Timing of IRA Contributions
asset allocation, market, valuation

With the start of a new calendar year, many investors are considering making 2014 contributions to their individual retirement accounts (IRAs). However, given the recent appreciation of stocks to the perceived point of overvaluation, and poor prospects for bonds in light of an anticipated rise in interest rates, many investors may hesitate to make early contributions. This brings about two questions: What is the historical penalty for such procrastination? What happens if the investor decides to spread the annual contribution over time in the allowable period?

A simplistic answer to the first question is given in an article in The Wall Street Journal:

Contributing $5,500 to an individual retirement account each January, rather than in April of the following year, over 31 years (with an average annual 7% return) could boost the IRA balance by $55,000.

This calculation assumes a constant rate of return on investment in each year, which is unrealistic. In addition, it assumes that the contribution is fixed at a currently allowed maximum amount, even though in recent years the maximum has been revised upwards to approximate inflation (granted, historical maximum contribution was fixed at $2,000 between 1981 and 2001). Also, it does not specify the percentage increase of the terminal balance. Finally, it does not specify the exact nature of the “moderate” portfolio in the IRA.

To provide a more accurate answer to both questions, Alpholio™ conducted a mini study. (Since this post is longer than a usual one, time-pressed or impatient readers may want to skim the charts and navigate right to conclusions at the end of this write-up.)

The Study

To make study results tangible, instead of pure indices, two low-cost, no-transaction-fee investment vehicles with sufficiently long life spans were chosen: the Vanguard 500 Index Fund Investor Shares (VFINX) and Vanguard Total Bond Market Index Fund Investor Shares (VBMFX) mutual funds. The younger of the two, VBMFX, determined the longest feasible study period beginning in January 1987. For both funds, total (i.e. with reinvested distributions) rather than just price returns were used.

Various IRA portfolios, ranging from 100% stocks (all-VFINX), to 60% stocks and 40% bonds (the “standard” portfolio), to 100% bonds (all-VBMFX) were investigated. All portfolios were rebalanced monthly to their nominal asset allocations. Instead of a fixed contribution, a maximum contribution allowed by law in each historical year was assumed. The study did not take into account the higher “catch-up” contributions allowed for older investors, or any withdrawals or mandatory distributions that could trigger taxes or penalties.

The study considered two scenarios. In the lump-sum scenario, the maximum allowable contribution was made in whole at the beginning of a single month ranging from January of the contribution year to the following April (the deadline for making a contribution for the prior calendar year typically falls in mid-April). In the dollar-cost averaging (or “spread”) scenario, the contribution was evenly split and made at the beginning of a number of months starting in January of the contribution year.

The type of scenario determined the terminal year of investment. In the lump-sum scenario, the terminal investment could be made from January 2012 to April 2013 (that is because as of this writing, monthly data through April 2014 are not yet available). To roughly time-align with the lump-sum scenario, the spread investment scenario assumed that the terminal investment would take place in 2012.

For all asset allocations, the penalty was calculated as one minus the ratio of the terminal value of the portfolio with delayed or spread investments to the value of the portfolio when all investments were made as early as possible in January (baseline). For example, if delayed or spread investments resulted in a terminal portfolio value of $93,000 and January lump-sum investments generated $100,000, then the penalty was 1 – 93/100 = 7%.

The Lump-Sum Scenario

As could be expected, due to generally positive returns of stocks and bonds over time, a delayed lump-sum investment carried a penalty. Here is the penalty for a 100% stock and 0% bond (100/0) portfolio:

Lump Sum Penalty for 100 / 0 Portfolio

Generally, the lump-sum penalty had a positive relationship with the investment delay — the longer investor waited, the bigger the shortfall of the terminal value of the portfolio. However, the penalty did not always grow monotonically with the delay, as can be seen by its significant decrease in November and December in the above chart.

This particular case underscores the impact of first years of investing. Here, the almost 22% negative stock market return in October 1987, followed by a negative 8% return in November 1987, caused the penalty to diminish if the investor delayed the contribution toward the end of that year. To further illustrate the importance of early contributions in the IRA life cycle: The $2,000 invested in January 1987 was worth over $27,000, or about 10% of the terminal value portfolio, at the end of 2013.

The trend line in the chart shows that on average a procrastinating investor suffered a penalty of 0.66% of the terminal portfolio value per month of delay, culminating in about 12% of penalty if all investments were made in April of the year following the contribution year.

The more the IRA portfolio tilted towards bonds, the smaller the penalty. Here is a chart for a standard portfolio:

Lump Sum Penalty for 60 / 40 Portfolio

With this asset allocation, the penalty reached just over 10% and accrued at 0.63% per month.

For a 40% stock and 60% bond portfolio, the maximum penalty was just below 10% and grew at an average rate of 0.60% per month:

Lump Sum Penalty for 40 / 60 Portfolio

Finally, for a bond-only portfolio, the penalty peaked at just over 7.5% and increased by 0.52% per month on average:

Lump Sum Penalty for 0 / 100 Portfolio

According to the article:

An analysis of traditional and Roth IRA contributions made by Vanguard Group customers for the 2007 through 2012 tax years showed that, on average, 41% of the dollars contributed to IRAs for any given tax year are invested between January and April of the following year. Half of those dollars are contributed in the first half of April—the final weeks when contributions for the previous year can be made. The study found only 10% of dollars are contributed in January of the corresponding tax year, the earliest month contributions can be made.

This means that the majority of investors pay a significant price for delaying their investments. Granted, many investors may find it hard to come up with a lump sum for the entire contribution each January. Others may want to spread their investment over two or more months to minimize the risk in fluctuating market conditions. Let’s take a look at the effects of the latter scenario next.

The Spread Scenario

For a stock-only portfolio, uniformly dividing the annual contribution carried an average penalty of 0.53% per each additional spread month. When the contribution was dollar-cost averaged over the entire year, the total penalty was just over 5.5%:

Spread Penalty for 100 / 0 Portfolio

For a standard portfolio, the penalty accrued at 0.41% per additional spread month to reach almost 4.5%:

Spread Penalty for 60 / 40 Portfolio

For a more conservative 40% stock and 60% bond portfolio, the penalty increased on average by 0.34% per month and peaked at almost 4%:

Spread Penalty for 40 / 60 Portfolio

Finally, for a bond-only portfolio, the penalty rose by 0.22% per spread month to reach a maximum of just over 2.5%:

Spread Penalty for 0 / 100 Portfolio

The above findings are consistent with those of a Vanguard study on outcomes of lump-sum and dollar-cost averaging of investments. That study used fixed 10-year intervals, sliding by one month in a longer period of 1926 to 2011. It found out that for a standard portfolio, in 67% of cases a lump-sum investment outperformed dollar-cost averaging over the first 12 months of each 10-year interval. The terminal value of the lump-sum portfolio was on average 2.3% higher than that of the dollar-cost averaging portfolio.


Not surprisingly, delaying or spreading IRA contributions within the allowable 16-month window for each contribution year resulted in a penalty of a lower terminal value of the portfolio. The per-month average accrual rate and the magnitude of the penalty depended on asset allocation in the portfolio: The more tilt toward equities, the higher the rate and magnitude. Contributions in early years had a dominant impact on penalty distribution due to compounding of returns.

Clearly, investors pay a substantial price for procrastination in a lump-sum contribution scenario. Therefore, the investment for a given contribution year should generally be made as soon as possible. However, in many cases a full contribution amount may not be available early in the year, the investor may be averse to taking the risk of a lump-sum investment in given market conditions, or may not have a complete view of his/her income and tax situation until later in the contribution time frame. In that case, dollar-cost averaging with smaller sums can help lower the risk of a one-time investment and penalty for a delayed contribution.

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Rebalancing Act
asset allocation, foreign equity, market, mutual fund, valuation

As the end of the year approaches, the investment industry is gearing up for the annual portfolio rebalancing act. An article in InvestmentNews gives the following example:

Still, advisers’ plan to stick to their long-term asset allocation was likely thrown out of whack this year by the divergence of stocks and bonds. For example, a client who started the year with a simple 60/40 portfolio comprised of the $287 billion Vanguard Total Stock Market Fund (VTSMX) and the $247 billion Pimco Total Return Fund (PTTAX), the two largest mutual funds in the world, would now have 66.3% invested in stocks and just 33.7% invested in bonds, pushing beyond the typical 5% leeway most advisers give their asset allocation.

To illustrate the divergence from asset allocation historical averages, here is a chart from a Vanguard blog post:

Mutual Fund and ETF Assets under Management

While the collective allocation of mutual funds and ETFs to equities has recently reached 57%, the biggest divergence from the historical median is in international equities. Allocation to bonds is also relatively high, while the proportion in domestic equities is close to the 20-year median.

The higher allocations to international equities and bonds are at the expense of cash. Assets in money market funds are at a historical minimum of about 18% in the observation period. This has undoubtedly been caused by the low interest rate policy of the Fed, which depressed returns of such funds. The danger is that when interest rates eventually rise, bond prices will suffer:

So in an intermediate-term bond fund, with an average duration of four to five years, the loss would be about 4% to 5%.

This means that it may actually be prudent for an average investor to shorten the duration by moving a part of investment in bonds to money market funds.

Historically, the proportion of international equities in the total equity allocation has been about 19%; currently, it is about 27%. The argument for keeping it high is a relatively low valuation of foreign stocks compared to domestic ones:

Stock Valuation per Market Region

When rebalancing portfolios, it is also important that investors understand the true exposure of their mutual fund holdings to various asset classes. The recurring problem, which Alpholio™ addressed in several prior posts, is that managers in some equity funds (especially value strategies) hold a large percentage of assets in cash. As a result, asset allocation in the overall portfolio can be distorted unbeknownst to the investor.

Alpholio™ provides current information on the exposure of mutual funds to various asset classes. This information is not obtained from the regulatory filings or selective disclosures of fund holdings, which suffer from a number of problems.

In sum, when rebalancing a portfolio either on a fixed schedule or as a result of divergence from prior allocations, investors should take into account a broader market and interest rate context, rather than just follow rigid rules.

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Return of Irrational Exuberance
market, valuation









Tracking Exuberance









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High Stakes in Small Caps
market, valuation








Fund Ticker Technology
Conestoga Small Cap CCASX 41.5%
Brown Capital Management Small Company BCSIX 66.8%
Wasatch Small Cap Growth WAAEX 27.4%
Artisan Small Cap ARTSX 41.2%
Buffalo Small Cap BUFSX 34.1%
Loomis Sayles Small Cap Growth LCGRX 29.0%
Category Average 23.6%




  • A higher rate of organic earnings growth thanks to profit reinvestment


iShares Core S&P Small-Cap IJR 1.24 0.89 0.54
iShares Core S&P 500 IVV 1.29 0.94 0.45


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Cash Cushion in Equity Funds
mutual fund, valuation



The article discusses the following funds with high cash positions:

Name Ticker % of Cash
Pinnacle Value PVFIX 44
Fairholme Allocation FAAFX 14.8
Tweedy, Browne Global Value TBGVX 17
FirstEagle Overseas SGOVX 23.1


  • Inability to find sufficiently undervalued stocks
  • Paramount need for capital preservation in market downturns
  • Global markets currently being fully valued.




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Are Stocks Overvalued?
market, valuation






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