IRA Contribution Timing Experiment Rules

The following are the rules for Version 2 of the Annual vs. Monthly IRA Contribution Timing Experiment. These rules are meant to be the guidelines upon which the experiment is run.

The experiment begins on January 1, 2014 and will continue as part of a lasting effort to discover how investment timing affects performance over time.

Annual vs. Monthly IRA Contribution Timing Experiment Rules

  • Simulated Roth IRA accounts will be used for both accounts.
  • The accounts are assumed to have no annual fees, no transaction fees, no commissions, or trading costs.
  • No interest is earned on any cash balance between the time of deposit and the time of trade execution.
  • No selling will take place during the entirety of this experiment. Both accounts will adhere to the “buy and hold” mentality.

Contributions

  • The Annual Contribution IRA will contribute the yearly maximum, per IRS guidelines, on January 1st of each year.
  • During the first year of the experiment, the Monthly Contribution IRA will contribute $1,000 on January 1st.  Contributions occurring during the subsequent months of the first year will be of an equal monthly amount equivalent to the remainder of the contribution maximum. Rounding may occur for simplicity.
  • After the first year, the Monthly Contribution IRA will contribute an equal monthly amount on the 1st of each month. The amount will be based on the annual maximum, per IRS guidelines, divided by 12 months. The first 11 months of contributions during the year may be rounded down for simplicity. The December contribution may include up to an extra dollar of contributions to make up for the rounding.

Investments/Purchases

  • The Annual Contribution IRA will invest the entire contribution by purchasing the fund of choice on the first trading day of the year.
  • The Monthly Contribution IRA will invest the periodic contribution by purchasing the fund of choice on the first trading day of each month.

Fund

  • The fund of choice for this experiment will be the Vanguard Target Retirement 2045 Fund (VTIVX).
  • The investment minimum for this fund is $1,000.
  • All forms of income from dividends and capital gains will be reinvested.
  • Because of the nature of this fund, there are no asset allocation concerns or any need to periodically re-balance.

Reporting

  • An update will be posted on the blog each month to report the changes and summarize the activities that occur in each account.
  • For simplicity, the numbers in the tables will be rounded and formatted to only two decimal places.

IRA Contribution Timing Experiment

How To Save 40% On Netflix

These days, everything is subscription based, as to try to keep customers paying for a product or service as long as possible. It’s a great business model and something that I would try to implement myself if I was trying to sell something. However, for the consumer, subscriptions can be a terrible, terrible thing.

Think about all the things in your life that are subscription based. Some of them necessities like water, gas, electricity, and trash service. Then, we have the luxuries, which unfortunately, a lot of people consider necessities. These include telephone and cell phone service, cable or satellite television, magazines, newspapers, and internet. The list goes on and on.

Those luxuries are killing your paycheck. They add up quickly and unless you take action, they’re not going to go away.

My Netflix Subscription

Don’t get me wrong, it’s completely fine to have a lot of those luxuries. Myself, I have never had cable or satellite television service my entire life (and I probably never will). I think I spend more than enough money for internet service and I can watch everything I need using Netflix. The thing is, I’ve been so busy lately that I haven’t really been using the service very much. Besides the Instant Watch plan, I also had a subscription to the two disc at a time (unlimited) plan.

During the past several months, I started to notice that I was holding onto rental discs for weeks at a time, never having enough time to sit down and watch a movie. I decided that it was a good time to review my use of Netflix, and since I wanted to keep the service, see if there were any other plans that were more appropriate for me.

I logged into my account and looked at the DVD plans. Since I average about two movies a month, I found that the best plan would be the Limited Plan. The plan allows for one disc out at a time, with a limit of two rentals per month. Perfect.

How Much I Saved

I changed my plan toward the end of the month and the changes took effect at the beginning of the next. My monthly bill with Netflix on an Instant Watch and two-disc unlimited plan used to cost me $24.18 per month. Not much, and a much cheaper alternative to cable or satellite. However, taking my usage into consideration and changing my plan to an Instant Watch and one-disc (two rentals per month) at a time plan is now only costing me $14.46 per month.

Yeah, it’s only a difference of $9.72 per month, or $116.64 per year. But you’re looking at it all wrong. This is money and finance we’re talking about, so you need to compare the change using percentages. By changing my plan I am saving 40.20% per month. That’s a significant savings.

What You Should Do

Review the Netflix subscription plan you have.

  • Realistically assess how you use the service in the present.
  • Don’t consider what-if questions. You can easily upgrade later if your usage increases.

Select a new plan.

  • Log into your account and review the current plan options.
  • Choose a better fitting service plan or cancel a plan as appropriate.

Review your payment method.

  • Make sure you are using a secure password.
  • You had better be paying your Netflix bill with a rewards credit card!

Calculate how much you will save.

  • Figure out how much you will be saving each month, and year, in dollars.
  • Calculate how much your savings will be in percent.

Do something awesome with the money.

  • Use the extra money to pay off debt.
  • Or, invest the extra money.

My Romantic Valentines Day Gift

My wife doesn’t know it, but I gave her the most romantic Valentines Day gift.

I put time aside to contribute the annual maximum into each of our non-deductible Traditional IRA’s and converted them into our Roth IRA’s using the backdoor method. I re-balanced our asset allocation across all of our retirement investment accounts, re-calculated and set new percentages for our future contribution allocations in our employer sponsored retirement accounts, and contributed Lunar New Years gift money into our daughter’s 529 Plan.

Yeah that’s right, I’m a romantic. I’m a sexy beast when it comes to financial security.

Backdoor Roth IRA

If you make too much money to contribute directly to a Roth IRA, you can do so indirectly. It’s called the Backdoor Roth IRA method. The easiest, and tax-free, way to do so is when you do not have any money in an existing Traditional IRA. I keep my IRA’s at Vanguard and my Traditional IRA has as a zero balance, but for once a year.

The maximum you can contribute to an IRA this year is $5,500 (those over age 50 qualify for additional catch-up contributions). To get started, you deposit the money into a Traditional IRA. Make sure you buy into a money market fund or use a cash account. You don’t want to earn any interest, dividends, or create any capital gains (if you end up making a few cents, it’s not a big deal). When the money clears, immediately transfer it to the Roth IRA. During the conversion process, the brokerage will ask if you want to withhold taxes. Make sure you choose No.

That’s pretty much it. It’s not complicated at all. In fact, if you have a Vanguard account, they have a selection in the contribution area called “Convert to Roth IRA.” They make it so simple.

Here’s the important part, when tax time comes around, you will get a Form 1099-R showing that you took a distribution. Don’t get scared when you see the box that shows “Taxable Amount $5,500.” I got a little freaked the first time I did a conversion and saw that. When you do your taxes, make sure you do not take a deduction on the Traditional IRA. Most likely, if you’re using the Backdoor Roth IRA method, you can’t take a deduction anyway, but you want to select the option that says you made a Non-Deductible Traditional IRA contribution. If you (or your tax preparer) filled out the forms correctly, you will have no tax liability on the conversion.

Re-Balancing Your Asset Allocation

Although trading in retirement investment accounts (with mutual funds) usually doesn’t incur commissions or trading fees, I try to only re-balance once a year. Studies have actually shown that re-balancing often diminishes returns slightly anyway.

Like I have said before, I think the best decision most investors could make is to invest in an all in one retirement mutual fund. That said, sometimes having employer sponsored retirement accounts can make asset allocation a little tricky. For myself, I have a custom allocation because of the fund choices available in the employer sponsored retirement accounts. My allocation is similar to the Vanguard Target Date Retirement Funds, but includes a small REIT allocation and a slightly lower international fund component.

Asset allocation is a tricky topic, because of the account and fund availability component, so the only advice I’ll give here is to make sure you take the entire situation into account when coming up with your asset allocation. You have to include all of your accounts, and include your spouses accounts as well. If you don’t do that, you risk having duplicate or overweight investments.

Employer Sponsored Retirement Accounts & Future Allocations

Most of us will make most of our investment contributions to an employer sponsored retirement account, like a 401k. It’s a natural effect because of taxes and the benefits of matching programs. If you have a target date fund in your 401k, you’re on easy street. Just set it and forget it. But if you don’t have access to an all in one fund, you have to do a little extra math.

Again, I’m not going to say much in this category because it’s a little complicated. Just keep in mind how much you’re contributing into this kind of account over the course of the year and do the math to keep the allocation in line with the rest of your investments.

529 Plan

I live in California. I keep my daughter’s 529 Plan in Utah. Why? Because it’s the best plan, and far better than the California plan. Remember, with 529 plans, you can use the money and go to school anywhere you want.

Anyways, while she is still too young to spend any of her own money, all of her gift money goes into the 529 account. On her birthday, I give her a gift of money and invest it into the account. I plan on doing so every year until she is 18. However, I do not intend on making regular contributions into the 529 Plan because my retirement is more important and a bigger priority than her education.

Remember, there is no such thing as financial aid for retirement. There are so many ways kids can pay for school. There is no need to struggle to pay for a child’s education, unless you’re fabulously rich, and then become a financial burden on them later. I think it’s quite better to let your children figure out how to pay for school (or just go to an affordable one), as there are so many life lessons to be learned doing things independently (with occasional guidance).

Romance

So do you see the romance so far? You don’t?

First of all, I believe there is nothing more romantic than planning for a long, and financially secure, life together. I think it’s much more romantic to ensure a life without welfare and food stamps than to worry about giving a card that will eventually end up being recycled and flowers that will die in a few days. Second of all, all trades and transactions took place on Valentines Day.

Take notice. The ultimate romantic gesture you can do is to give your significant other financial security for the rest of their lives. It takes year-round planning, not just one Hallmark day of the year.

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