How Investing Contribution Frequency Affects ROI
Some people choose to set up a defined retirement contribution schedule. Others prefer the flexibility of occasional investments. Some investors take the middle ground and make lump sum contributions. It begs the question: does investing contribution frequency affect ROI?
It does, and it’s important to understand how (and why). While there’s no real wrong answer for how often you should save, investors need to remain cognizant of how compounding periods and investment frequency work in tandem with each other. It’s about exercising control over your investments in the smartest possible way. For some, this means investing less more often. For others, it means investing more with less frequency.
Here’s a look at the role of contribution frequency on investment growth. Keep in mind that any figures or examples are in a vacuum, and don’t necessarily account for dividends, taxes and other variables outside of surface costs and rates.
Does Contribution Frequency Matter?
To answer this question, we encourage you to check out our investment calculator. It allows you to adjust contribution rate and frequency, to see the impact on ROI with all other variables remaining static. Below is an example. Assume the following variables remain static:
- Starting amount of $10,000
- 8% rate of return
- 30-year time horizon
Using these variables, let’s examine the effect of contribution frequency using the same amount of money relative to the contribution interval:
- $100 donated weekly amounts to $760,223
- $200 donated bi-weekly amounts to $758,693
- $450 donated monthly amounts to $780,009
- $2,600 donated semi-annually amounts to $723,979
- $5,200 donated annually amounts to $689,700
While these figures are all relatively in the same range (minus annual contributions), it’s clear there’s an ideal time to invest: monthly. Why? There are a few reasons.
First, monthly contributions help investors avoid market volatility that can occur over the course of a week or two. Investing monthly means playing on macro trends. Second, larger amounts compound quicker, which allows investors to reap additional ROI from larger investments. Finally, monthly investments combine the best of both worlds: dollar cost averaging and lump sum investment.
Dollar Cost Averaging
If you’re a regular investor, you have the opportunity to dollar cost average. This involves purchasing shares of a company at a lower price than the aggregate average of all shares held, so as to bring down that average. For example, if you buy shares of XYZ Company at $10, $8 and $6, your average cost per share is $8.
Investing in more frequent intervals allows you to capitalize on short-term price fluctuations. So, while the macro trend line of a security may trend up, you’ll have the opportunity to buy when it dips. The lower the aggregate average share price, the higher your ROI potential over time.
Lump Sum Investing
Lump sum investing is sporadic one-time investments of larger sums. You get a work bonus of $2,500 and decide to invest the full amount, for example. The lump sum gives you buying power and kickstarts the compounding process. For example, you can by 100 shares of a company valued at $25/share. A periodic investor might find themselves limited by lower buying power and thus, they’ll have a smaller amount to compound.
Unfortunately, because it’s a one-time investment, you’re not benefitting from regular contributions. Likewise, it’s a static point in your investment timeline, which means there’s no opportunity to average down. If you bought shares at a premium and the price falls, you’re not able to buy in the dip. Or, if you are, it’s not typically with the same buying power as your lump-sum investment.
Consider Contribution Limits
As you consider how often to invest, pay attention to the contribution limits of your investment vehicles. In 2021, that’s $6,000 for IRAs and $19,500 for an employer-sponsored 401(k). These are important numbers because they can help you plan a contribution strategy.
For example, if you want to invest monthly in your Roth IRA, you can plan to invest $500 each month to meet the $6,000 cap. It’s easy to plan for this amount and make a one-time contribution at the end of the month.
Pay Attention to Fees
The other factor to consider as you map out contribution frequency are fees. While many brokerages now offer zero-fee transactions, there are other fees to consider. Account maintenance fees, margin calls, cash sweep balances and more all demand a certain amount of money on-hand in your account. It’s important to plan your investment schedule around these figures, to keep your account in good standing and to avoid penalties.
It’s also a smart idea to keep track of investment vehicle-specific fees. How much does your ETF charge in management fees? What’s the minimum required monthly contribution for your periodic payment plan to a mutual fund? Keep these costs top-of-mind as you choose your investment schedule.
Is There a “Best” Contribution Schedule?
The true answer to this question is “whenever you can spare it.” While a lump sum monthly contribution investment will yield the best rate of return over a longer time horizon, it’s not always feasible for every investor. Moreover, contribution amounts can change if you’re a periodic investor. The best contribution schedule is the one you can maintain.
And this is why it’s important to do your research and advance your investment knowledge. Sign up for the Investment U e-letter below to stay ahead of the trends latest market movement.
Investing contribution frequency does have an impact on total ROI. The good news is, the difference tends to be negligible between weekly and bi-weekly investments. The sweet spot is lump sum monthly investments, which gives you the power of a lump sum and the benefits of dollar cost averaging. Keep that in mind as you decide how and when to invest.