Ask Money

Frontload 401(k) contributions?

Chris Farrell Dec 3, 2008

Question: I am a married 31-year old. I am a corporate lawyer and my husband is an entrepreneur. I’m in the process of setting my 401(k) contributions for 2009. In the past, I’ve always contributed up to the annual limit (my employer does not match, but it does invest profit-sharing in my 401(k) account) spread out over the course of the year. This year, I’m considering front-loading my contributions so that my annual contribution of $16,500 is taken out of the first 8 or so paychecks of the year.

I’m considering this because (1) I’d like to take advantage of the market’s current low prices; (2) we have enough in liquid assets that I can afford to take home a smaller paycheck for the first three or four months of the year; (3) I’d prefer to make the contribution while my job and income are stable — who knows what could happen as the year progresses?

In addition, about half of my annual contribution will be in the form of a Roth 401(k), rather than a traditional pre-tax 401(k).

Are there any risks with this plan? Should I avoid frontloading my contributions? Emily, San Francisco, CA

Answer: I can’t see anything wrong with what you want to do, but there is a trade-off. If you keep making the same contribution throughout the year, you’re dollar cost averaging. That means you’re putting the same amount of money into your 401(k) on a regular basis. The true advantage of dollar cost averaging isn’t financial, bit psychological. Dollar cost averaging takes emotion –fear, greed, and panic–out of investing.

What you want to do is make a small bet by frontloading your contributions that the market is currently undervalued, and that you’ll come out ahead compared to regular dollar cost averaging. I’m sympathetic to your point of view. If you’re right, and the market does rebound over the course of next year, you’ll come out ahead. If you’re wrong, you’ll be slightly worse off. That’s the risk or trade-off.

There is a wonderful passage in Reminiscences of a Stock Operator written in 1923 by Edwin Lefevre. (It’s a fictionalized biography of Jesse Livermore, the famed 19th century speculator.) Lefevre tells this story: Somebody asked Baron Rothschild, the great merchant banker, wasn’t it difficult to make money on the Bourse (the French stock market)? The Baron replied that, “on the contrary, he thought it was very easy.” “That is because you are so rich,” objected the interviewer. “Not at all,” said the Baron. “I have found an easy way and I stick to it. I simply cannot help making money. I will tell you my secret if you wish. It is this: I never buy at the bottom and I always sell too soon.”

In a sense, whether you frontload your contributions or stick with the normal payment schedule, you’re following Baron Rothschild dictum. Good luck.

There’s a lot happening in the world.  Through it all, Marketplace is here for you. 

You rely on Marketplace to break down the world’s events and tell you how it affects you in a fact-based, approachable way. We rely on your financial support to keep making that possible. 

Your donation today powers the independent journalism that you rely on. For just $5/month, you can help sustain Marketplace so we can keep reporting on the things that matter to you.