Is this dumb? Please set us straight...

[napali]

My husband and I have saved enough money for a down payment on a house (20%). However, due to logistics, we can't purchase yet until 2-3 years from now.  We also have a 6-month emergency fund.  Both savings are sitting in a savings account right now.

We've been thinking about putting part or most of the funds into VFIIX so it's not just sitting there earning less than 1% in interest.  We're very new to investing so this could be dumb and would like to know if we're off our rockers.

We have no debt if that helps. We max out on our TSP and Roth IRA accounts. We also have some money to invest on taxable accounts and I guess this is one of the first steps we're thinking of doing.

Thanks in advance!

Edited for typos.

[sol]

I think putting your 20% in something like VFIIX is a fine idea, at least in the short term.  It's invested in Ginnie Mae government backed mortgages, so keep in mind that once the Fed starts raising rates in 2014, returns could conceivably start to drop.  I wouldn't worry too much about the refi risk, since rates are already so low. 

It's had pretty consistent returns for over a decade, with very few down months and no down years.  It's not the most exciting of funds, but for a short term cash store it's about the best risk/return balance I would shoot for right now. 

edit:  the other Vfund I use for short term cash storage is VIPSX, which is basically an inflation-protected basket of gov issue securities.  It's had better returns than VFIIX, at the cost of slightly more volatility.  If you're still looking at 2-3 years out, it's probably a better option.

[napali]

Thank you sol!  I agree, it's not the most exciting fund, we're just looking for a place to park it until we're ready.

I also read one of MMM's blog article where he says he doesn't keep much cash on hand for emergency and would use his HELOC if/when needed.  Since we don't have a home yet, I wonder if we should just leave our EF alone or put some of it into VFIIX as well (just thinking out loud here, we're certainly open to suggestions).

[sol]

Since you're a federal employee (based on your mention of the TSP) I would actually suggest you worry less about your emergency fund than most folks.  One of the perks of federal service is that you get good insurance and relatively high job security.  At the very least, you're very unlikely to find yourself suddenly unemployed next month.  If you're term or military near discharge, that changes things.

With that in mind, I think feds with secure jobs are better served by considering their job security as part of their EF, and so devoting a smaller portion of their portfolio to cash stores.  I can make an exception for folks like you who are buying a house soon.

In a similar vein, once you have decided on your risk tolerance, I recommend you move up one bracket on the TSP's Lifecycle funds, if you're using them.  The asset allocations the TSP uses are based on the (mostly) standardized distributions used by the mutual fund market, which are not designed for people with defined-benefit pensions.  If you have a pension coming, it basically replaces a portion of your bond (fixed income) allocation.  As a result, you should be a little heavy on stocks in your TSP compared to non-federal workers with the same time horizon, and the TSP board doesn't account for that in their asset allocation percentages.  This is a matter of personal preference, of course, so don't risk up just because some internet stranger said so.

[Mr Mark]

The old 'Risk vs reward vs time' problem.

You seem to ask for very low risk of loosing a significant part of your capital in 2-3yrs, but (like all of us) want the most return?

The only answers means either:

1/ spreading it around, in risky assets, and you could get  9 -15%++ annual return! But watch out, it could drop 10 = 20% too right when you want it!
- Bonds seem high as interest rates are at long-term historic lows. If interest rates go up (say, to 4 or 5%?) bonds will loose a big % - perhaps up to 20 - 30%. Extrapolating their gains over the past 5 years is flawed, and not historically typical.
- Equities/Stock. Seems temporarily 'over bought', but big corrections perhaps should be small for a few years?Yields on blue chips will match inflation and fees.
- Cash: Inflation easily at 2 or 3% (gas anyone?) and interest rates at 1% = loosing deal upfront.
- Gold?? A bubble if ever there was (IMHO). See greater fool theory.

Or
- Money Market/CDs. At least you'll almost certainly not loose too much.
- I've heard of I Bonds from the US Treasury (anyone know more?), which it seems would give you a pretty secure capital return over 3 yrs with 3%?

Or a mix of the above?

But if you want high returns with no risk to capital, join the queue!!

[judgemebymyusername]

Another +1 for VFIIX and VIPSX here.

That being said, I highly suggest you consider switching some of your funds around between your Roth IRA and taxable investment accounts when you do this. Basically, you want your bond funds to sit in your Roth and your equity funds in your taxable account. You can find more info here http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement

[nondualie]

Kind of depends on your reading of the macros too.  Many (including me) think we are do for another market correction in the wake of QE/Twist ending and the political silly-season upon us...plus gas prices, etc.

There's been some inching upward of the ten-year T-Bill this week; which could portend rising interest rates are coming in the not too distant future...which could hurt your bonds, but would also drop housing prices, so you may end out okay there.

[Mr Mark]

Kind of depends on your reading of the macros too.  Many (including me) think we are do for another market correction in the wake of QE/Twist ending and the political silly-season upon us...plus gas prices, etc.

But that's still a market timing bet. The low of the next correction could be higher than prices now.

For the needs they describe, the safety of intermediate T bills at 3% seems ideal. VFIIX and VIPSX. 20% in S&P500 tho, not a bad addition...

[judgemebymyusername]

VFIIX and VIPSX. 20% in S&P500 tho, not a bad addition...

Why add S&P 500 risk and volatility? The purpose is for an emergency fund and home down payment principal maintenance with a chance for some growth. If they are planning to use the home down payment in 3 years, and put it into a combination of those funds in 2006, they would have lost too much.

[sol]

If they are planning to use the home down payment in 3 years, and put it into a combination of those funds in 2006, they would have lost too much.

Your chart only tracks share prices, not total returns.  If you include the dividends, VFIIX is up about 75% in ten years and only lost about 1% in the 08 crash.  Go check out the vanguard page:

https://personal.vanguard.com/us/funds/snapshot?FundId=0036&FundIntExt=INT

[judgemebymyusername]

If they are planning to use the home down payment in 3 years, and put it into a combination of those funds in 2006, they would have lost too much.

Your chart only tracks share prices, not total returns.  If you include the dividends, VFIIX is up about 75% in ten years and only lost about 1% in the 08 crash.  Go check out the vanguard page:

https://personal.vanguard.com/us/funds/snapshot?FundId=0036&FundIntExt=INT

I agree with using VFIIX and VIPSX. Including stocks such as 20% S&P 500 as mentioned by another poster is not wise, which is why I included a graph. Here's a chart of total returns of VFIIX, VIPSX, and S&P 500 over a roughly 3 year period which an initial investment of $10k in each.

[napali]

Thank you everyone, for all your input and suggestions.  We're going to go ahead and open a Vanguard account. 

B - thank you for the link.  That was very helpful.

[Mr Mark]

I like the time period chosen! A different 3 yr sample could offer alternative outcomes. Maybe it's market timing, but I'd still prefer the 20% stock, with annual rebalancing.

[judgemebymyusername]

I like the time period chosen! A different 3 yr sample could offer alternative outcomes. Maybe it's market timing, but I'd still prefer the 20% stock, with annual rebalancing.

The time period was chosen intentionally to show what can happen. One should plan for the worst and hope for the best. An emergency fund is not something that should be subject to loss. Why do you recommend adding stock to such a short time horizon? Do you have any supporting research or evidence? IMO it's unnecessary risk.

[sol]

Why do you recommend adding stock to such a short time horizon? Do you have any supporting research or evidence? IMO it's unnecessary risk.

The usual rationale is that you put the majority of your cash reserve in something like a fixed income bond fund or CDs, and then you put a minority into equities such that the maximum expected loss (say 50%) would take you back to zero when added to the small positive return of the CDs.  This effectively changes the risk spread by combining a +2% majority with a (+-50%) minority to get a combined return of between zero and +4% or so.

It's not a grand idea, but I know folks who do it.  They figure if the downside risk is still no net loss, then they are willing to take a shot at higher returns.

[Mr Mark]

Sol,

Exactly. 

Over 3 years, intermediate duration bonds are not risk free if interest rates and/or inflation rise. Trends based on recent (10yr) bond history are biased, as interest rates have done nothing over that time but fall to historic lows.  [and I was not refering to the EF, just the deposit]

By adding a dose of equities, yes, the volatility goes up, but it increases upside too. Plus, the housing market could recover significantly over the 3 yrs, eroding their 20% deposit target, and some equity could offset some of that risk.

[zoltani]

Since this thread was pretty heavy on the VFIIX discussion I didn't want to start a new topic.

Why has VFIIX been tanking lately? 
Is it at its lowest since early 2011.

[tooqk4u22]

Since this thread was pretty heavy on the VFIIX discussion I didn't want to start a new topic.

Why has VFIIX been tanking lately? 
Is it at its lowest since early 2011.

I don't know if I would call a 1% drop "tanking" but the reason why it has declined is due to the rotation out of bonds into equities and more specifically the yield on the 10US Treasury has increased from 1.70 ish to 2.00 ish in the last month - i.e. the risk free rate (benchmark) increased and therefore everything else adjusts accordingly. 

[KingCoin]

Taking some extra risk in equities isn't a bad idea IMO for a few reasons.
1) If you already have the 20%, you're going to have 2-3 years of time to save up an additional 'stache, mitigating your draw down risk.
2) The purchase of a house isn't some sort of fixed, cliff vesting liability. You can always rent for an additional couple years, or buy a smaller house if need be.
3) Housing prices will likely be somewhat correlated to equities, so if markets go like gangbusters the next couple years, housing prices could well be higher. I wouldn't go as far as calling equities a hedge to a future home purchase, but they may be a bellwether.

[COguy]

On Ibonds:  I use them almost exclusively to store my house down payment. 

http://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm

They will give you some base yield (0% right now) plus the CPI recalculated every 6 months.  So, you are basically guaranteed to match inflation (before taxes).  They are exempt from state tax and federal tax is only due at the time of sale.  Right now, in my opinion, it is a better deal than any other cash/money market/bond out there if you don't mind the hassle of opening a treasury direct account.

But, you cannot redeem in the first year and you lose 3 months interest if you sell in the first 5 years.  There is also a $10,000/year purchase limit. 

Basically, pretty good for storing a down payment for 1 year to 5+ years.  You can also use them to fill in your TIPS allocation (if you have one) since most TIPS are auctioning at negative real yields right now.