I often get asked how to invest the down payment for a home purchase.
If you live in a high cost of living city like Los Angeles, San Francisco, or New York, like many of my clients do, then the down payment is often hundreds of thousands of dollars, and it takes more than a few years of savings to accumulate.
Home prices have skyrocketed over the past several years, and even more so during 2020 where buyers got cabin fever during the covid-induced quarantine and bid up home prices more than usual.
A lot of people feel like they are spinning their wheels, as home prices are appreciating faster than they can save for a down payment. Well, that’s not always true, but it often feels like it.
And keeping all this money in cash often means you’re missing out on significant stock market gains as well. The fear of missing out on both housing and stock market gains can be a very painful, and the attraction to invest your down payment in stocks is hard to overcome.
But investing doesn’t come without risk.
If you do choose to invest in stocks, how you invest should depend on your time horizon.
If you’re planning on buying a house in less than two years, the best thing to do with your down payment is absolutely nothing.
You can keep it in cash or a “high-yield” savings account. High yield is in air quotes, because nothing is really high yield anymore.
Most high-yield accounts have a current yield of a laughably low rate of 0.5-0.6%. Plus you pay taxes on them, so after tax it’s more like 0.4%. That’s a whopping $400 on every $100,000 you keep in the account.
Periodically, tax-free Municipal Bonds offer a slightly higher tax-free yield but right now is not one of those times. Currently, high quality (or investment-grade) Municipal Bonds with a two-year maturity offer a 0.3% yield which is probably the lowest yield on record. If interest rates rise, you could lose your principal, something most home buyers want to avoid.
Even Intermediary Municipal Bonds (bonds that mature in 5-7 years) only yield 1%. Using Investment Grade Corporate Bonds can get you a slightly higher yield of 1.7% for shorter term maturities, and 3% for intermediary maturities. But these come with slightly higher risk so you should again exercise caution.
However, if your time horizon is longer than 2 years then things become a little more interesting.
Depending on how long you have to invest, your risk tolerance, and your capacity for risk, you can start investing in stocks and other asset classes like Real Estate Investment Trusts and even Gold.
If your time horizon is open-ended, or around five years, then a portfolio of 50% stocks and 50% bonds might be suitable. And if it’s completely unknown, or definitely greater than five years, then you probably want to consider investing according to your maximum risk tolerance, which could be a globally diversified portfolio of 70-100% stocks.
Every year you want to reassess your time horizon and if you think you’re getting closer to buying a house, you probably want to scale back your risk and exposure to stocks.
This way, you can take some risk if your time horizon warrants it, but you’re also scaling back as your time horizon and risk tolerance shrinks.
Each investor’s situation is unique, and you should discuss with your financial advisor before taking any steps.
Designing custom portfolios for my clients is one of the services I provide, along with detailed financial planning and answering one-off questions such as “how much of a house can I afford?”.
If you want to discuss your portfolio or other questions, feel free to schedule an introductory meeting.