How should I invest monthly deposits so I can save for a home purchase?
I'm looking for the best way to invest my money. I want to create savings for a possible home purchase within the next 2-3 years. If I have $700 to start with and $400 in monthly deposits, what are my options for the best outcome in a 2 year span?
This won't be the answer you are hoping for, but investing is a long-term game. If you think you'll need access to your money within 2-3 years, the "book" says to stick with conservative short-term investments (like a money market fund, short-term bonds, CDs, etc). The reason is, that if you happen to invest in stocks and there is a market downturn, you could temporarily "lose" value in your account. The ideal response would be to not sell and liquidate the account, but to wait for the market to rebound so you can recoup your losses. This happened in 2008 and it took us a few years to get back to even and you may not want to wait an extra few years to purchase that house. So, with that said, it's safer to stick with ultra conservative investments for that time horizon. Unfortunately, CDs and money market funds aren't paying much interest over 2-3 years, but at least you'll know your money is safe. The best thing you can do is save as much as possible and buy a home that is within your means. With no interest, you should have over $15,000 in 3 years.
Another thing to consider is to speak with a mortgage lender to determine what potential first-time homebuyer programs might be available to you (assuming this is your first home). Sometimes, you may be able to receive grants from your state, or you may not be required to put as much down for a down payment when buying your first home. With good credit, one can currently borrow 95% on a conventional mortgage and pay a little extra for mortgage insurance (not saying I recommend to do so, but it's available). The key is to know that you don't necessarily need to put 20% down to purchase a home, even though that would be ideal to do so.
Good luck to you and good job thinking about these things 2-3 years ahead of time.
Joe Allaria, CFP®
Congratulations on starting to save for a home!
I believe it would be best to keep these funds liquid and safe. This will allow you to have the funds available, ready and worth atleast what you saved when you need them. You can look at a money market, savings account or even a CD. Outside of these types of vehicles, I would be concerned with a return of your investment rather than a returns on your investment. This will assure the funds are there when you need them.
Should your time frame substantially change over time, then you may be a in a position to change this strategy but based upon a two year span I believe this would be best.
Good luck with achieving your goal!
With a time frame of 2 to 3 years, your best way to save is in a savings account. Look for accounts that pay the best interest or look for a CD that matches your timeline. Usually, credit unions and online banks tend to pay the most competitive interest rates. I do not recommend investing in the market because if the market dropped, you probably would not have enough time to recover, delaying your goal of buying within 2 to 3 years. Personally, I don't think the potential for gain is worth the risk for loss with a short window of time.
You’re doing the right thing by setting up a scheduled savings plan. However, you have to be careful investing those funds if you need them in such a short time horizon (2 years), especially in risky investments like stocks. Volatility in stock prices is normal, you don’t want to be in a position where your savings are down 10% – 15% (or more) when you need it for your down payment. You can consider less risky investments like bonds, but remember those are not risk free either. If you do invest in bonds, make sure you stick with high quality and short maturity bonds to minimize any loss of your principle. Keeping your money in a money market account is not a bad option either. You won’t get great interest, but you will be protected from loss. Remember, risk and return are related – if you are going for a return greater than cash – you need to be prepared for the extra risk associated with that return.
This is a very good question. For someone trying to save for a home purchase down payment with a very short time horizon, options are limited. We know that there is a potential for downside within the shorter time frames for both stocks and for bonds. Historical data shows this with actual numbers of negative periods over 1, 5, and 10 year periods. To be certain you have the funds you need, it would be prudent for you to use the highest yielding conservative bank or credit union savings vehicle you can find. You may want to consider an online savings vehicle as long as it is FDIC insured. To keep things simple at first, you can set up a mechanism to have automatic savings deducted from your paycheck directly deposited into a separate savings account that you establish at the same bank, so that on or close to the same day your paycheck hits, the deduction for monthly savings is automatically drafted. In this way, you pay yourself first and take a major step in realizing your goal. When the funds in this account reach a certain level, you can move them to a higher yielding account. This could also be done automatically if the link is established in advance. Be careful to keep this separate account as a “hands off” account so that you, in fact, get to purchase that home. This is a very good and simple strategy to make sure that you save for near term goals. You can have several “put and take” accounts for specific purposes. The shorter the time horizon, the more conservative they may be. With longer time horizons, such as college education savings or retirement, then other options for investment become available. The principle of paying yourself first still applies! Good luck!