Financial Planning: How To Save For A Home Through Investment

What is the best strategy when saving for a house 1, 3 or 5 years in the future? This article examines different potential investment baskets.

Saving for a home is a major goal for most people. When the time comes to sign papers, you need to have a big bundle of money ready to be forked over. Furthermore, there are strong secondary reasons to have that bundle be as big as possible (besides having more money, that is.)

For example, if you want a big house, but can't afford to put up 20% down, you may be required to take on additional insurance. This is solely for the benefit of the lender, but it may cost you thousands per year as long as you've got less than 20% equity in the house.

Then there's the obvious reason of having to take on a smaller loan. The more you put down up front, the smaller your monthly payments and the more you can sock away into retirement savings, college funds, charity or whatever you decide on.

With this in mind, it may be tempting to go for something with good growth potential. Why let tens of thousands of dollars rot away in a checking account for years as you accumulate money, when you could have it work hard for you in an aggressive stock fund that may bring in 10, 15 or even 20% return every year?

Not so fast. There are no free lunches in the market; anything with big potential upside comes with a big potential downside. How would you handle a sudden 30% drop in your down payment in the last few months before you're planning to make the leap? And it may sting even more having to sell at a loss if you knew that your investments were likely to bounce right back later in the year.

So, what it boils down to is striking a balance between the amount of risk you're willing to accept and the length of time you'll be saving for. In other words, if you're planning to buy your house in a matter of months, your primary concern is keeping your assets safe and liquid - such as a money market fund, or perhaps even the ol' checking account.

With a longer time span, the options are considerably broader. Let's look at a couple of possible investment baskets for different time horizons. If you plan to buy your house...

In 1 year:

Keep the money nice and safe. Put 50% in a money market fund and 50% in a 12-month Certificate of Deposit (CD). Any additions thereafter go into the money market fund. The return won't take your breath away, but you'll at least eke out a few percent - and you'll need the extra dollars to pay for all the inexplicable fees your lender will spring at you for no particular reason besides the fact that they can.

In 3 years:

While the primary focus is still on preserving capital, you can take a smidgeon more risk. Put 30% in a money market fund, 40% in a 3-year CD and 30% in a short-term, high quality bond fund. Any additions thereafter can be either put into the money market fund or, if you get it in lump sums, buy short-term CDs that align with the planned buy date (i.e. if you're 2 years out and get a chunk of extra money, you buy a 2-year CD, if you're 1 year out you buy a 1-year CD and so on.) As for bond funds, look for quality (treasuries and the like) rather than eye-popping returns. In this case, greed is your enemy.

In 5 years:

With this long time span you can afford to take on a little more risk to goose up the returns. Put 20% in a money market fund, 20% in CDs, 40% in quality bonds and 20% in a value stock fund. Don't try individual stock picking - go with a big, reputable mutual fund that plays it safe. Small upstarts with gunslinger managers may be more inclined take on risk in an effort to beef up returns - which could backfire in a major way.

These are some basic suggestions. Obviously, you should do a reality check before actually investing a single cent. Is the stock market overvalued? It may be better to go easy on the stock fund and put more into bonds. The Fed is telegraphing several rate hikes in the year to come? Cut back on bonds and increase the CD holdings.

Furthermore, you should adjust your holdings as you get closer to the purchase date. If your stock portion is in the hole a year out, make an assessment whether you think the market is rebounding or if you're better off cutting your losses now. If the former, stay put and sell after the rebound. If the latter, sell now and park the money in a money market fund.

Last but not least, keep a close watch on the expenses, as these can siphon out a lot over the years. Good luck!

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