Where should I invest for the short term?
I currently have $40,000 in my savings account and $12,000 in student loans outstanding, which is my only debt. I plan to purchase my first home in two or three years. For the time being, what is your short term financial recommendation? Do I pay off my student loans in full? Should I continue to increase my savings for a down payment? Should I purchase a short term money market account or CD?
Nice work. Sounds like you are moving in the right direction.
I would agree with Dominique that (with current rates) you’ll getter a better return by paying off the student loans vs. putting the money in a money market account. However, buying a home you are going to live in is often a very good investment over the long run. You may want to prioritize that, especially if the student loan rates are low. Make sure you have ample savings for the down payment and any unexpected costs that could arise (having to replace the water heater, fixing the plumbing, etc.) I would also suggest having at least 6-12 months in emergency savings in case you lose your source of income. And don’t forget about closing costs, costs to furnish the home, moving. etc.
However, I would caution you on buying if you aren’t sure you plan to stay in the home for at least 10 years. There are some very good calculators you can find online where you can compare renting vs. buying. Here is one for example: http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html?_r=0
As far as where to put your savings, it sounds like you have the right idea. 2-3 years is not enough time to take on risk to gain a better return on your portfolio, so I would agree that a money market fund, savings account, or ultra-short term high quality bond fund is best. You can find the best savings account rates on bankrate.com: http://www.bankrate.com/funnel/savings/
Great question. Congratulations on the killer savings account!
With being so close to being debt free, I would highly consider that option. The advantages are:
-you will be debt free! No more debt payments, that pretty much speaks for itself;
-even with $28,000 in the bank left (in addition to your ability to save), you will have enough for a decent down payment (e.g. 10%). Even if you decided to buy a home today, you could afford a nice home with your current savings;
-although some consider student loans as "good debt", the loans still accrue interest and interest paid is not interest earned. Even if you are debt-free for the next 3 years while saving for your home, you can find a mortgage company to underwrite your loan without a credit score.
Money market accounts are paying little interest currently and that interest income is taxable. Also, it is likely that your student loan interest rate is much higher than any interest bearing savings account. So pay yourself by eliminating those loans.
Good luck and I hope this helps!
Thank you for this question.
I can see where you might be torn about paying off the student loan versus saving more toward your goal of a down payment on your first home.
In most cases, I would lean toward paying off the student loan. First, you most likely are paying a greater interest rate on the student loan than you could get in a savings account, money market or a short-term CD. A dollar saved is a dollar earned. By paying off the loan you will be able to have greater focus on your first home down payment savings goal. There will be no more distraction of payments to the student loan. Eliminating debt can also make people feel more empowered and confident.
As for an investment choice, in saving toward your home down payment goal and an anticipated use as early as 2 years out, I would suggest utilizing a capital preservation investment that has the highest possible interest rate while maintaining liquidity. An FDIC money market that pays 1% or more would be a good alternative in today's environment. FDIC money market accounts paying more than 1% can be found on line through bankrate.com.
Personally, I am a big fan of getting debt obligations satisfied quickly. Not knowing details of your finances, it is hard to answer, but I will try my best.
Do you have surplus cash flow now? Have you reviewed your household budget to try to make adjustments to increase your surplus? How long did it take you to build your savings to $40,000? Do you know how much you will need for a down payment and safety cushion?
Assuming you have surplus cash flow, I would recommend accelerating loan payments, rather than taking money out of savings. This will benefit you in 2 ways. First, you will reduce your debt. Next, you are demonstrating to a potential home lender that you are disciplined. If your surplus will allow you to satisfy the debt before you buy your home, that would be great. So, if you set a target of satisfying the debt in 12 months, increase your loan payment by $1,000 monthly. Keep in mind you are actually "paying" yourself the rate of interest by paying down the debt instead of paying interest to the lender. If your cash flow is sufficient, use anything over your increased debt payment to save toward your new home. Keep in mind it is very important you have a safety net saved that will not be used for the down payment.
Regarding where to put the $40,000, find a safe liquid savings vehicle. The rate of interest probably will not make a big difference for such a short term. If the rate of return is 1%, that will come out to approximately $40 a year in interest. Better than nothing, but not significant. Hope this helps!