We’ve all been told that we should save for retirement. In fact, saving as much as possible from your paycheck is one of the keys to achieving financial independence at a relatively young age, thanks to compounding interest and the ever-increasing stock market.

The two best vehicles for retirement savings are the Individual Retirement Account (IRA) which anyone can open, and the 401(k) or similar employer-sponsored retirement plan. To accumulate wealth and become financially independent in the fastest way possible, you’ll want to max out an IRA as well as your employer-sponsored retirement account if you have one. (And don’t stop there! Break some normal lifestyle changes, and you should be able to save and invest even more!)

While you should max out both retirement accounts, in this post I’ll focus on the 401(k) accounts without loss of generality.

## Strategies for retirement contributions

Most employers offer a program where they will match your retirement contributions up to a certain percentage; if I contribute 5% of my paycheck, my employer will match 5%. At the very least, you should make sure you are meeting any minimum contribution amount required to receive your full employer match, because this is basically free money for you! But you likely can contribute even more. The maximum annual contribution limit is set by the IRS and is currently set at $18,000 for 2017.

So, to contribute the remaining amount, you could use one of these strategies:

- make
**equal contributions**from your paycheck throughout the year (the easiest and most obvious strategy); **“front load” your contributions**in the first part of the year, until you reach the maximum contribution amount.

I first read about the “front loading” strategy over at the Mad Fientist blog. There are many great reasons to use the “front loading” strategy:

- stock prices generally increase over time;
- contributions to a tax-deferred account means you won’t be paying taxes until later in the year (because income from your paycheck will be reduced);
- you will more quickly shield your money from taxes by getting it into your tax-advantaged account sooner;
- if you leave your job part way during the year, you’ll already have gotten closer to reaching your annual contribution limit and therefore will have better utilized your tax-advantaged account for that year.

I was most excited about the prospect that my money could start working for me sooner and capturing stock price increases earlier in the year. But will we really realize more gains with this strategy?

I realize that there are certainly cases where investing at the beginning of the year would be a *bad* idea. One example would be if a recession hit after the midway part of the year. If you already had your maximum contribution invested before that time, you would probably do worse than if you had not invested some of your money until later in the year when stocks were relatively cheap.

With the front loading strategy, it seems a bit like we are trying to time the market, which in general is a bad idea when investing. However, as long as you are investing in **overall market index funds** (mutual funds or exchange-traded funds (ETFs)), all you are really counting on is that overall the market will increase. These days, you can and should invest in the overall stock market using very low cost mutual funds like the Vanguard Total Stock Market Index Fund (VTSAX) or its ETF variant (VTI).

This got me wondering…

## Is front loading really a better strategy?

While we can’t predict the future, we can try to understand the past. So I did some analysis to understand how often you would win by using the front loading strategy compared to the equal contributions strategy. For this analysis, I used historical stock market data from 1978-2016 (1978 was the year when the 401(k) was introduced in the U.S.). I assumed that each year, an amount equal to the 401(k) limit for that year was invested.

In the front loading strategy, 8 equal investments were made (one every two weeks) from the start of the year in order to reach the annual limit. In the equal contribution strategy, equal contributions were made throughout the entire year (26 equal investments in most years) to reach the annual limit.

I used the S&P 500 index as an overall stock market measurement, since we have data on the S&P 500 index all the way back to 1978. I assumed that the retirement contributions were used to invest in shares of this index. I treated each year independent of the other years, and for every year, I computed the value of the total investment at the end of the year for each strategy.

*Figure 1: Yearly relative performance of front loading compared to equal contributions*

Figure 1 shows the yearly relative performance of front loading compared to equal contributions. This was computed as the difference between the final value of the front loading strategy and the equal contribution strategy as percentages of the total amount invested that year. The green bars represent years where the front loading strategy outperformed the equal contribution strategy, and the red bars represent years where the equal contribution strategy outperformed the front loading strategy.

There definitely appears to be more green than red on the graph, indicating that front loading would have been a smart strategy over all of these years. I found it interesting that there was a strong positive front loading performance following both the tech bubble in the early 2000s and following the subprime mortgage crisis in 2008. Also, the only time that equal contributions outperformed front loading for more than 1 year in a row was 2000-2002.

For completeness, I computed the statistical summary of the data from Figure 1 to get some hard numbers.

*Figure 2: Statistical summary of relative performance of front loading compared to equal contributions*

Figure 2 shows a box and whisker plot of the data. The median is shown at the red line, while the inter-quartile range, the range between the first and third quartiles, is shown with the solid blue box (the left edge of the box is the first quartile, i.e., the 25th percentile).

The first quartile sits roughly at 0, meaning that in about 25% of the years since 1978 it would have been better to use the equal contribution strategy compared to 75% of the years where it would have been better to use the front loading strategy. The data suggests that for half of the years since 1978, a front loading strategy would have resulted in gains of between 0% and 6% compared to the equal contribution strategy (and greater than 6% in a quarter of those years).

Please understand that this analysis is based on *historical* data. In no way does this guarantee that the front loading strategy will work next year, the year after, or even that it will ever work again. Consistently predicting the market is in general impossible. Still, I was convinced enough to try it myself.

## Front loading my own contributions

So my wife and I front loaded our contributions in 2016. My employer matches 5%, so I needed to make sure that I was contributing at least 5% during all 26 pay periods in 2016. That total amount is far less than the $18,000 limit, so I front loaded the remaining amount into the first part of the year by reducing my paycheck to near $0. My wife receives an automatic 3% with no matching requirements, so she reduced her paycheck to $0 to front load until she reached the $18,000 limit.

Note that in order to do this, you need to be able to pay the bills during the front loading period. Make sure that you leave enough in each paycheck or have adequate liquid funds to do so.

Now that 2016 is complete, how did we fare (not counting the employee match amounts)?

Strategy | Final Value | Abs. Gain | % Gain | |
---|---|---|---|---|

Both | Equal | $19,411.13 | $1,411.13 | 7.84% |

Rob | Front | $20,776.10 | $2,776.10 | 15.42% |

Leiah | Front | $20,547.63 | $2,547.63 | 14.15% |

Assuming investments in VTSAX, equal contributions throughout the year would have resulted in a final value of $19,411.13.

Using the specifics of my situation, front loading $18,000 resulted in a final value of $20,776.10, an increase of $1,364.97 or 7.58% compared to an equal contribution strategy. Using the specifics of my wife Leiah’s situation, front loading $18,000 resulted in a final value of $20,547.63, an increase of $1,136.50 or 6.31% compared to an equal contribution strategy.

We have set up front loading again for 2017 :-)

Is anyone else out there front loading? Do you have any hard numbers on how well it has worked for you?