Buying time with a balance transfer
In the previous post last week I explained why lump-sum investing makes much more sense than dollar cost averaging (DCA) for the long-term investor. Studies have statistically shown that it is to your advantage to put your money to work as soon as possible because time is your greatest ally when saving for retirement.
At the end of the post I made mention that we, like many other new investors, are unable to immediately invest the maximum allowed into an IRA at the beginning of each calendar year because we lack sufficient available capital to do so. We are then forced to DCA throughout the year to max out our Roth IRA accounts.
Knowing that it is to our advantage to put money to work as soon as possible we’ve been looking into possibly utilizing a no-fee 0% balance transfer offer(s) to max out our Roth IRA accounts on the first day of January and then pay down the debt throughout the year. Essentially, we would be making our regular monthly contributions as planned, but the difference being that the full amount is already being put to work while we are making our regular payments to the credit card company instead of Vanguard.
With greater reward comes greater risk and this strategy certainly introduces some additional risk that must not be taken lightly.
As with all balance transfers, if a monthly payment is late then the interest rate will default to some ridiculous level thus defeating the purpose of this strategy. It would be absolutely critical that at least the minimal payment be paid on time each month. We would need to balance transfer $8,000 to max out both Roth IRA accounts, so a typical minimal payment would be up to $160 (usually 2% of the balance). In addition, we would have to pay off this balance within a 12 month period, so we need to average around $667 a month – any month we delay paying this full amount would mean additional hardship later on down the road.
Toward the end of 2005 we’ll be evaluating our situation and will then decide at that time whether we are comfortable in using this strategy for the coming year.
At the end of the post I made mention that we, like many other new investors, are unable to immediately invest the maximum allowed into an IRA at the beginning of each calendar year because we lack sufficient available capital to do so. We are then forced to DCA throughout the year to max out our Roth IRA accounts.
Knowing that it is to our advantage to put money to work as soon as possible we’ve been looking into possibly utilizing a no-fee 0% balance transfer offer(s) to max out our Roth IRA accounts on the first day of January and then pay down the debt throughout the year. Essentially, we would be making our regular monthly contributions as planned, but the difference being that the full amount is already being put to work while we are making our regular payments to the credit card company instead of Vanguard.
With greater reward comes greater risk and this strategy certainly introduces some additional risk that must not be taken lightly.
As with all balance transfers, if a monthly payment is late then the interest rate will default to some ridiculous level thus defeating the purpose of this strategy. It would be absolutely critical that at least the minimal payment be paid on time each month. We would need to balance transfer $8,000 to max out both Roth IRA accounts, so a typical minimal payment would be up to $160 (usually 2% of the balance). In addition, we would have to pay off this balance within a 12 month period, so we need to average around $667 a month – any month we delay paying this full amount would mean additional hardship later on down the road.
Toward the end of 2005 we’ll be evaluating our situation and will then decide at that time whether we are comfortable in using this strategy for the coming year.
posted by Brian at
10:59 AM
7 Comments:
I don't like this idea. You are relying on the fact that you will be able to pay off that amount in the time limit of the balance transfer promo period. What happens if you have a significant life event and are unable to pay off that credit card debt? You'll be left with $8,000 on a credit card charging you a high interest rate, and the money will be stuck in an IRA that has penalties of withdraw before a certain age.
So, basically you'll be stuck with a huge debt and when next year rolls around you'll spend all your time paying off the debt and not putting anything into your IRA. Much safter to go for the monthly contributions.
By
Anonymous, at 10/03/2005 2:48 PM
I agree – there is certainly risk involved with this approach.
In our situation, with both my wife and I having secure jobs, combine this with the fact that we have some emergency funds to fall back on with a very manageable minimum payment I tend to believe that the instance of us missing a payment due to hardship is highly unlikely.
Thank you for your input.
By
Brian, at 10/03/2005 3:21 PM
I did this sort of thing when I decided I wanted to max out my 2004 Roth, it was march, and I hadn't put a dime in yet. Of course I was all bummed about loss of DCA until your recent post ;)
I was able to pay down a 1.9% loan for the 3k pretty aggressively and switch to making contributions for 2005. I'm definitely glad I did it, but taking on 3k of "debt", even for a few months JUST after I had cleared all other credit cards was a psychological bummer...even though it was the right thing for me at the time.
Definitely food for thought...
By
Caitlin, at 10/03/2005 6:33 PM
After reading your previous post I thought of this very strategy. I do agree with the comment that there is some risk, however if you have enough emergency money suddenly the risk is not that bad. In reality, I can't max out both my wife's and my roth ira's because my emergency fund is not big enough but I could max one of them out and keep paying my normal monthly contributions on the other. In fact, that is my goal for 2006.
By
Monkey, at 10/04/2005 6:45 AM
You are willing to take out a loan to fund your Roth, but not willing to put some of that emergency fund cash to use to pay down your mortgage? Do you see the inconsistency here? Why would you ever go into debt further to fund your retirement account? I just don't think it's wise. You would be better off using that excess cash to pay that mortgage off early.
Also, since the Roth IRA allows you to withdraw principle at anytime without penalty, why not use this as your emergency fund? If it is truly only for emergencies, why keep that excess cash earning taxable interest when you could be paying off a much larger liability, your mortgage (especially the second one).
I am not scolding you, just challenging you to think outside the box some more. Thanks, Ed.
By
Eddie, at 10/04/2005 8:41 AM
Eddie...we have gone through this before on the emergency savings. I appreciate your comments, but I will not get into this again with you.
You have your opinions on what constitutes an adequate emergency fund, and I have mine. Let's just leave it at that and move forward please.
By
Brian, at 10/04/2005 9:25 AM
Didn't mean to argue, just trying to understand the juxtaposition.
By
Eddie, at 10/04/2005 10:44 AM
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