Author Topic: Optimal Investment Strategy While Saving for New Home  (Read 3147 times)

thow

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Optimal Investment Strategy While Saving for New Home
« on: October 28, 2015, 02:21:15 PM »
My wife and I are planning to purchase our first home in 2-3 years and I am wondering about the optimal way to allocate my savings.

Our cash emergency fund is currently sufficient to cover eight months of living expenses if I should lose my job. In my field that is plenty of time to find a new gig. I don't think I need to put any more cash there.

My company does not offer 401(k) matching, but I put 15% of my pre-tax income in there.

The bulk of my savings goes into low cost index funds of the type MMM recommends.

What is the proper allocation of savings between 1) cash, 2) 401(k), 3) index funds?

MVal

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #1 on: October 28, 2015, 02:38:25 PM »
Do you have a Roth IRA? First time homebuyers can use Roth money to purchase a home. I would avoid using ANY 401K money for home buying as you will suffer a 10% penalty, plus pay taxes on the distribution.

nereo

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #2 on: October 28, 2015, 02:39:33 PM »
Hello Thow

There is no 'optimal' way to allocate savings.  There is only "your way," and that depends on your own personal goals, risk tolerance, income, ta liability, astrological sign, favorite ice-cream flavor and opinion of Taylor Swift's singing abilities.

First, I'd encourage you to come up with an Investment Policy Statment (IPS).  That will help you decide where you want to put money, and in what amounds.

Second, I'd ask you how dead-set you are on purchasing a home in this time frame.  If you are fairly certain you want to buy a home in under 3 years, I would start saving all of that money into a simple savings account.  Just to be clear, this is what *I* would do.  The reason I would do this is that it is a very short time frame, and the return on investment isn't nearly as important as having that money there in a down payment when you need it (in other words: you don't want the market to drop 20% a few weeks or months before you are ready to make an offer on a home).
However, if you are flexible on your home purchasing time-line, and it could be anywhere from 2-5+ years, I'd put it all in my index fund.  If the market takes a drop, you have to be ok with delaying your home purchase for a while.  If it goes up (which it tends to do about 70% of years) - hey... you a larger down payment than you need!  Great!

As for investing in general - since you don't have any company matching I'd recommend funding your IRA first (and an HSA if you have one), then your 401(k), and then put the rest into taxable accounts.


thow

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #3 on: October 28, 2015, 04:59:09 PM »
Thanks for the advice guys. To be clear about the first time home buying, are we talking about a Roth IRA or a regular (?) IRA. I understand there is some kind of difference...

BarkyardBQ

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #4 on: October 28, 2015, 05:06:30 PM »
Another perspective...

What is your ability to save the downpayment 6, 8, and 12 months before you buy?

If you invest now in your 401k and other equity investments, could you just stop those investments in the future, save your down payment, buy the house, and then continue investing. This would allow your investments to have longer to grow and your cash to not sit for too long.

MVal

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #5 on: October 29, 2015, 08:34:32 AM »
Thanks for the advice guys. To be clear about the first time home buying, are we talking about a Roth IRA or a regular (?) IRA. I understand there is some kind of difference...

Roth IRA is what you can use for home down payment. Roth IRA - you put money in after tax, so the contributions are all yours to take out anytime you want (although you ideally leave it there to grow). Traditional IRA - you put pre-tax money in, so you reduce your taxable income in the present. If you try to take this out, however, you will have to pay taxes on the distributions, so don't touch this ever unless you're doing a Roth conversion ladder (read more about that on Seattlecyclone's blog!).

Check out Madfientist's website, he has a lot of good information about things like this. www.madfientist.com

nereo

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #6 on: October 29, 2015, 09:27:08 AM »
Thanks for the advice guys. To be clear about the first time home buying, are we talking about a Roth IRA or a regular (?) IRA. I understand there is some kind of difference...

Roth IRA is what you can use for home down payment. Roth IRA - you put money in after tax, so the contributions are all yours to take out anytime you want (although you ideally leave it there to grow).
(snip)

MVal is correct about a ROTH being the correct IRA to fund a downpayment on your first home.  However, I would think long and hard about using your ROTH in this manner.*  The reason is that once you deplete your ROTH for this purpose you loose all of that tax-free growth forever, and you can never refill those buckets again. 

Imagine you've put in $22k in contributions into your ROTH.  If you use that to pay for the down payment on your home that money is now locked into your house.  If you had left it there for 30 years it could have yielded $220k of tax-free money at 8% returns.  instead, it's invested in your home which hopefully keeps up with inflation and you will be taxed on hte proceeds when you sell.

A far better plan (if it is possible for oyu) is to leave your ROTH alone and fund the downpayment with other savings from taxable accounts.

*I'm not saying you should never use a ROTH in this manner - just that you should look for other options before depleting your 'stach of tax-free future money.  If you have other savings or can save more before buying... use those funds.

thow

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #7 on: October 29, 2015, 10:20:44 AM »
Thanks all for the tips and the clarification about the IRA accounts.

I'll start contributing to one of those accounts first rather than my 401k, and will start redirecting more savings into cash in preparation for the down payment.


Radagast

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #8 on: October 29, 2015, 11:43:16 PM »
I have thought about this quite a bit too. We will also probably buy a house in about 5-7 years, which is an odd investment time frame. 2 years, no problem. 20 years, no problem. But 5-10 years is just a weird period. I'm thinking I will invest our taxable account in the most aggressive portfolio that, per backtesting in Portfolio Visualizer, has never had a 10% decline.

LAGuy

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #9 on: October 30, 2015, 09:52:43 AM »
I used the Roth method of saving for a house. You'll see a lot of people saying it's a bad idea, that you should instead max all your retirement savings AND save for your down-payment. I don't think that's realistic for most people. My own mind frame was, "I'll save in this Roth for a house. I have no time frame in mind and I'll only remove the money at that time if it makes since to do so." That way I could invest more aggressively. I withdrew and bought in 2011 here in Los Angeles. So far best investment return I've ever seen. As for the tax benefits of a Roth....a house also receives tax deferred benefits on gains. I just looked at it like moving money from one tax deferred account to another.

LAGuy

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #10 on: October 30, 2015, 09:55:01 AM »
Oh, but keep in mind. If you go the Roth route, the account needs to be open 5 years before you can withdraw your contributions. It sounds like you don't have a Roth yet. So open one this calender year and that will count as year one. Just fund it with a dollar for now if you don't otherwise have funds.

thow

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #11 on: October 30, 2015, 10:37:41 AM »
Gotcha thanks for that pointer about the 5 year. I had learned about the withdrawal pipeline technique before, but forgot about that.

I'll open the account and start putting money in it this year. Should be doing that anyways...

nereo

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Re: Optimal Investment Strategy While Saving for New Home
« Reply #12 on: October 30, 2015, 12:08:42 PM »
Oh, but keep in mind. If you go the Roth route, the account needs to be open 5 years before you can withdraw your contributions. It sounds like you don't have a Roth yet. So open one this calender year and that will count as year one. Just fund it with a dollar for now if you don't otherwise have funds.
Incorrect.  You can withdraw contributions from a ROTH at any time tax free and penalty free (after all, you've already paid taxes on those contributions).  The 5-year time frame is for using the $10k maximum on contributions + earnings for a down-payment on a house or other qualified expense.