Investment Options for Earmarked Funds

[SunsetSail]

I would appreciate thoughts and comments on my situation in regard to where to hold cash. I specifically would like to avoid any rent vs. buy discussion as that debate has been address enough in my opinion. The question of where to hold cash has probably been debated enough as well, but I would like thoughts on my specific situation as the answer to that question often starts with ‘it depends’.

DW, my two kids (2 & 4) and I are currently renting. We sold our house last year and originally planned to buy in the area where we currently rent toward the end of this year. We now are considering renting longer (2 years+) given our good rent situation and the high price of houses in our area.

We pay $2,100/month in rent (this is a moderately high cost area of so cal., good schools, safe area, etc.). At current prices we want spend about $500K on a house and we have about $225K set aside to purchase it. The money is currently earning .9% in a fully liquid savings account. My hope is that house prices will continue to drop and the purchase price will be closer to $400K but we aren’t counting on it.

The heart of my question is what to do with the cash. I’ve mentally categorized the general options as follows:

(1) Nothing – leave it where it is now.
(2) Several long term CDs at a low early withdrawal penalty bank (like Ally), currently paying about 2.4% for five years with a two-month interest penalty for early withdrawal.
(3) CA tax-exempt intermediate term muni bond fund yielding about 3.44% with an after-tax equivalent of about 5.6% in my marginal bracket.

Option 1 isn’t really an option compared to Option 2. So it really comes down to the level of risk I’m willing to accept at a given return between 2 and 3. I’m fully aware of the risks involved in holding bonds, especially in this economic environment as well as the financial condition of CA. Normally I wouldn’t have a question about avoiding the risk of Option 3. However, I can’t help but thinking that there generally is an inverse correlation between housing prices and market interest rates. This situation may mitigate some of the interest risk rate risk for Option 3.

What would you do in this situation and what considerations am I missing?

 

[rayvt]

House down payment? Keep is as safe as possible. I would not touch CA munis with a ten foot pole.

Option 2 sounds good to me. Or if you want to be more liquid, a savings account at DiscoverBank or Alliant CU---both pay around 1.15%.

FOr #2, I'd break the money up into several CDs. There is no downside but there may be advantages--like you don't have to break the entire 225K CD.

 

[growing_older]

I realize that's the conventional advice, but if it were me, I would at least question it. If you instead invest the money in some reasonable asset allocation, you will on average have more money than you will with a safe bank account. If something unfavorable happens, you may end up with less money. For short term obligations where you need the entire sum, then losing money is catastrophic and you are willing to sacrifice any chance of higher earnings to guarantee that the money you currently have in hand will still be available when you need it. In this case, you do not seem to need all the money at some near future date. You likely have options to postpone your housing purchase if markets need time to recover, or you might be able to put less money down. It might be worth actually calculating what the possible upside and possible downsides are, in order to make a more informed decision.

 

[steelyman]

You sound as if you wish to be as conservative as possible with this money (just as I would tend to be). A good money market fund might be an option - interest rates aren't going to be hanging around where they are for the next 2+ years, I don't think. If you wanted to hedge your bets, you could split between the CD option and the MMF. I agree with the comment about the CA munis.

 

[LOL!]

House down payment a few years away? Put it in a balanced fund or even an equity fund. 20% down is $100K on a $500K house, so you have double that amount sitting around doing nothing.

How much are you adding to your investments every year? If the stock market drops, you will probably easily stay well above the amount needed for the house down payment.

Before we bought our house, we invested our money mostly in stock mutual funds. When we were ready to buy, we could have just made a 100% down payment, but chose to get mortgage.

Anyways, with a flexible unknown goal set for a few years in the future, I think a CD or safe fund is a ridiculous place to put your money. If the equity market doesn't do well, you simply buy a smaller house or you continue to save for another year. In other words, you can easily afford more risk with this money.

Or just go buy a house next month.

 

[rayvt]

My first thought upon reading: "we want spend about $500K on a house and we have about $225K set aside to purchase it" as that this person is way offbase. Or at least, so far away from conventional thinking that I have a hard time relating. Or that there is some massive big thing that they are not sharing.

You don't need to put 50% down on a house. To me, that's as absurd as waiting until you can buy it for cash.
You only need 20% down--and that's to get the best rates. Realistically you only need 10% down.

So.....they only need $100K for a downpayment and generously $25K for moving-in expenses. Therefore they are planniong to over-invest $100K in the house. That $100K would be put to better use by being invested in stocks, etc.

To my mind, somebody who is so conservative that they insist on putting 50% down is likely to be so safety-minded that they will not feel comfortable with anything more risky than an FDIC insured bank.

OTOH, probably the smartest thing you could do with a house in California is to not buy a house in California.

 

[steelyman]

So.....they only need $100K for a downpayment and generously $25K for moving-in expenses. Therefore they are planniong to over-invest $100K in the house. That $100K would be put to better use by being invested in stocks, etc.

This could be a reasonable compromise, although the original post indicated the desire was to put the full $225K down on the home.

2-1/2 years ago, we all went through nearly a 40% drop in the market, so to me it seems not a good idea to place the whole bucket in any stock funds for a 2-1/2 year time frame. It could happen again. Yes, there's been a steady 2-yr market advance since then, but who's to say that will repeat itself? Keep the money you know you will need in the short term safe.

 

[SunsetSail]

How much are you adding to your investments every year? If the stock market drops, you will probably easily stay well above the amount needed for the house down payment.

We save about $70K/year between tax deferred and non-tax deferred.

It isn't a matter of needing money for a house down payment. We could buy the house we want outright, but that would deplete too much of our investments.

In regards to the other posts about the house payment being too much - we have a < ten year time frame for retirement so the goal is to have a mortgage that we can pay it off in ten years or less without a payment that is out of line with our current rent (after tax).

It probably comes down to whether we want to risk missing an opportunity to get a great deal on a house should it arise in the next few years vs a relatively small return that would allow us to move immediately on a house. However, I'm not convinced by the numbers either way (to the extent these things can be quantified), so I want to know what others would do.

I appreciate the thoughts and opinions so far, thank you.

 

[SunsetSail]

Thanks for the thoughts rayvt.

That $100K would be put to better use by being invested in stocks, etc.

In certain circumstances I would agree with you. However, for us cash flow concerns trump maximization of returns even in the case of tax-subsidized leverage. A lesser down payment would mean a much higher drain on cash.

To my mind, somebody who is so conservative that they insist on putting 50% down is likely to be so safety-minded that they will not feel comfortable with anything more risky than an FDIC insured bank.

If we were so conservative we wouldn't even considered CA munis.

OTOH, probably the smartest thing you could do with a house in California is to not buy a house in California.

Non-financial issues trump in this decision. If not for those, I would probably be packing for Texas.

 

[GregLee]

In regards to the other posts about the house payment being too much - we have a < ten year time frame for retirement so the goal is to have a mortgage that we can pay it off in ten years or less without a payment that is out of line with our current rent (after tax).

Similar to my situation. I put 73% down to get a 10 year mortgage with $1000/month payments, which was about what I had been paying in rent. However, I didn't allow enough for home maintenance, like two termite treatments (one of them cost $5000), so it got a little tough to keep up those mortgage payments.

 

[jayc]

CD's at Penfed as an example. You may be able to find a little higher rates at local credit union. 5 yr only jumps to 2.25%

25K 4 yr CD - 2%
25K 4 yr CD - 2%

Use above for 20% down payment if you buy a house. May need to only cash 1 in early because of your current savings rate. I always leverage R.E. to the max at first then decide later whether to start building equity depending on market conditions.

Start CD ladder with the rest buying 4Yr (or other highest %) every 4 months with 25-30K. You have doubled your return and have approx 50-75K maturing every year. You can also probably reduce your emergency fund a little. IMO. Everyone needs an asset class of CD ladder. One less worry after you fluff the pillow every night.

 

[rayvt]

In regards to the other posts about the house payment being too much - we have a < ten year time frame for retirement so the goal is to have a mortgage that we can pay it off in ten years or less without a payment that is out of line with our current rent (after tax).

Well, now we're back to the "mortage or no mortgage in retirement" question. There are valid arguments on both sides---and these have been hashed out over and over again in numerous threads.
I come down (hard) on the "mortgage" side. We recently refi'ed into a 30 years FRM at 4.00% (no points). Scheduled to finally get paid off when I'm 93. What with inflation and all, the monthly payment in 20-25 years can be paid out of petty-cash.
We could have instead paid it off by taking money out of our "dividend portfolio" of preferred stocks & Dividend Champion stocks. But that portfolio is yielding about 8%. So we couldn't see where that would make sense.
Surprisingly, while I was running the numbers my wife wandered by, took a look at the figures, and said, "You are not going to cash in my dividend stocks to pay off the house, so just forget that idea."

It probably comes down to whether we want to risk missing an opportunity to get a great deal on a house should it arise in the next few years vs a relatively small return that would allow us to move immediately on a house.

One thing I learned when I was heavy into real-estate investing: "The deal of a lifetime comes around about once a month."

However, I'm not convinced by the numbers either way (to the extent these things can be quantified), so I want to know what others would do.

This is mostly a matter of personal preference and emotion, and very minorly an issue of best financial alternatives. After all, you have to live somewhere. So you have to pay for your housing. Either rent to a landlord, or mortgage to a bank, or imputed cost (opportunity cost) of having your cash tied up in the house.

One thing I know from my personal experience with co-workers. We always kept a high mortgage balance and refinanced when rates went down, and invested the money. One of my good friends & co-workers did the opposite. They got a 15 year mortgage, never refi'd because that would extend it, and sunk much of their extra money into extra principal payments. We retired at 58 with a new 80% LTV mortgage. They are still working at 58, but with a paid-off house.

 

[SunsetSail]

rayvt,

I do appreciate the comments. However, I am really just looking to know whether people would keep the money liquid, go for CDs, or go another route like muni bods. I included the other information as background to help give context. I've been through the other parts of my plan and nothing has shifted to make me want to change my plan.

 

[SunsetSail]

CD's at Penfed as an example. You may be able to find a little higher rates at local credit union. 5 yr only jumps to 2.25%

25K 4 yr CD - 2%
25K 4 yr CD - 2%

Use above for 20% down payment if you buy a house. May need to only cash 1 in early because of your current savings rate. I always leverage R.E. to the max at first then decide later whether to start building equity depending on market conditions.

Start CD ladder with the rest buying 4Yr (or other highest %) every 4 months with 25-30K. You have doubled your return and have approx 50-75K maturing every year. You can also probably reduce your emergency fund a little. IMO. Everyone needs an asset class of CD ladder. One less worry after you fluff the pillow every night.

Interesting approach. In essence swapping out some current savings to avoid some or all of the early withdrawal with the same net position. I'll have to think about how that could fit. Thanks.