When it comes to investing for your future, it's better late than never. And in some cases, for tax purposes, the government is happy to let you put things off.
You still have until Tax Day — April 18 this year — to make contributions to a traditional or Roth individual retirement account for tax year 2022. The same goes for health savings accounts.
If you haven't filed your taxes yet, contributing to a pre-tax account, such as a traditional IRA or an HSA, can lower your taxable income for last year, making such a contribution a popular last-second tax move.
But if you wait until the 11th hour to make your contributions every year, you're sacrificing time that your investments could be growing, which, in turn, could cost you thousands of dollars in returns, says Maria Bruno, head of U.S. wealth planning research at Vanguard.
"It's a timing decision. If you can ... prioritize making that contribution early," she says. "Make it as soon as you can to get that compounding clock started much earlier. Over time, the compounded earnings can be really impactful."
Bruno's logic is straightforward. Each year, you have about a 16-month window to invest in an IRA — from January 1 until Tax Day the following calendar year. By investing at the end of that window instead of the beginning, you forgo 16 months of returns.
In any given year, market indexes could be up or down during that period. But given that stock prices have historically trended upward, losing out on time in the market every year could add up over the course of your life as an investor.
Consider the following calculation, which Bruno shared with a writer for the New York Times. Two investors make a $6,500 contribution to an IRA each year, and each earns an annualized 6% per year on their investments. One investor invests their entire lump sum in January each year. The other invests in April and credits the contribution to the previous calendar year.
After 10 years, the January investor's portfolio would be worth about $6,500 more than the April investor.
After 30 years, the difference is even more stark. The January investor will have amassed about $358,000, compared with about $319,000 for the April investor. The price of procrastination: $39,000.
OK, you may be thinking, but who has $6,500 lying around at the beginning of every year? It's far more likely that you're investing a small amount at regular intervals. If you're doing that, especially in the form of automated contributions to a retirement plan, you're practicing a strategy known as dollar-cost averaging.
For many investors, the strategy kills two birds with one stone. It ensures that they're contributing a percentage of what they earn toward their investments without thinking about it, and it overcomes anxieties about market timing. By investing consistently, regardless of what the market is doing, you ensure that you buy more shares when stock prices are lower and fewer when they're higher.
Plus, you avoid the paralysis that can come with trying to plunk a big chunk of money into the market when things look dicey.
If that's your strategy, either out of necessity or as an emotional hedge, you're likely doing fine, says Bruno. "In most situations, that's going to be better than putting everything in on April 15," she says.
But if you do have the means, investing larger amounts earlier statistically increases your chances of higher returns.
Researchers at Vanguard recently compared both historical and simulated investment results for portfolios that cost-averaged with those that invested a lump sum at the beginning. The results: lump-sum investing outperformed dollar-cost averaging 69% of the time.
Does that mean you should abandon your consistent investing approach altogether? Probably not, says Bruno. But if you come into a chunk of money from an inheritance or a tax refund, you'd be better off investing it as soon as possible rather than investing it gradually or holding it in cash.
"The overarching message is, make sure you're invested and not just putting it into a cash account," Bruno says.
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