Saving & Investing a Mortgage Down Payment?

[Eagle]

Hypothetically speaking if you were to save up 20% to put down on a house you were planning to buy in 5 years what would you invest in?

Would you put it in a CD? Or perhaps a mutual fund? Or perhaps a low cost index fund?

[Petunia 100]

After my divorce, I did not know when I would be buying my next home. So, I took my down payment money and parked it at Vanguard. I went with 70% money market, 15% total stock market, 15% total international market.

My reasoning was that in the event I did not buy another home for a decade, I did not want the money parked 100% in cash for all of that time. If the stock market had tanked when I wanted to buy, making it unattractive to sell the index funds, I still had 70% in cash.

[feh]

Hypothetically speaking if you were to save up 20% to put down on a house you were planning to buy in 5 years what would you invest in?

Would you put it in a CD? Or perhaps a mutual fund? Or perhaps a low cost index fund?

If you're sure of the time frame, I'd say a CD. Maybe a short term bond fund, if the yield is higher.

Equities should be avoided with such a near horizon.

[scfr]

CD(s) ... If I weren't locked in to buying in 5 years I may go for a shorter term (depending on the penalty for early withdrawal on 5-year CDs) in order to give myself some flexibility on the date.

[jIM_Ohio]

Hypothetically speaking if you were to save up 20% to put down on a house you were planning to buy in 5 years what would you invest in?

Would you put it in a CD? Or perhaps a mutual fund? Or perhaps a low cost index fund?

Look at the variables, and decide what you know and what you do not know.

You want to buy a house
You don't know for certain you will (that is a 75%-100% certainty, however in 5 years a lot can change- job, marital status, family, disability...)

You have an idea what the house will cost, but you don't know for certain. You might move to east side of town, you might move to west side. You might buy a farm, you might buy a condo in an urban area. In 5 years even this could change.

You don't know when the transaction will close. For example, do you want to start looking in 5 years, or are you looking now and thinking moving in 3-5 years fits your timeline? Even then, you don't know the exact closing date now. Meaning this is not like saving for college where you know the year you graduate 13 years before you start. The date for buying a house is open ended. You have control over the date maybe 6-9 months before you need most of the money.

What you do know
1) Interest rates then will be different, and a betting man will suggest they will be higher.
2) You want to save money for a large purchase
3) Having easy access to money now is not important, having easy access in 5-9 years is important.

What I would do is create a timeline
1) What is earliest you would buy? Maybe interest rates vs opportunity align in 3 years? 5 years?
2) What is latest you would buy? If you saw bad conditions in 5 years (pricing and interest rates), could you wait 9 years?
3) Attach a cost to #1 #2 -if you buy early $Xk and if you buy late $Yk


I would then outline a plan similar to other responses... for example

If you decided you might buy in 3 years, make sure you save enough to make a decent down payment in 3 years. If you know you could wait 9 years, then add a layer of complexity to plan.

For example first 3 years invest 75% cash and 25% equities, if opportunity does not present itself, shift to 40% equities and 60% cash. Knowing that most new money is going into equities, if you decide the timing is not right, just keep adding cash.

By year 7 you would want 80-90% cash, this means you are rebalancing a 40-60 portfolio to 20-80. You are looking for an opportunity to sell high (so do not buy into a bull market). Meaning with a year like this where S&P 500 is up 8%+, I am NOT buying equities. In a ear like 2011 where S&P was up only 1%, I would be buying equities. By year 9, 95% cash using same logic (only buy equities in a bear market).

Most market cycles are about 18 months (so if you identify a bear, you have a 6-18 month window to buy equities). If you identify a bull market, you are likely parking cash for 12-24 months with new investments.

One other reason for thinking through situation like this, is let's say your planning now is 90% correct, 5 years is the exact time you expect to buy, and you also followed my advice to be 40-60 (40% equities, 60% cash) and the market crashed in year 4 right after you went to 40% equities. You have a buying opportunity in market, and waiting another 2 years for the portfolio to recover is reasonable (meaning because of market, you waited until year 7 to buy house).

If waiting the additional two years sounds like a good idea, it's OK to go 40% equities (the risk you took cost you two years of home ownership).
If waiting causes you stress, then don't follow my advice to be 40% equities.

FYI- 40% equities-60% bonds/Cash is the highest equity percentage where the standard deviation is "almost" less than the annual return (7% return, 7.1% standard deviation- this means 75% of the time this portfolio will return between -.1% and +14.1%). This is a risk I can accept, but I cannot speak for you. Over 7 years likely 5 of the years will fall into this range, and two will be outside this range (75% of time the returns are in the range of 1 standard deviation).

The other math to look at is the value of a higher return...

If the house you want is $200k and you plan to put $50k down, you need to think... if I save 20% for 5 years, will I have $50k.

If you invest $20k and it earns 2%, that is a return of $400. If it returns 7% that is $1400. Over 5 years that is $2000 extra compared to $7000 extra. Is the added risk worth saving less money, or getting a better house?

Only you can answer that question.

[Eagle]

Thanks for the responses guys.

For clarification the reason this is a hypothetical question is a friend asked me this question. We put our money in a mutual fund until we were ready to buy.

We bought our house last year.

[krantcents]

Although I own stocks and mutual funds, I only invest in low cost index (Vanguard) mutual funds. A 5 year horizon for investing is the minimum! I would probably be a little more conservative with money I need in 5 years. I would look for the most consistent performing fund. One example is Vanguard Healthcare Fund (17.29% return since inception). This fund is 30 years old!