How to Maximize Periodic Contributions
Not everyone can set aside huge sums from every paycheck for a retirement fund. For many, it’s essential that they have access to their money now to make ends meet. If you’re one of those individuals, it’s still vital to consider periodic contributions to your retirement.
Periodic contributions are a smart, predictable way to keep up with your retirement savings without overcommitting yourself. For those with strict or unpredictable cash flows, periodic payments into a retirement fund are a great way to stay focused on the future without burdening yourself right now.
What Are Periodic Contributions?
Periodic contributions are scheduled investments. They take place at the same time every month for the same amount. If you have an employer-sponsored 401(k), for example, you’re likely on a periodic investment schedule. The same amount of money comes out of each paycheck and goes right into your 401(k) before you even know it’s missing. This is the appeal.
When you don’t need to worry about when and how much to invest, you can let the market work for you. This is great for individuals who may not have large sums to invest and so may need to be more conservative with their investments as a result.
What Is a Periodic Payment Plan?
Periodic payment plans are typically mutual funds. They allow investors to accumulate shares over time through consistent contributions of smaller, fixed sums. They come with a set time horizon and monthly contribution thresholds. For example, XYZ Fund may require $100 per month for 15 years. Investors can follow this plan to automate their investment savings. The fund manager does the rest to ensure they achieve maximum ROI.
It’s important to note that periodic payment plans are an indirect form of investment. You’re not actually purchasing shares of the mutual fund. Because the invested amount is too low to purchase direct shares, the periodic payment plan acts as a trust. It allows investors access to an investment vehicle they might not otherwise be able to fund.
Modest Investments Still Add Up
Any amount saved and invested helps move the needle toward your retirement goals. Consider the power of investing $100 versus placing it in your savings account. Every invested dollar is making money – usually at a faster rate than even low-yield savings accounts compound interest. Your $100 goes a lot further invested than it does sitting in a bank account. And that’s to say nothing of inflation, which actually decreases the value of your static cash over time. Even if it’s only a few dollars at a time or periodic investments, in the long run, investing modestly always trumps not investing at all.
To see the power of compound interest at work, check out our compound interest calculator. You’ll see exactly how small, periodic contributions can add up to a big return on investment (ROI). Even a few dollars matter when they’re consistent.
The Purpose of Periodic Investments
Whether through a periodic payment plan or scheduled contributions of your own design, periodic payments serve the purpose of simplifying investing. They also come with several important benefits, as opposed to lump-sum or discretionary investing. There are three pillar benefits to periodic investments that make them enticing to “hands-off” investors. The purpose of these contributions is…
- To automate investing. If you don’t need to think about your contribution, you’re less likely not to miss it. The physical act of transferring money manually or deciding on securities to invest in can cause anxiety for many investors. Periodic contributions erase this uncertainty and keep investments consistent.
- To safeguard against volatility. Short-term markets are volatile. Prices swing up and down within a given week, which makes them unpredictable. Periodic investors aren’t worried about short-term volatility. Instead, their consistency allows them to focus on macro trends. There’s no need to “time the market” with programmatic contributions.
- To hedge against risk. No matter how the market performs, you’re on the winning side. If it’s a bear market, consistent investment means “buying low.” If the market is bullish, every new investment dollar helps you gain wealth. This best-of-both-worlds outlook mitigates risk for periodic investors.
There’s a strong appeal to periodic investment schedules – especially for new or indecisive investors. The consistency makes it worthwhile, and takes the headaches out of navigating market uncertainties.
A Look at Dollar-Cost Averaging
When talking about periodic contributions, it’s important to discuss dollar-cost averaging. This is the practice of lowering the cost-per-share average of your investments by consistently buying new shares at a lower price.
Thanks to market fluctuations, security prices rise and fall. For periodic investors, their investment intervals and amounts stay the same. This means opportunities to capitalize on dollar-cost averaging. For example, the price of a company might slide over the course of two quarters. If you invest bi-weekly, you’ll be able to continue to buy shares at a lower price. As you do, you’ll bring down your average cost per share.
It’s important to realize that this works in reverse as well. You could end up buying shares at a higher and higher price as the company outperforms the market. In these situations, you’ll continue to reap the benefit of a well-performing company and its ROI.
Create a Schedule for Periodic Contributions
The best way to benefit from periodic contributions is to develop a schedule and stick to it – or stick to the schedule mandated by your periodic payment plan. For example, you might sock money away throughout the month and make a contribution to your retirement fund on the last Friday of the month.
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The bottom line of investing is that beyond how much or how often you invest, being a consistent contributor matters most. The power of compound interest works best if you build your principal over time. Whether it’s $100 every few weeks or $1,000 every couple of months, what matters is that you’re saving regularly.