you contribute to an employer-sponsored 401(k), you’re already doing a form of dollar-cost averaging, even if you didn’t realize it. 

Instead of worrying about manually moving money from one account to another, you can set a fixed contribution to be automatically deducted from your paycheck each month and not have to even think about it. 

Plus, many employers match your investments up to a certain percentage, so it’s always a good idea to contribute at least what gets matched. Employer match on a 401(k) is a great way to save for retirement and maximize what you’re socking away each month. Also, you’ll be leaving dollars on the table if you don’t use your employer match. 

Bottom Line

Investing for retirement is a long game. Make sure you have a clear retirement plan, and contribute however you can in a way that makes the most sense for your finances. It’s never too early to start considering your retirement, and there can be ways to save even if you’re facing financial challenges, like debt